Why GDP Flatters Finance and Hides Extraction
Cross Posted from Class Unity.
Class Unity: Hello everyone and welcome to another Class Unity event. Today we’re joined by a returning guest, Professor Michael Hudson, as well as Professor Dirk Bezemer. Michael Hudson is a professor of economics at the University of Missouri Kansas City, a researcher at the Levy Economics Institute at Bard College, and the author of many books and papers on political economy, the history of economics, economic history, finance, and imperialism. Dirk Bezemer is a Dutch economist who is professor at the Faculty of Economics and Business at the University of Groningen. His work addresses the financial sector, credit creation, credit cycles, monetary policy, and the cause of economic crisis. In a September 2009 opinion piece in the Financial Times, he wrote that a dozen economists whom he listed had predicted the 2008 financial crisis but were ignored. So both of our guests have written extensively on the role of the financial system in worsening inequality and financial crisis, and we’re talking to them today about their work on finance and the capital gains economy.
Let’s start with one basic question. In your papers you make a distinction between two dynamics in the economy that you say is overlooked by mainstream economists: the distinction between the current production and consumption on the one hand, and finance, insurance, and real estate on the other. So for our viewers at home, can you explain this distinction? Why is it so important for understanding the economy we live in today? Dirk, do you want to start?
Dirk Bezemer: Classic. Thank you. This is important because we live in what you might call the capital gains economy. So we think of capitalism as a system which is motivated by the pursuit of profit, but it might be more appropriate nowadays to characterize it as a system which is motivated by the pursuit of capital gains, also known as asset appreciation. The big gains and the way to get really rich is really to have assets and see them increase in value, and we will come to how that happens and what it needs in the system, and that this is not sort of innate inherent in capitalism as such but it’s really a special feature of capitalism since about the 1980s. But it means that to understand how the system works it’s not enough, or even better not try to understand how profit is formed, but we better understand how the values of assets such as bonds, stocks, and real estate are formed. And that is why we need to make a distinction between those two dynamics.
On the one hand, the GDP, the gross domestic product, which is the sum of all incomes. Incomes are either wages or profits, and that is the focus of conventional economics and properly so in industrial economies. But nowadays we live in financialized economies, including real estate financialized economies, where capital gains and the value of assets, including real estate assets, is really the important dynamic and certainly the way to understand inequality. Let me leave it at that for now.
CU: Sure. Michael, do you want to add to that?
Michael Hudson: Yes. The real key is: what is a product? We’ve spent much of the last few years trying to analyze the national income and product accounts and the GDP, and we realize that what is counted as a large part of GDP and national income and product is not a product at all. It’s a transfer payment. For instance, when Dirk and I were in Washington putting our statistics together, I called the Commerce Department and said I was bewildered. I know that credit card companies make more money from late fees than they do in interest. Well, we could find interest payments in the NIPA accounts. I asked, where are the late fees? And the answer was: I could not have made this up, providing financial services. Well, the theory is that this is a service, and the underlying reaction a century ago against classical political economy and the whole value theory of rent and prices and value, and rent being the excess of market price over value, meant that this rent was unearned income, and it was deemed unearned because it was not involved in creating a product.
When landlords raise the rent, they don’t create a product, they charge more. When monopolies impose monopoly rent, that’s not a product. And when banks charge interest and late fees and provide all of the other management operations they do, much of this is not creating a product. And so what we tried to say was: well, when you’re comparing the product of the United States, European countries, and let’s say China or other countries, and we adjust the—we divide the GDP into what’s really a product and what’s a transfer payment—we have an entirely different picture of the economy. And the anti-classical revolution a century ago basically said there’s no such thing as economic rent, and Milton Friedman says there is no free lunch. Well, what we find is that the whole economy is about getting a free lunch, and that not only is the financial sector playing a rising role in national income and GDP accounts, but its role is not to really increase production because it’s overseen de-industrialization since the 1990s. Its role is to create wealth financially mainly by debt leveraging.
You can look at how 80% of bank lending in the United States, England, and other countries is for real estate, and the effect has been to increase the degree of debt leveraging for real estate, and that increases the prices. And many families, during the runup of housing prices in the early 2000s, made more money on the increasing market price—I won’t say value, but market price—of their homes than they did earning a salary to actually produce goods and services. And so this is why we realized that the aim was to create capital gains. Well, how do you sustain this system? How do you stop it from collapsing like it did in 2008 and 2009? Well, the only way to really keep it going, the Federal Reserve decided, was to follow the zero interest rate policy and just provide enough credit to enable debtors—households, corporations that were taken over, and countries—to keep paying their debts by lending them the money to pay the interest. That’s what Hyman Minsky called the Ponzi stage of the financial cycle.
We looked at the economy basically financially as a Ponzi scheme to keep what seems to be the economy growing, but it’s really keeping the debt overhead solvent. It’s keeping the financial sector solvent. And all of this is counted as increasing GDP and national income when it’s actually creating an economic polarization that concentrates income growth and the wealthiest 1 to 10% of the population. And they don’t make money primarily by increasing production but by transfer payments, by financial engineering, by asset price inflation. And that’s what we’ve been trying to explain: how do we use the statistics to siphon through? And we found a lot of problems with the statistics because they’re made under certain economic assumptions, and the assumptions underlying the GDP and NIPA accounts do not reflect how economies really work.
CU: Dirk, do you have anything to add to that before we move on?
DB: I think we’ve said quite a lot already, just two numbers to maybe drive home what we’re talking about.
In other work that I’ve been doing with Steve Roth, we’ve put together numbers that show the difference between saving and wealth. So the usual conception is that people get rich by saving. People get rich by making a lot of profit, having a nice company, being entrepreneurial or working very hard in any way, have high income and save a lot out of it, and that is how they accumulate wealth. But that’s not how people get rich. People get rich by owning assets and seeing them increase in wealth.
So what we did is we added up the savings in the United States, in aggregate in total from 1960 until 2024, the most recent. So the U.S. statistics are fantastic. It’s the only country in the world for which you can do this. And so, in nominal dollars, not taking account of inflation, everything in nominal dollars, cumulative, so added up year by year, savings increased from 1960 until now from $0.3 trillion to $29 trillion. Okay, $29 trillion was saved. Now what is the wealth that households in the United States have? It is $169 trillion. Okay. So it’s impossible that they got so rich by saving because their wealth is a multiple of all the savings in a country added up over all the decades since 1960. So this shows the end result of what I call the capital gains economy and the end results of the dynamic that Michael just talked about.
MH: Well, one of our charts showed that if you—the capital gains in the economy is larger than the GDP. The annual capital gains is larger than the GDP, to give you a sense of proportion. And it’s very funny, you know, when you think of savings, think about what the Austrians said: that the financial sector and bankers provided creditors a service as part of the production economy. The service was not consuming, by being abstinent, and that led Karl Marx to quip that the bankers, the French bankers, the Rothschilds must be the most abstinent family in Europe, you know, just to give you an idea of that. I mean, it’s not really a financial service that makes these gains.
CU: So, we’re wondering: why is it so hard for mainstream economists to talk about this? And in your papers, you talk about the gap in mainstream economics where finance and rent would go. So, I’m going to quote from your paper, “Finance is Not the Economy.” You say it may seem ironic that Ricardo wrote just when Britain’s economy was strapped by war debts in the wake of the Napoleonic wars that ended in 1815. These taxes raised the cost of living and doing business while draining the economy to pay bond holders. Yet the bank’s parliamentary spokesperson, and indeed lobbyist, Ricardo established a countervailing orthodoxy by claiming that money, credit, and debt did not really matter as far as production, value, and prices were concerned. So to what extent is the relationship that you both describe here between an economist and the government pervasive in the world of economics we see today? Is it possibly an explanation for how we’ve arrived at having economic models that, as you say, also in the same paper, and I’m quoting again, do not include credit, debtor, or the financial sector?
DB: I think there’s two approaches to answering this. The first is, let’s say, political economy, or let’s say a special interest way of looking at it, which is to say that, of course, if the financial sector dominates business schools, etc., this is the kind of—they will create a blind spot for the money they make, and there is something in that, and we can talk more about that.
And the other way to look at it is that, okay, so how is this done? Or also if you don’t buy that, you know, if you say that’s a conspiracy theory, I don’t buy that, then you might dispassionately look at the history of economic thought and say, okay, what are the theories that economists, macroeconomists, have which prevent them from seeing this or which make them argue with this.
In a nutshell, as you just said, those are theories which ground everything in the real sector where all incomes need to be explained by real sector dynamics, so-called fundamentals such as technology, technological improvements, or trade, or such things, and not by financial dynamics. And so if there are exorbitant incomes, this can only be explained because the people making these incomes must be producing a lot.
So famously, Lloyd Blankfein, he was the CEO at Goldman Sachs. After the crisis of 2007 and 2008 he was asked—of course then the exorbitant salaries or incomes of bankers came under scrutiny—and he was asked how could he account for this, and Blankfein said, well, the people at Goldman Sachs must be very productive, and he wasn’t even joking because the only way in conventional economics that people can make so much money is only by being very productive. So there’s much more to say about this, but I’m sure that anybody, you know, any of you who studied a bit of economics recognizes this idea that it’s only possible to make a lot of money if you are very, very productive, at least if markets work well.
And that’s because—and so in closing, literally I also wrote about this in the article that you quoted at the start, at the introduction, and in other papers: literally macroeconomic models, they have the productivity of labor, they have capital in their productive capital, but they do not have the level of debt, or the numbers that I just quoted. How much wealth there is in the economy—these facts do not play a role in macroeconomic models. And that is logical. There’s a consistency within the model which, however, does not really map onto the real world.
CU: Michael, do you have anything to add to that?
MH: The question is: why is what we’re doing different from what economists do? My own background and where I learned my approach was not academically. There was no discussion of finance or money or anything like that. When I took my PhD at NYU, where I learned about finance was working on Wall Street, first for the savings banks for three years, learning about how banks channeled savings into mortgage loans and bid up the price of housing, and mostly at Chase Manhattan Bank, where the bank wanted to know —how much money could Latin American countries, especially Argentina, Brazil and Chile, afford to pay for their dollar debts. And so I had to estimate their export potential, what they needed for imports. I had to make an economic model.
The banks, Chase and other banks, knew that there was a limit on how much debt other foreign countries could pay, and yet, as I think Dirk’s mentioned, it was the financial sector that, a century ago, financed this huge public relations campaign to say debts are not a problem, that debts automatically provide—you know—credit provides the means to be paid. All credit is productive, and creditors wouldn’t make a loan unless they could calculate to repay it. So while academically the banks had financed this public relations campaign through the mass media, and if you read the Wall Street Journal and the papers, debt’s not a problem, the banks knew that there was a problem.
Well as it happened, I focused mainly on Chile, and that led me to study copper prices because Chile’s balance of payments was basically guano and copper. As a result I became a copper price specialist, and I was invited to the New School graduate faculty to teach international economics because two professors were working for the World Bank as consultants and they wanted to get my forecast for copper prices for something the World Bank was doing.
I had never taken a course in international economics. It just wasn’t—it was taught by someone I could tell knew nothing about it. And so I thought, okay, the only thing that’s worth teaching for me is something I don’t know about. So I began to teach international economics, and I developed—I also had been studying. I worked for Gus Kelly, the reprinter of economics classics, of classical economics, and I wanted to teach a course in the history of financial theories.
Well, this was at a time when Bob Heilbroner was department chairman, who wrote a bestseller and was—never really got a PhD but was given a PhD for his book, and he contributed his entire salary to the New School which didn’t have much money. Heilbroner said, you know, why are you talking? He wrote about Adam Smith, what Adam Smith had for breakfast, how he felt later, nothing about Adam Smith’s concept of value, price, and rent.
And when I was focusing on economic rent as part of the economy, that got Heilbroner furious. “You’ve got to leave. You know, Michael Hudson’s just a Wall Street thug. We don’t want Wall Street people. We want an academic,” not, you know—and so I indeed went —that’s when I left to join Herman Kahn at the Hudson Institute and become a futurist.
So the fact is that you can’t—what Dirk and I are talking about, you can’t fit into the curriculum. It is taught at the Levy Institute at Bard College by people like Randy Wray and the modern monetary theorists. We did have a grounding at the University of Missouri Kansas City. I didn’t have to go there. They didn’t have enough money to bring me and some others there, so we—I could stay in New York and it’s now been dispersed. I’m an emeritus there. I’m not teaching actively anymore. I’m essentially talking to groups like yours because you’re the audience for this, not academic students who are—they’re not getting credit for a degree for this.
So we’re maybe—we should call ourselves a new discipline like reality economics or futurism or, you know, what are we going to call what we’re doing?
CU: Well, Michael, you mentioned you learned a lot about the economy by working in finance on Wall Street. So, one of our members asks: even if academic and government economists don’t want to understand these arguments, does Wall Street understand?
MH: Yes. But banks—when I went, I was very lucky. I went to Chase at a time when economic research really did research. Since I left—that was 60 years ago—the economic research department is really research and publications and it’s turned into just sort of, well, like the Wall Street Journal sort of. It’s not really doing research so much but expressing the kind of ideology you’ll get in, say, the Citibank reports that are very ideological. So I don’t think there’s any research that’s being done.
The research that is being done on debt capacity is by the underwriting companies, the financial speculators, who want to say: how much debt, if we take over this company, how much debt can we load it down with? How much can we borrow and then pay ourselves a special dividend and how much can we extract before we leave it as a bankrupt corporate shell? So they’re doing this. They know just exactly what’s happening. Their strategy is to create a post-industrial corporate shell and make a fortune doing it. But that’s not what’s taught.
And in business schools I think that’s probably taught. Well, I don’t want to really teach students: here’s how you can loot a company and make a fortune on it. I’d rather talk about critics saying, look, there must be an alternative to this, instead of going to a business school and saying there really isn’t an alternative and we’re making so much money and when you graduate you’re going to get such a good job loading companies and the economy down with debt.
DB: Yes. Maybe I can follow up on that. Michael and I have been writing several papers together. Clearly we look at the economy in the same way in many respects. But here our ways do part. I’m an academic. So I can testify from firsthand experience that there’s a lot of research going on in academics and also that in the United States, places like the Roosevelt Institute or the New School or the University of Missouri Kansas City, which you mentioned, there are some places where the things that we write and that we publish in the journals that are issued there are actually recognized. And I can also confirm that in Wall Street, in the world of investing, these dynamics are very well understood.
And the academic models which are, by the way, being developed, so-called stock-flow consistent models—so macroeconomic models different from the ones I just referred to—which do track debt and assets and net worth, they are considered heterodox but they are being published and they are being taken very seriously in the world of investment because they’re very helpful in the actual world. So I’m a bit more positive about academia, but then I work in academia.
MH: Well, let’s look at the examples that you just cited, Dirk. The New Schools broke. Stephanie Kelton, who graduated from there in the 1990s, wanted to go there and teach when she left Missouri to come to New York when her husband got a job in Long Island. They didn’t have enough money to hire her. They’re broke. They have no endowment. There’s no big vested financial interest that will endow them because it’s not a message they really want to get out.
The core of the people who were at UMKC, the heterodox group, have all moved, gone back or moved to the Levy Institute, basically. And that is sort of funded by—well, that is sort of broke too because of problems with Levy’s will. So they’re not well funded. And the problem with UMKC students was they couldn’t get very good jobs at the prestige universities because they hadn’t published in the prestige journals.
So, of course, Dirk, you and I are looking for journals that are open to what we’re saying, and we found them. These are not the main prestige journals that get students tenure track jobs at universities in the United States. That is really the problem. So yes, there is an academic opening for it. But we’re here because this is where I think there’s a—this is our audience.
CU: We have another question from the audience. Your papers address the way contemporary measurements of GDP, actually obscure the destructive and parasitic role of a lot of financial activity by counting the sums which subtracts from incomes earned through production and value added as though they were additions to it. Unlike the mainstream view, you distinguish producing and selling commodities for profits, the classical picture of capitalism, from unproductive financial gains which simply distribute wealth through credit and debt creation, which are the current forms of rent extraction.
So first we want to understand the problems with the contemporary ways of measuring GDP, which overlook or even obscure the ways our economy is far less productive than it might appear. What’s wrong here? How did we get here? And what’s the alternative? Practically, do we just need less finance and more production? Theoretically, is PPP the better metric?
DB: So did you say is PPP a better metric?
CU: Right. That’s part of the question: is PPP the better metric?
DB: Okay. I don’t get that. But let me start with the first part. Do we need more production and less finance? Yeah. Literally. I’m not joking again. There was academic research published—listen up Michael—published in a high ranking journal, Journal of Economic Growth, very much mainstream. And this research showed with statistical analysis that the expansion of the financial sector, measured by the amount of credit there is in the economy relative to GDP, the expansion of the financial sector used to correlate positively with GDP growth. And if you do some statistical analysis, then correlation can be interpreted as causation, or you can make a good case that there was causation. More financial services, more banks, more bank branches, more credit, more loans was actually leading to more economic growth, just as Schumpeter theorized a century ago.
But since the 1990s this correlation has fallen to zero and has even turned negative. So for highly developed capitalist economies like the Netherlands and the United States and other countries, it’s negative. Which literally means that you have less economic growth if you have a larger financial sector. So the lesson after the great financial crisis, which of course was the reason for this kind of research, is that we need to shrink the financial sector to support the productive sector.
The funny thing is I have some colleagues, I spoke to some colleagues, who said, yeah, and interesting: in the 1990s I did statistical analysis like this already and I found these puzzling negative correlations. I just put them in a drawer because it couldn’t be true. And of course only after the financial crisis was this publishable. So you know that just shows the way that science works. You know there’s nothing like a conspiracy theory here. This is the way that every community works.
The financial crisis created the openness to admit what heterodox people had been saying for a long time, and it’s still true because since then the financial sector has not shrunk whichever way you measure it, by credit, by debt, by total value of financial assets. It has not shrunk, and so it stands to reason that it’s still harming the productive sector.
And then when we conclude that we need less finance or more production, of course that is not to take, let’s say, a productivist standpoint nowadays with the climate crisis and ecological problems. We might say, well, what kind of production do we need? I mean, dirty production or green production? That is super important but that’s a separate issue from what we’re talking about here. I just want to put that on record as well.
And so is GDP the right measure? No it’s not for the things we want to talk about. But it is still a very helpful measure in many other respects. And PPP—maybe I misunderstood the question, but purchasing power parity means to adjust the GDP to relative prices between countries. That is certainly necessary in international comparisons, but it doesn’t really speak to the issues we are talking about.
CU: Yeah, that helps. Michael, go ahead.
MH: Yeah, the financial sector’s product is debt. Credit on the asset is debt. And a few years ago, the head of Goldman Sachs said that his partners were the most productive workers in the United States. Look at how much money they made. So that’s where you get from all of this.
You know, what’s the solution? Well, how do you—of course it’s more production instead of financialization. How do you do it? Well, the country that solved the problem best is China. What did it do? It kept financialization as a public utility to be used to fund direct new capital formation, not to act independently. And that to me is the only solution, number one: to realize that the existing economy and Trump’s hopes to re-industrialize cannot survive, cannot recover, without wiping out an enormous amount of debt right now.
So much income from not only labor but from corporations and the public—cities and states as well as the government—are paid as debt service that it’s crowded out. It prevents income from being used for industrialization.
And just yesterday the Wall Street Journal and other companies published charts showing America passed the $1 trillion mark in stock buybacks for this year. And there was a long discussion of Intel – that Trump wants to buy into – why has Intel stock gone so far down? Why did the company end up as a failure? It used most of its gains for stock buybacks, not to make the kinds of investments in R&D that Nvidia made. Intel could have been Nvidia, but it didn’t. It said our goal is to make our stockholders rich, not to develop the company long term, because long term we’ll be working for another company. Our time frame is three months to one year, and we can make more money in three months and one year than R&D that’s going to be, you know, for the future. We don’t care about the future. We care about right now. And we can make money by buying stocks and making ourselves wealthy – in stock prices – than we can in investment.
CU: I think this might be a good time to talk about the different forms of debt, different forms of bank lending. In your paper “Finance is Not the Economy,” you break down different categories of bank lending. You say there are non-financial business loans, there are household consumer loans, and loans that fuel household consumption, and there are household mortgages which are loans for people to buy houses. So, Dirk, it seems like these are very, very different forms of lending that have different effects on the economy, both positive and negative. So can you talk about why they’re different?
DB: Yeah sure, thank you.
So when we think about the impact of the financial sector on the economy, and we restrict that to banks for now—of course the financial sector is much bigger, but to keep it simple, for banks, and also for reasons of data because we have data on bank loans for virtually any economy but we don’t have data on stock markets—I mean, most countries have stock markets. We don’t have data for all countries on other things. So if we just look at bank loans and we think through conceptually, we think through what does it do to the economy, then one of my contributions has been, I mean building on other people’s work, to collect data and to do the analysis for different kinds of bank loans.
And if your concern is that financial sector expansion might mostly benefit the rich, those who own assets, by increasing asset prices instead of benefit the economy broadly, both workers and capitalists, by increasing production, wages, and profits, then you want to focus on those loans that don’t support production but that support assets.
And the biggest asset market in every country is the real estate market, way way bigger than stock markets, of course, or bond markets. And since the 1980s we see an explosive growth of real estate loans, not just in the United States, also in other rich countries, and since the 1990s in many emerging economies as well. It’s funny, they’re always called emerging economies, never sinking economies, but of course that’s not what they are always.
And so logically it’s this increase in mortgage loans, and including commercial real estate loans, which has really spurred the real estate market and on the back of it many other financial asset markets, such as securitized loans and so on.
And if you don’t make that distinction you’re puzzled at why there could be such an increase in debt without any increase in GDP, without any increase in incomes. But of course, when I take a mortgage of, let’s say, €500,000—it’s about the average price in my country now—and I spend it on an existing home, by far, most mortgages are spent on existing homes, not to build new homes, all that happens is that a home changes hands and the debt increases by half a million euros and nothing else. End of story. There’s no growth in the GDP. There’s no income. I mean, maybe I want to have a new kitchen, maybe I don’t. Those are all very small additions to actual productive activity relative to the increase in the debt.
And this has been my model to explain why we see such an increase in debt without an increase in activity, and of course why that could actually be bad for the economy because I now have, in my example, half a million in additional debt, and over the next 30 years—this is the typical maturity of mortgage loans in my country—I need to subtract this plus interest, so about three times 500,000, from my income which I can’t spend in the economy. So it is actually bad for economic growth—you know—it’s not rocket science. It’s really simple and it could be explained to people who haven’t studied economics. Actually, it is much harder to explain it to people who have.
MH: I think it’s not simply that there’s no growth resulting from this increase in housing prices and mortgage debt. It’s actually negative growth because when I first bought a home in 1967, the bank’s rule in New York was: you would limit the amount that you would loan to 25% of the borrower’s income and you’d require a 10% down payment.
Well, now the loans have gone up to over 43%—a federally guaranteed 43%—of the borrower’s income. So as you spend more and more of your income, that’s 18 percentage points of your income on mortgage debt service, this income is not available to buy goods and services. It actually crowds out the circular flow between wages and the purchase of the products that labor’s supposed to buy. So it’s a diversion of income from all this.
The classical economists spent a century trying to prevent this situation. They wanted to base the tax system on a land tax. That’s what Adam Smith and the French physiocrats and John Stewart Mill and the first plank of the Communist Manifesto was all about: that rent should become the tax base, not taxing labor’s wages or the profits of capital.
The banks initially didn’t take much of an interest in this Ricardian economics and rent theory in 1815. They wanted free trade. They wanted England to industrialize because it caused more foreign trade and that’s how they made their money in trade financing and then in investment in rent extraction in foreign railroads and canals and infrastructure basically.
But by the end of the 19th century the banks joined with the real estate interests in attacking the whole concept of land taxation. And today what has increased the ability of banks to lend more and more money against real estate is that real estate has been pretty much freed from having to pay federal income tax.
If you look at the NIPA, income tax payments by corporate real estate are just about zero because of what Dirk and I have described: the depreciation write-offs and all of the tax advantages to this. So instead of the classical economic policy of taxing away economic rent to focus the economy on value creation, the value of the cost of production, we have exactly the reverse. You favor the rentier economy. The financial sector—Goldman Sachs—and Warren Buffett has said, you know, that he pays, on all of his financial gains, he pays a lower tax rate than his secretary. Well, that’s a—so the tax system is largely responsible for this and that’s one of the things that would have to be fixed in order to de-financialize the economy and refocus it along production-oriented lines.
CU: One question from the audience about what we can expect in the future. What do you think we might reasonably expect as far as developments on the horizon go in relation to the problems of finance and asset price inflation that you two address in your work? We’d be interested to hear your thoughts about the shorter term and the longer term. Is there anything to mention about the Trump administration’s policies in this connection, specifically with regard to actions or policies that intend to keep asset prices increasing? Is the future of the dollar system or BRICS bound up with those problems?
DB: So if I could start on that, the basic dynamic is that assets which have no supportive role for production are inflated. Of course, real estate does have a supportive role for production to a degree, but the prices of real estate have increased way beyond that. So it’s not possible to rationalize the increase in real estate prices by reference to their importance for the productive structures. And the same is true for stocks and the same is true for many other assets.
This dynamic is that assets which are really divorced from the productive structures, can actually increase much faster than other assets. I mean, if you think about tangible capital assets, it’s not really possible to increase their price so fast. It’s especially financial real estate assets where you can do that, and financial assets can be created at the stroke of a pen or with a keyboard.
And so this dynamic has found a new outlet in crypto. Cryptocurrencies are basically nothing. My students have been pressing me for years to also lecture on crypto when I teach banking and finance, and I’ve always resisted that because I said crypto—you know, crypto is called cryptocurrencies, I said that’s wrong. It’s not a currency. It’s not money. We can talk—there’s always very complicated stories about ledgers and about the ways that it is created in very energy-intensive ways, but it’s got nothing. It’s not of any monetary interest.
However, Trump, by politicizing crypto, is making it politically relevant and is clearly inflating the market again. I mean, I think since 2018, the crypto market has inflated and crashed seven times. So we’re now looking at the eighth time that it is being inflated, probably much more than any time before.
And so this dynamic is just continuing. Also his pressure on the Fed to decrease interest rates, that would of course be a boon to leverage investments. So I see no end to this in the short term.
In the long term, as Michael’s analysis, particularly building on Ricardo, has shown, in the long term this is not a sustainable development. I don’t mean ecologically unsustainable but financially unsustainable, right? So debts that cannot be paid will not be paid, and you can roll them over and you end in a Ponzi scheme. But a Ponzi scheme, there’s one thing certain about a Ponzi scheme, mathematically certain, that it will crash. And so whether it will be a soft landing as they say or a hard crash, nobody can predict. But in the short term it’s worsening, and in the long term, yeah, it will have to come down and it will be very painful.
MH: Well, the only thing that I can add to what Dirk has said is to focus on some of the things that Trump has done to make things much worse besides making a few billion dollars for himself in crypto.
One of his proposals—well, his tariff act and his economic budget deficit act has led people to worry that the economy is going to be inflated over the long term. So despite the fact that Trump is now in a legal fight going on today in the courts to try to gain control of the Federal Reserve Board to lower interest rates, the interest rates he’s talking about are short-term rates, not—and the short-term rates, basically you borrow short-term to make an arbitrage gain by buying long-term assets.
But the long-term rates are going to go up because foreigners are moving very rapidly out of long-term U.S. 10-year bonds and especially the 30-year bonds because they say if America is going down this path, of the Republicans and Trump, we’re going to have a big inflation and that’s going to mean negative interest rates over 10 or 30 years.
So while short-term rates are going down, long-term rates are going up. That’s making it much harder for the average American family in their 20s and 30s to buy homes. And there have been charts on home ownership by 20 year olds, 30 year olds, 40 year olds, 50. And the 20 to 35 year olds have been going down and down and down. They can’t afford it. And the home ownership in the United States has been shrinking relative to absentee ownership. The Census publishes data on this. And there’s—because private families joining the labor force cannot afford to take out mortgage loans with their student debt and the credit card debt and the auto debt and things. This leaves the market open to absentee ownership buying real estate for all cash because that yields more than you can make.
And of course the private capital companies themselves are very highly leveraged, putting as little of their own cash as possible. So you have a debt pyramid financing all cash purchases of real estate to avoid having to pay the high mortgage rates that owner occupants would have to pay.
Well, the other thing that Trump has proposed is to privatize the Federal National Mortgage Authority, Fannie Mae and Freddie Mac. These are the government agencies that have bought mortgages from the commercial banking system, packaged them, and sold them to institutional investors, guaranteeing the payments.
Trump wants to privatize this because he’s talked to his Wall Street donors, and they say, “We can make much more money than the government’s making by compensation for risk,” because the risk is going up now that you’re having default rates and arrears on mortgages and other debts rising. Let’s privatize Fannie Mae. Well, that means that the rates are going to go up even more for mortgages, accelerating the concentration of real estate ownership in the hands of absentee owners for all of this.
And the final point regarding crypto is there are almost weekly exposés of how much money Trump and Melania have made personally by underwriting their own crypto. You issue crypto, and in the first few hours there’s a huge immediate influx by Trump’s supporters and insiders to buy it. The public joins in: “I want to support Trump.” And then the insiders sell, and the public, the supporters of Trump, all lose their value. And Trump says this is a great model for the economy. We can base the whole economy on this.
He wants to begin pushing the banking system to not regulate the crypto trade. If you regulate it, they can’t cheat people. And crime is the most lucrative business for the last 2,000 years, probably. So, if you regulate crime, you’ve crushed the engine of economic growth. I’m exaggerating for effect, but you’ve seen what happened with the crypto fraud already. Everything that Dirk says about his fears about it, I share.
CU: Wow. This seems like a good topic. We should stick to this. I don’t know if I have a question. Dirk, do you want to add anything?
DB: We could, of course, and you know more about conditions in the US and Trump and crypto, the US crypto market, maybe, than I do. For me, it’s really interesting, the theoretical side of this. Crypto is the manifestation of a theoretical tendency.
Michael’s written about this, Bronze Age economics. There’s a lot of scholarship that shows that market economies and capitalism especially—we talk about the difference, but I’m sure you’re aware of it—capitalism has an inherent tendency to instability, and that tendency is located in the financial markets.
Marx thought that the instability of capitalism was downward, that capitalism would collapse. But Minsky, who was a Marxist who studied Marx extensively and who was a student of Schumpeter at Harvard—this is the American economist Hyman Minsky, who worked from the 1950s to the 1990s—Minsky said that the instability of capitalism is upward.
There’s an inherent tendency of capitalism, or what I’ve called debt shift, for liquidity that’s created by debt to shift away from production into non-production, into asset markets. And all that it needs for this to happen is deregulation. Nothing actively needs to happen. It’s already inherent in the capitalist financial system and in the capitalist economy at large.
What we see now, and what we’ve seen over the last 40 years, is that dynamic. We’ve seen it also in the Gilded Age, and then there was a long interregnum of the so-called mixed economy: the depression, World War II, and then the mixed economy model, where the state and regulation—zoning restriction on banks, interest rate caps, and so on—had a much larger role. We didn’t have a financial crisis until the late 1960s again. But actually crisis is the normal stage and instability is the normal state of capitalism, so that’s why it needs to be continually regulated.
So more than crypto. I’m really interested in the mechanisms which are unleashed by deregulation, of which crypto is one of the many, many manifestations, just as the mortgage markets were the last manifestation.
MH: Quite right. What’s really an issue is what is capitalism? Most people think of it as industrial capitalism. That’s what Marx talked about. And Marx actually was an optimist about industrial capitalism. He thought, yes, it would develop into monopolies, but it would develop—this would lead it to develop into socialism. That was his optimistic idea.
He thought as industrial capitalism evolves into socialism, we’re going to get rid of all of the rent-seeking. We’re going to get rid not only of land rent but monopoly rent and banking. In his day, banking really was becoming productive in Germany, where the banking and the government and heavy industry, largely military to be sure, were very different from the English and American banks. They did not press for heavy dividend payouts. There was no thought of stock buybacks to make money. They actually pressed: no, keep reinvesting the money in more and more expansion. That was the German model, and I’ve described all of this in Killing the Host.
If you look at Marx’s optimistic view of industrial capitalism becoming industrial socialism, that’s what China did. And what China did, the socialist movement has dropped. It’s funny: many Marxists and many governments—I won’t name them—call themselves Marxists, but they’ve never read Volume Two and Volume Three of Capital, where Marx describes the kind of financial dynamics that Minsky described and Dirk and I have described.
China solved this by saying, “We’re going to not permit the financial sector to be privatized any more than we want economic rentier income to be privatized.” If there is economic rent, which there’s always going to be—a rent of location making some properties better situated and more desirable than others—then this is going to be the social base. Obviously China has had problems in that area in the last few years, but at least it’s kept the financial and banking sector, money and credit creation and its allocation, in the hands of the People’s Bank of China instead of Goldman Sachs.
CU: We have one question about the word feudalism. In the paper “Finance Is Not the Economy,” you argue an economy based increasingly on rent extraction by the few and debt buildup by the many is in essence the feudal model applied in a sophisticated financial system. I was wondering if we could talk more about the term feudal model. I gather that it is connected to the increase of required overhead for wealth creation and contemporary capitalism. In what other ways do you see the contemporary economy as a feudal system? Michael, do you want to start with that?
MH: Yeah. It’s unfortunate that Daniel Burnfin is not here because he has asked me to write a long paper explaining all this. The term is a little misleading. What I meant by survival of feudalism is: the great fight of industrial capitalism was a progressive revolutionary force. In order to industrialize England, the British economy had to disenfranchise the hereditary landlord landowning class that was extracting land rent.
What motivated Ricardo to write his Chapter Two of Principles of Political Economy was the fight over the Corn Laws in 1815. The landlords wanted to block the free-trade importation of low-priced grain in order to maximize their land rents. Ricardo said, “Let’s look at this.” If England had to become self-sufficient in its grain production, then the price of food was going to go up and up and up as recourse was made to more and more infertile soils.
This was junk economics. Ricardo had no idea of what the chemical fertilizer revolution by Liebig and others was creating. But at least he said that if you leave control of parliament in control of the landlord class, it’s going to keep wanting to increase its land rents, and that is going to raise the price of food and require British industrialists to pay their labor force such high wages that we can’t compete with other countries with lower-cost food, whose labor is much less expensive than that of Britain.
That was what Ricardo meant by his labor theory of value. It was really a classical theory of economic rent. The strategy of industrial capitalism was to cut all of the unnecessary costs of production—to do with Britain’s economy what Dirk and I have been describing as would be an ideal for the Western economies today.
Indeed Britain undertook a 30-year fight from 1815 to the repeal of the Corn Laws in 1846 to prevent the landlord idea of increasing its land rents and gaining at the expense of British industrialization.
Once this idea of economic rent was developed so clearly by Ricardo, it was picked up by John Stuart Mill through his father James Mill largely, and the Ricardian socialists who went much further than Ricardo and said, “Well, actually, not only do we need free trade in grain in order to minimize the cost of living for labor to be competitive internationally,” the labor theory of value, “but we want land to be the tax base,” to essentially free the economy from the legacy of feudalism.
The legacy of feudalism was not only the legacy of warlords gaining the land and imposing ground rent, but also the kings of Europe went deeply into debt to finance their wars against each other. And the problem for the creditors was: how are you going to have the money to pay these debts?
The history of Britain from 1215, with its new laws, blocked the kings from taxing their revenue. Parliament didn’t have the power to prevent kings from taxing foreign trade. So the bankers helped develop trade monopolies whose monopoly rents were dedicated to paying their war debts. The financial sector helped the kings of France, Spain, England, Austria—all develop monopolies whose monopoly rents were dedicated to paying their war debts.
All this was the result of feudalism. The industrialists said we have to wipe away this legacy of feudalism in order to create industrial capitalism. This is different, and we have to end the power not only of the landlord class to raise rents at the expense of the industrial economy, but get rid of the monopolies by taking them into the public domain and making them public utilities.
That’s what I meant by post-feudalism. The failure of this policy, and the untaxation of land, and the deregulation of—the re-privatization of monopoly rents—is what I meant by a return to the same situation that you had in feudalism.
CU: We’re getting to time here, and I want to thank you both for appearing. Before we wrap up, if either of you or both of you have any final thoughts to share with us, feel free.
DB: If there are any billionaires amongst you who want to support useful research, look up my papers and send me an email. Apart from that, thank you so much for your perceptive questions, and I’m sure there are many more waiting. Also feel free to send me an email with those questions or for discussions. Thank you very much for having me.
CU: Yeah, thanks a lot. Michael, anything before we wrap up?
MH: Dirk really said everything that I could say there. The reason we write these papers is we want other people to pick up the ideas and run with it themselves, and that seems to be what motivates your group, and that’s why we’re here, and that’s why we’re so glad to appear before you. I think you’ve asked all the basic questions. You’ve covered the spectrum.
CU: Okay. Thank you so much, both of you. It’s been a great conversation.
DB: Thank you so much. Bye-bye.