The Fourteenth Banker Blog

November 8, 2010

The American Latvia

Filed under: Running Commentary — thefourteenthbanker @ 11:04 AM

These videos are of a speech Michael Hudson made several weeks ago to the American Monetary Institute. It is pretty engrossing. I hope you find time to watch it. Some of his examples are simplified to serve an explanatory purpose. I agree with much of his historical analysis and his description of the current problems of wealth distribution and political power. However, the financial system is complex and not all institutions or transactions are exactly as described in this speech. So let’s not quibble about that.

In the first segment he correctly points out at about the 3:30 mark that banks do not lend for productive purposes (in general). They lend on existing assets and cash flow streams. This is particularly the case with large banks that have much standardization and centralization of functions. As Amar Bhidé states in his book, “The financial system has been giving up, albeit unwittingly, on the decentralization of judgment and responsibility. Case-by-case judgments by many, widely dispersed financiers with the necessary ‘local knowledge’ have been banished to the edges, to activities such as venture capital, which accounts for a useful, but tiny proportion of financing activity.” Without this decentralized judgement and responsibility, banks are simply incapable of providing productive risk capital as Hudson describes. Instead, capital is consistently deployed to increase the values of existing assets, much like Bernanke proposes to do today.

All Tea Party supporters should watch this speech because it explains how America is becoming the new Latvia and how labor (90% of us) is and will continue to pay the freight. The greater public has been co-opted by a blind faith in the Neo-Classical economic paradigm. They believe that their angst, created by flat to decreasing real incomes for those still employed, high unemployment, and extreme volatility in perceived wealth, has been caused essentially by too much regulation and too much government. While I agree that inefficient or ineffective government is a problem, it pales relative to the effects of the power structures dividing up the wealth in a way the average citizen cannot grasp.

Further in the speech, Hudson refers to this increasingly debt based system and how all cash flow streams and assets are ultimately “capitalized”. In other words, debt is issued against them and profits are extracted by those able to do so. Perhaps you have seen this as we have more and more toll roads, red light cameras, and prisons run by private companies for profit. Those who outsource these things see one part of the picture, the part where government outlays are supposedly reduced. They do not see the part of the picture where those assets and cash flow streams are used to move wealth to the top of the social structure. Tea Party favorite Rand Paul unwittingly plays into this with his ideas on privatization. From an interview this weekend comes this quote:

When pressed on “This Week” about which programs the he would cut, Paul declined to identify individual programs. “All across the board,” the senator-elect said.

Amanpour challenged Paul, saying, “But you can’t just keep saying all across the board.” Still, the newly elected senator refused to budge. “No, I can. I’m going to look at every program, every program.” He later continued on the theme: “You need to ask of every program — and we take no program off the table. Can it be downsized? Can it be privatized? Can it be made smaller?”

This things that are privatized will then be leveraged and the profits will be extracted up front. Any change in the cash flow stream will then create future losses on that leverage and those losses will be allocated to taxpayers or the most unwary investors who bought the residuals after all the fees and equity dilutions for management have been stripped.

While John Hussman is writing on a different topic, the Bubble Crash cycle, his points tie in as well. After acknowledging that the markets already rose on the Fed action, Hussman effectively makes it clear that this has little to do with real wealth.

As a result of Bernanke’s actions, investors now own higher priced securities that can be expected to deliver commensurately lower long-term returns, leaving their lifetime “wealth” unaffected, but exposing them to enormous risk of price declines over the intermediate (2-5 year) horizon. This is not a basis on which consumers are likely to shift their spending patterns. What Bernanke doesn’t seem to absorb is that stocks are nothing but a claim on a long-term stream of cash flows that investors expect to be delivered over time. Propping up the price of stocks changes the distribution of long-term investment returns, but it doesn’t materially affect the cash flows. This reckless policy has done nothing but to promote further overvaluation of already overvalued assets. The current Shiller P/E above 22 has historically been associated with subsequent total returns in the S&P 500 of less than 5% annually, on average, over every investment horizon shorter than a decade.

With no permanent effect on wealth, and no ability to materially shift incentives for productive investment, research, development or infrastructure (as fiscal policy might), the economic impact of QE2 is likely to be weak or even counterproductive, because it doesn’t relax any constraints that are binding in the first place. Interest rates are already low. There is already well over a trillion in idle reserves in the banking system. Businesses and consumers, rationally, are trying to reduce their indebtedness rather than expand it, because the basis for their previous borrowing (the expectation of ever rising home prices and the hope of raising return on equity indefinitely through leverage) turned out to be misguided. The Fed can’t fix that, although Bernanke is clearly trying to promote a similarly misguided assessment of consumer “wealth.”

My final point before leaving you to this treasure trove of speechmaking is this. Today we have what we have. We cannot change it overnight. Evolutionary change is our only viable option until more dramatic shifts in our culture enable bolder political action. Right now the regulators are in the process of determining how to implement the provisions of Dodd-Frank. Simon Johnson penned a strong statement. It is essential to win these little battles on the regulatory front.

The Volcker Rule is not a panacea but if designed and implemented appropriately, it would constitute a major step in the right direction.  The effectiveness of our financial regulatory system declined steadily over the past 30 years; it is time to start the long process of rebuilding it.

Rebuilding the financial sector must be done a one step at a time. We must hope to rebuild it before we become the American Latvia and must sacrifice whole segments of our society to feed our parasite.

Please watch Professor Michael Hudson.



  1. Rand Paul does NOT want privitization. I don’t know why the left keeps saying this… ONCE in a public TV show as a pundit a decade ago he mentioned how Chile’s plan, run with individual accounts that can’t be raided, was working well for Chile and would be a better deal. That was when those ideas were the current reform ideas. What he wants now is to gradually lift the retirement age to 70 for those 55 ys old and younger, and maybe have means tested deductibles for medicare. Or I should say those are ideas he proposes, he just wants to fix the system.

    Comment by JKR — November 8, 2010 @ 11:56 AM | Reply

    • Unless the quote is wrong, he is for privatization of some sort. I don’t think the comment was about Social Security. From the context of his remarks I suspect it is just about cutting costs by privatizing various government services. Thanks for the clarification.

      Comment by thefourteenthbanker — November 8, 2010 @ 12:07 PM | Reply

    • Increasing the retirement age does not scare hard working Americans. Rand Paul can have all of ours support there. What scares us all is how is Rand Paul or anyone else going to figure out a way to keep 70 yr olds employed? We have a 17% unemployment rate for young adults in this country today.
      If Rand Paul has no plans of taking on Wall Street then make no mistake the system stays in place. And as long as the system of wealth inequality is in place, nothing changes.
      To bring jobs back to America Rand Paul is going to have to take on Wall Street.

      That’s where the rubber meets the road!

      Comment by Vocalbanker — November 8, 2010 @ 2:44 PM | Reply

      • Keeping employed after 50 is scary all by itself. It makes one very obsequious for the sake of survival. If you are in debt and rent , you may be able to pull the plug and probably should to survive. As Hudson points out, the parasites understand the way to put you in the ass kissing mode is debt. I retired at 68. Two days before I retired the company got notified they would be audited by the IRS. So, they asked me to stay on as a consultant. That carried to 70.

        Fruit Loops like Rand Paul and his father always have faith based ideas just like their opposites. We seem to utterly abhor fact based ideas.

        Given all those aging boomers out there, for some time past, maybe even a decade, we have been an obsequeist workers society.

        Comment by Jerry J — November 9, 2010 @ 1:11 PM

  2. Michael Hudson’s talk was tremendously thought-provoking. Thank you for bringing it to my attention.
    I think it might be of interest to combine what he said with Ilargi: and his quote of Ashvin Pandurangi:

    “The reality is that there is only one way back to a true democratic system now, and this path will require nothing less of us than the courage of our forefathers.”

    Comment by Eric W — November 9, 2010 @ 1:55 AM | Reply

  3. Thanks for the link to Michael Hudson’s lecture. He is largely correct, of course. All though the lecture he kept reminding me of the economist and engineer Gottfried Feder. It was Feder who founded with Anton Drexler the German Workers Party in 1919. Read Feder’s Wiki.

    More seriously. Hudson puts his finger on the parasite as being the employee that controls the organization. After all, the top 5 individuals owning JPM own less than 1/2 percent of the stock. Similarly, the top employees running the state ornanizations of the USSR toppled their system too. Parasites the same, just slightly different arrangements of public ownership of the capital employed. Deposits or otherwise the citizen directly or indirectly owns the capital employed in the bank assets.

    Comment by Jerry J — November 9, 2010 @ 12:59 PM | Reply

  4. […] another, longer talk by Hudson, see this post from The Fourteenth Banker, which includes his full presentation to the American Monetary Institute […]

    Pingback by The currency wars and the demise of the dollar | eats shoots 'n leaves — November 9, 2010 @ 6:17 PM | Reply

  5. Thanks 14th for the post and the video links for Michael Hudson.

    I thought Hudson had Georgist-leanings, so it’s interesting to hear his criticism, that the Georgists much like free-market fundamentalists base their views on the notion of a “barter economy”.

    Comment by tippygolden press — November 11, 2010 @ 1:43 PM | Reply

    • Actually, what Hudson says is:

      (1) the Georgist version of a land tax is a “goofy model”
      (2) in 1926, the Georgists put their efforts into Nazi Germany and pushed for ultra-right wing causes in America

      see: video#5 @ about 06:45

      Comment by tippygolden press — November 11, 2010 @ 6:06 PM | Reply

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