Here’s a good chunk of a speech given by Micheal Hudson, a former Wall Street economist, to the Council of Economic Advisors to the President of Brazil (CDES). Mr. Hudson seems to have a pretty good handle on the insidious repercussions of the financialization of the World Economy where “financial maneuvering and debt leverage play the role that military conquest did in times past. Its aim… to control land, basic infrastructure and the economic surplus – and also to gain control of national savings, commercial banking and central bank policy.”
It’s the best explanation I have yet to read on how the banking and financial elite of Europe and North America have stopped at nothing to extract as much wealth out of the global economic system for themselves at the expense of production and technological innovation which is essential to maintaining a healthy middle class and thus a functional economy.
It is not widely recognized that most commercial bank loans merely attach debt to existing assets (above all, real estate and infrastructure) rather than being invested in creating new means of production, or to employ labor, or even to earn a profit. Banks prefer to lend against assets already in place – real estate, or entire companies. So most bank loans are used to bid up of prices for assets, especially those whose prices are expected to rise by enough to pay the interest on the loan.
The fact that bankers can create interest-bearing debt on computer keyboards with little cost of production poses the question of whether to leave this free lunch (economic rent) in private hands or treat money creation as a public “institutional” good. Classical economists urged that such rent-yielding privileges be regulated to keep prices and incomes in line with necessary costs of production. The surest way to do this was to keep monopolies in the public domain to provide basic services at minimum cost or for free while land taxes and user fees could serve as the main source of public revenue. This principle has been flagrantly violated by the practice of erecting privatized “tollbooths” that extract rent revenue without a corresponding cost of production. This has been done in a way that benefits only a select few.
The unchecked explosion of global credit and debt – and hence, pressure to sell off natural monopolies in the public domain – is largely a result of the credit explosion unleashed after gold convertibility ended in 1971. The ensuing U.S. Treasury-bill standard left foreign central banks with no vehicle in which to hold their international reserves except loans to the U.S. Treasury. This gives the U.S. balance-of-payments deficit a free ride, which translates into a military free ride. After the Korean War forced the dollar into deficit status in 1951, overseas military spending throughout the 1950s and ‘60s equaled the entire U.S. payments deficit. The private sector was almost exactly in balance during these decades, while U.S. “foreign aid” actually generated a balance-of-payments surplus, as a result of aid tied to U.S. exports rather than to the needs of aid-recipient countries.
While other countries running trade and payments deficits must increase their interest rates to stabilize their currencies, the United States has lowered its interest rates. This has increased the “capitalization rate” of its real estate rents and corporate earnings, enabling banks to lend more against higher-priced collateral. Property is worth whatever banks will lend against it, so the U.S. economy has been able to use the dollar standard’s free ride to load itself down with an unprecedented debt overhead – an overhead that traditionally has been suffered only by countries fighting wars abroad or burdened with reparations payments. This is the Treasury-bill standard’s self-destructive blowback.
It is an object lesson for Brazil to avoid. Your nation today is receiving balance-of-payments inflows as foreign banks and investors create credit to lend against your real estate, natural resources and industry. Their aim is to obtain your economic surplus in the form of interest payments and remitted earnings, turning you into a rentier tollbooth economy.
Why would you need these “capital inflows” that extract interest, rents and profits as a return for electronic “keyboard credit” that you can create yourself? In today’s world, no nation needs credit from abroad for domestic-currency spending at home. Brazil should avoid letting foreign creditors capitalize its economic surplus into debt service and other payments.
The way to avoid this fate was outlined from the French Physiocrats and Adam Smith through John Stuart Mill and Progressive Era reformers: by ending the special privileges bequeathed by Europe’s military conquests (privatization of land rent), and by collecting “free lunch” rentier income as the tax base to save it from being privatized and capitalized into bank loans. Taxing land and resource rent lowers the cost of living and doing business not only by removing the tax burden on labor and industry, but by holding down housing and real estate prices, because whatever the tax collector relinquishes is available to be pledged to carry bank loans to bid up property prices.
In the 19th century the American System of political economy was based on the perception that highly paid labor is more productive labor, such that well-educated, well-fed and well-clothed labor undersells “pauper” labor. The key to international competitiveness is thus to raise wages and living standards, not lower them. This is especially the case for Brazil, given its need to raise labor productivity by better education, health and social support systems if it is to thrive in the 21st century. And if it is to raise capital investment and living standards free of debt service and higher housing prices, it needs to prevent the economy’s surplus from being turned into a “free lunch” in the form of land rent, resource rent and monopoly rent – and to save this economic surplus from bankers seeking to capitalize it into debt payments. This is best achieved by taxing away the potential rentier charges that turn the surplus into unnecessary overhead.
But because the wealth of nations is now calculated from the banker’s perspective, surplus income is viewed as potentially available to capitalize into debt service. Rather than using the surplus to invest in capital formation and public infrastructure, the distinguishing characteristic of our time is financialization – the capitalization of the economic surplus (corporate cash flow, real estate rent and other economic rent, and personal income over and above basic living costs) into interest payments for bank loans.
This is the business plan of bank marketing departments and is a far cry from what Adam Smith wrote about in The Wealth of Nations. Loan officers see any net flow of income as potentially available to be pledged as interest payment. Their dream is to see the entire surplus capitalized into debt service to carry loans. Net real estate rent, corporate cash flow (ebitda: earnings before interest, taxes, depreciation and amortization), personal income above basic spending needs, and net government tax revenues can be capitalized into as much as banks will lend. And the more credit they lend, the higher prices are bid up for real estate, stocks and bonds.
So bank lending is applauded for making economies richer, even as families and businesses are loaded down with more and more debt. And the easier debt leveraging becomes, the more asset prices rise. Lower interest rates, lower down payments, more stretched-out amortization periods, and even fraudulent “devil may care” lending thus increase the “capitalization rate” of real estate and business revenue. This is applauded as “wealth creation” – which turns out to be debt-leveraged asset-price inflation and can infect an entire economy.
The limit of this policy is reached when the entire surplus is turned into debt service. At this point the economy is fully financialized. Income spent to pay debts is not available for new investment or consumption spending, so the “real” economy is debt-shackled and must shrink.
The financial takeoff thus ends in a crash. That is what the world is seeing today, at least outside of Brazil and its fellow BRIC countries. For these economies, the question is whether they will follow the same financialization path.
Wyndtunnel 
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