Michael Hudson

How financial oligarchy replaces democracy

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The intellectual deception at work

Financial lobbyists seek to distract voters and policy makers from realizing that “normalcy” cannot be restored without wiping out the debts that have made the economy abnormal. The larger the debt burden grows, the more economy-wide austerity is required to pay debts to banks and bondholders instead of investing in capital formation and real growth.

Austerity makes the problem worse, by intensifying debt deflation. To pretend that austerity helps economies rather than destroys them, bank lobbyists claim that shrinking markets will lower wage rates and “make the economy more competitive” by “squeezing out the fat.” But the actual “fat” is the debt overhead — the interest, amortization, financial fees and penalties built into the cost of doing business, the cost of living and the cost of government.

When difficulty arises in paying debts, the path of least resistance is to provide more credit — to enable debtors to pay. This keeps the system solvent by increasing the debt overhead — seemingly an oxymoron. As financial institutions see the point approaching where debts cannot be paid, they try to get “senior creditors” — the ECB and IMF — to lend governments enough money to pay, and ideally to shift risky debts onto the government (“taxpayers”). This gets them off the books of banks and other large financial institutions that otherwise would have to take losses on Greek government bonds, Irish bank obligations bonds, etc., just as these institutions lost on their holdings of junk mortgages. The banks use the resulting breathing room to try and dump their bond holdings and bad bets on the proverbial “greater fool.”

In the end the debts cannot be paid. For the economy’s high-financial managers the problem is how to postpone defaults for as long as possible — and then to bail out, leaving governments (“taxpayers”) holding the bag, taking over the obligations of insolvent debtors (such as A.I.G. in the United States). But to do this in the face of popular opposition, it is necessary to override democratic politics. So the divestment by erstwhile financial losers requires that economic policy be taken out of the hands of elected government bodies and transferred to those of financial planners. This is how financial oligarchy replaces democracy.

Paying higher interest for higher risk, while protecting banks from losses

The role of the ECB, IMF and other financial oversight agencies has been to make sure that bankers got paid. As the past decade of fiscal laxity and deceptive accounting came to light, bankers and speculators made fortunes jacking up the interest rate that Greece had to pay for its increasing risk of default. To make sure they did not lose, bankers shifted the risk onto the European “troika” empowered to demand payment from Greek taxpayers.

Banks that lent to the public sector (at above-market interest rates reflecting the risk), were to be bailed out at public expense.[2] Demanding that Greece not impose a “haircut” on creditors, the ECB and related EU bureaucracy demanded a better deal for European bondholders than creditors received from the Brady bonds that resolved Latin American and Third World debts in the 1980s. In an interview with the Financial Times, ECB executive board member Lorenzo Bini Smaghi insisted that:

First, the Brady bonds solution was a solution for American banks, which were basically allowed not to ‘mark to market’ the restructured bonds. There was regulatory forbearance, which was possible in the 1980 but would not be possible today.

Second, the Latin American crisis was a foreign debt crisis. The main problem in the Greek crisis is Greece, its banks and its own financial system. Latin America had borrowed in dollars and the lines of credit were mainly with foreigners. Here, a large part of the debt is with Greeks. If Greece defaulted, the Greek banking system would collapse. It would then need a huge recapitalization — but where would the money come from?

Third, after default the Latin American countries still had central banks that could print money to pay for civil servants’ wages, pensions. They did this and created inflation. So they got out [of the crisis] through inflation, depreciation and so forth. In Greece you would not have a central bank that could finance the government, and it would have to partly shut down some of its operations, like the health system.

Bini Smaghi threatened that Europe would destroy the Greek economy if the latter tried to scale back its debts or even stretch out maturities to reflect the ability to pay. Greece’s choice was between submission or anarchy. Restructuring would not benefit “the Greek people. It would entail a major economic, social and even humanitarian disaster, within Europe. Orderly implies things go smoothly, but if you wipe out the banking system, how can it be smooth?” The ECB’s “position [is] based on principle … In the euro area debts have to be repaid and countries have to be solvent. That has to be the principle of a market-based economy.” (Ralph Atkins, “Transcript: Lorenzo Bini Smaghi,” Financial Times, May 27)

A creditor-oriented economy is not really a market-based, of course. The banks destroyed the market by their own central financial planning — using debt leverage to leave Greece with a bare choice: Either it would permit EU officials to come in and carve up its economy, selling its major tourist sites and monopolistic rent-extracting opportunities to foreign creditors in a gigantic national foreclosure movement, or it could bite the bullet and withdraw from the Eurozone. That was the deal Bini Smaghi offered: “if there are sufficient privatizations, and so forth — then the IMF can disburse and the Europeans will do their share. But the key lies in Athens, not elsewhere. The key element for the return of Greece to the market is to stop discussions about restructuring.”

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