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FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

The Financial War Against Iceland Part 2

Politics / Credit Crisis 2009 Apr 11, 2009 - 03:48 PM GMT

By: Global_Research


Diamond Rated - Best Financial Markets Analysis ArticleContinues from Part1 - Nations that have not paid their debts - Let us draw up a roster of nations that have annulled their debts – or run them up with no intention of paying. The list starts with the world’s largest debtor, the United States. Its government owes $4 trillion to foreign central banks. A moment’s thought will show that there is no way it can pay, even if it wanted to do so. The United States is running a chronic trade deficit, on top of which is a deepening outflow of military spending.

In addressing this chronic living beyond the nation’s international financial means, American diplomats are almost the only ones in the world who conduct international diplomacy the way that textbooks assume that all countries should do: They act purely and ruthlessly in their own national interest. This interest lies in getting the proverbial free lunch, by giving IOUs for other countries’ real resources and assets, with no intention or ability to pay.

U.S. officials already have suggested that this debt be wiped out. Their plan would convert it into “paper gold.” Foreign central banks would simply stamp their U.S. Treasury bonds “good only for payment among central banks and the International Monetary Fund.” No other nation would be allowed to wipe out its debts in this way. Only the debtor at the center would be able to continue issuing debt-money without foreign constraint.

To be sure, U.S. diplomats have freed countries from debt when they have a political reason to do so. The most famous modern example of an economy-wide debt cancellation is that of Germany in 1947. The Allies cancelled German personal and business debt, on the ground that most were owed to former Nazis. The only debts left on the books were current wage-debts that employers owed to their work force, and basic working balances for companies and families.

A generation earlier, in 1931, the Allies wiped out Germany’s reparations debt stemming from World War I, and negotiated a moratorium on their arms debts to the United States. The world’s leading governments realized that keeping these debts on the books would collapse the global economy. But by the time they reached this conclusion it already was too late. The combination of Inter-Ally arms debts owed to the United States and the reparations debts imposed by the Allies largely to pay America already was one of the major factors pushing the world into a depression.

The U.S. economy was collapsing under the weight of its domestic debt pyramiding. Other countries had used less debt leveraging, but all ended up writing off large swaths of real estate and business debts during the Depression Years. By the time the Second World War ended in 1945, most countries were free of debt. Prices reflected direct production costs, with minimum diversion of revenue to pay banks, absentee property owners and other rentiers.

In the postwar period the World Bank lent dollars for governments to build infrastructure – only to turn around a generation later and help loot what it had financed. After Mexico and other Latin American governments announced that they were insolvent in 1982, U.S. diplomats organized a debt write-down in the form of “Brady bonds.” By 1990, Argentina and Brazil had to pay 45% on new dollarized foreign debt, and Mexico paid 23%.

Having stuck Third World countries with debts beyond their ability to pay, the IMF and World Bank used their creditor leverage to force governments to impose draconian austerity plans that had the effect of preventing growth toward industrial and agricultural self-sufficiency, thereby also crushing prospects for competitiveness. The IMF and World Bank then demanded that debtor countries sell off their public infrastructure, land, subsoil rights and other assets to pay the debts that these institutions sponsored so irresponsibly. (If IMF loans were not simply irresponsible, then they knowingly crippled debtor-country economies.) It is an age-old story of conquest, now accomplished without conventional warfare.

Two thousand years ago Rome stripped Asia Minor and other provinces and colonies of money using military force. Its financial oligarchy then translated their economic power into political power, destroying democracy and bringing on centuries of Dark Ages. The historical lesson is that economies taken over by creditors are plunged into depression as predatory lending strips away the surplus, leaving nothing remaining for subsistence, let alone capital renewal. This prevents nations from paying their debts, leading to widespread foreclosure, an extreme polarization of property and wealth, and impoverishment of its people. The ensuing lack of prosperity ends up crippling the ability to sustain a military overhead, and such countries tend to be conquered, as the Goths overran Rome. Outsiders always were at the gates – but it was the hollowing out of Rome’s domestic economy that left it prone to conquest.

Most recently, creditor-sponsored dirigiste takeover of national economic and social institutions has turned Russia, the Baltic States and other post-Soviet economies into neoliberal kleptocracies, driving skilled labor abroad in tandem with capital flight. Latvia is being pushed back toward subsistence life on the land. Creditor mismanagement is the most important problem that any country today should strive to avert.

Creditors play the terrorism card

9/11 signaled the beginning of a new power grab in the United States and Britain. U.K. officials have used anti-terrorist legislation to seize Icelandic assets abroad. What makes this so ironic is that throughout history it has been creditors who have used violence against debtors, not the other way around. I know of only one exception, and it did not involve bloodshed: Jesus overthrew the tables of the moneychangers in Jerusalem’s temple. It is the only record of a violent act in his life.

Psychologists have explained the creditor proclivity for violence by the tendency for rentiers to fight for unearned income – inheritance, or other “free wealth” that they have obtained without effort of their own. People who work for a living and are able to support themselves believe that they can survive, and so there is less of the kind of panic that creditors and other free lunchers feel at the thought that their extractive revenue may end. They fight passionately against the prospect of having to live on what they produce or earn by their own merits. So the last thing that rentiers really want is a free market. In a shameless irony, they tend to accuse populations of being terrorists if they seek to defend themselves against predatory creditors and land-grabbers!

Describing creditor violence, Plutarch describes how Sparta’s king Agis IV and his successor Cleomenes III sought to cancel the debts late in the 3rd century BC. The city-state’s creditors murdered Agis, drove Cleomenes to suicide in exile, and killed Sparta’s next leader, Nabis – and then called in Rome to fight against pro-debtor democracies throughout Greece. Livy and other Roman historians describe how a century later, in 133 BC, the Roman Senate responded to the Gracchi Brothers attempt at debt and land reform by pushing the democratic Senators over the cliff to their death, inaugurating a century of bloody civil war.

In the 19th century the United States sent gunboats to collect debts from Latin American countries, installing collectors at the local customs houses. England applied similar imperial force to ruin India, Egypt and Turkey, stripping their assets with debt and plunging their populations into poverty that persists to the present day. More recently, America’s hand in the violence that overthrew Chile’s elected president Salvador Allende has continued this policy. Having south to isolate the Soviet Union, Cuba and other countries that rejected creditor-oriented rules and rentier property interests, the United States then capped its Cold War victory over the Soviet Union by promoting a flat-tax regime that imposed the fiscal burden entirely on labor and industry, not on finance and real estate. Instead of being democratized, the post-Communist countries were steered directly into oligarchic kleptocracies that ran up rising debts to the West.

This is just the opposite of the free markets that were promised them back in 1990-91. Instead of economic growth, the “real” economy of production and consumption shrunk, even as foreign financial inflows inflated property prices for housing and office space, fuel and public utilities. Real estate and utility services hitherto provided freely or at subsidy to the economy at large were turned into a predatory vehicle for foreigners to extract income, putting the domestic population on rations, much as what occurs under military occupation. Yet the public media, academic centers and parliaments have persuaded populations that this is part of a natural order, even the product of how a free-market is supposed to operate, rather than a retrogression back to quasi-feudal institutions. The simplistic idea is that making money is itself “capitalist” ipso facto, regardless of whether industrial capital is being created or dismantled and stripped.

How hard times affect people

Public health reports throughout the world document how lifespans shorten as economic inequality and poverty increase. The moral is that “debt kills,” by impoverishing and destroying populations. Those who try to defend themselves are branded as terrorists by their financial predators. Malthus’s population doctrine, after all, was composed to rationalize the free lunch of his landlord class, and World Bank policies to reduce the populations of indebted Third World countries likewise was the natural complement to the financial asset stripping it endorsed. Fewer people to feed, clothe and house in a situation where investors seek mainly the public enterprises for whose construction governments have already run into foreign debt, plus land and resources supplied by nature rather than by human labor.

Nowhere is the violence of creditors more pronounced than in their destruction of education, especially economic studies and knowledge of history. The first act of the Chicago Boys (University of Chicago monetarists, headed by Nobel Prize winner Milton Friedman) in Pinochet’s Chile after the 1974 military coup was to close down every economics and social science department in the nation, except for the monetarist stronghold at the Catholic University where they held sway. The idea was to strip academia of any alternative point of view. Matters are not much different in other countries. At a post-Keynesian economics conference in Berlin on “financialization” last November, I heard many complaints that alternative views to Chicago School orthodoxy were unable to get a hearing in the leading European academic journals. And just this March at the Eastern Economic Association’s annual meeting in New York City, I heard similar complaints that alternative economic ideas were excluded from the major refereed journals in which aspiring academics must gain entry in order to be promoted to tenure track jobs at most U.S. universities. An intellectual Iron Curtain has been lowered by dysfunctional “free market” orthodoxy. Evidently a free market in ideas is anathema to financial free marketers. With such strong intellectual control, of course, overt violence is unnecessary.

Such intellectual intolerance is in the DNA of the creditor mentality because it cannot withstand awareness and understanding of its destructive effects. The “miracle of compound interest” is not achievable in practice beyond the short run. To pretend that it may form the basis for a sustainable model of wealth creation does violence to rationality and economic logic. This is why the economic theory that creditors prefer – and subsidize – is learned ignorance propagated by useful idiots. Its role is to distract attention from society’s most important economic dynamics, those of finance and property polarization via debt, evidently on the premise that what is not seen or analyzed will not be regulated or taxed. One is reminded of Baudelaire’s quip: “The devil wins at the point where he convinces people that he does not exist.” A “free market” for rentiers thus is one “free” of alternative ideas.

That is the political function of mainstream economic theory today. And to cap matters, the creditor-oriented worldview does similar violence to the teachings of world’s major religions.

Christian endorsement of debt cancellation and Clean Slates

From at least as early as 2400 BC it was normal for Sumerian and Babylonian rulers to annul the population’s personal and agrarian “barley” debts upon taking the throne for their first full year of rule. In addition to annulling these debts, Mesopotamian Clean Slates freed bondservants and restored self-support land to former owners who had forfeited their crop rights to foreclosing creditors. The Babylonian word for these Clean Slates was andurarum, and Jewish law adopted them with the cognate Hebrew word deror. But by the first millennium BC, kings had come to represent local oligarchies, so Mosaic Law took Clean Slates out of the hands of rulers and placed them at the center of Judaic religion in the Jubilee Year of Leviticus 25. Like Babylonian law, it cancelled personal debts, freed bondservants and restored land tenure to its “original” holders.

Debt cancellation is at the heart of the laws of Exodus, Leviticus and Deuteronomy calling for debts to be cancelled periodically, and to liberate indebted bondservants. Ezra and Nehemiah describe how they returned from Babylon to restore order by canceling the debts – and re‑discovering the Book of Deuteronomy. But creditor oligarchies were on the rise throughout the Mediterranean region in the centuries that followed. By the time of Jesus the mainstream of Jewish leadership had mounted an attack on the Jubilee Year, endorsing Rabbi Hillel’s prosbul, a legal clause by which creditors forced debtors to sign away their rights to debt annulment at the Jubilee. In his first sermon, Jesus sought to retain the Jubilee year by unrolling the scroll of Isaiah and announcing that he had come to proclaim the Year of Our Lord.

The Jewish oligarchy appealed to Rome to crucify Jesus. As he and his followers gained adherents by advocating debt forgiveness, Rome used violence against them. But Christianity grew by creating communities of mutual aid. Upon achieving political power, the new religion’s most important economic achievement was to outlaw debt bondage throughout Western civilization. However, the idea of a Clean Slate had to be postponed until the Day of Judgment at the end of history.

As creditors drove the post-Roman economy into a Dark Age, Christians banned the charging of interest altogether, even on commercial “silver” loans. Ancient languages had no words to distinguish “interest” from “usury.” This distinction was drawn only in the 13th century, as Church theologians applied the term “interest” to commercial loans in which “silent backers” advanced money to entrepreneurs. It was permissible for bankers to charge a foreign-exchange agio premium (that typically included an interest charge in practice), as long as the charge could be justified by their own labor and related outlays to provide money-transfer and loans. However, mortgages loans and personal loans were deemed usurious. The 13th-century Churchmen treated usury as theft and hence in violation of the Eighth Commandment: “Thou shalt not steal.”

From antiquity through medieval European times, most theft took the form of usury, getting debtors to forfeit collateral they had pledged in exchange for emergency funds. Thomas Aquinas and Martin Luther in 1516 warned that this practice destroyed cities much as a worm destroys an apple from within its core. John Calvin in 1565, the last year of his life, likewise defined usury and fraud as theft on a plane with highwaymen and robbers. This ethic produced a line of development extending down to only a generation ago as Western law became more humane toward debtors. Debtors unable to pay are no longer turned into bondservants to their creditors, and debtors’ prisons have been closed down. Bankruptcy laws permit individuals (and corporations) to annul debts when they cannot pay.

But this eight-century-long historical trend is now being confronted with an anti-Enlightenment threatening to reverse it. In the United States, credit card companies have given enormous sums of campaign contributions to politicians willing to rewrite the bankruptcy laws to make home mortgage debts permanent and beyond the power of judges to write down. Wealthy individuals with more than one home can have their own mortgage debts on these properties written down, but homeowners with just a single residence are confronted with a lifetime of debt peonage. This is just the reverse of ancient law that protected the self-support land of citizens, but not their townhouses and other surplus property.

Credit without oligarchy

Most societies throughout history have sought to provide credit legally in ways that do not permit creditor oligarchies to emerge. Today’s creditor advocates are at war with the spirit of this idea. And in taking this position, they reject the thrust of the Enlightenment’s anti-usury laws, classical political economy’s distinction between productive and sterile investment, the St. Simonian attempt at financial reform, and the Progressive Era’s attempt to mobilize national credit to fund productive industrial investment rather than being extractive, benefiting only the few. The classical idea of economic freedom itself was formulated as the antithesis to feudal-epoch finance. And the ideal of freedom from predatory finance is what is being threatened today, as if society has forgotten how long and hard the reform struggle has been.

The fight to end debt bondage and debtors prisons took many centuries to achieve its humanitarian objective. Handel’s Messiah is a staple of the Christmas and Easter season celebrating the life and teachings of Jesus Christ. What has been forgotten is the context in which Handel arranged the first performance of this oratorio in Dublin, on April 13, 1742. It was a charity concert for the benefit “of the Prisoners in several Gaols, and for the Support of Mercer’s Hospital in Stephen Street, and of the Charitable Infirmary on the Inn's Quay.” Enough money was raised to free a hundred and forty two prisoners. The oratorio’s text accordingly contained references to “breaking bonds asunder” and “casting away yokes,” recalling the early Christian belief that the Messiah’s reign would bring liberty (Hebrew deror or debt cancellation) and release (Greek aphesis) from debt bondage. The “redeemer” was literally the redeemer from debt.

This recalls the original, literal meaning of the Lord’s Prayer. It refers not only to forgiving sins and sinners in the abstract, but specifically to “forgive us our debts” – a translation distorted in much modern reading. “Sin” was the word for “debt” in all Indo-European languages: Schuld (the root of German sollen and English should), and devoir, the root of English debt. It meant obligation – referring in ancient practice to the obligation of an offender to make good payment to atone for his offense, as in European wergild tradition. The original debts were not paid to the rich, but by them, for manslaughter or physical wergild injury to their victims (who typically had to settle for payment rather than taking revenge). Today’s offenders disrupting social harmony are wealthy creditors, but society is paying money to them, not fining them. Seen from the ancient perspective, it is as if indebted society owes retribution to the rich. No wonder the spirit of modern religion has so thoroughly overturned that of its origins!

It therefore seems remarkable that in our own epoch – strained as it is by unprecedented and questionably created debt overhead that reduces not just individuals but entire nations to debt servitude – no major opposition has appeared on religious grounds. Churches have avoided the issue that was the cornerstone of so much of their earlier concern, and moved toward other concerns rather than remaining on the high ground of alleviating the debt burden.

Back to basics, and a call for transparent statistics

The classical economics of Adam Smith and John Stuart Mill, the Progressive Era reforms and Social Democracy are rooted in the moral philosophy of the 17th- and 18th-century Enlightenment. The labor theory of value can be traced from the 13th-century Schoolmen via John Locke to Adam Smith and the Scottish Deists, via David Ricardo’s isolation of economic rent (what Mill called the “unearned increment” that landowners and others receive “in their sleep” rather than through their own labor) as an element of price in excess of cost-value. The distinction between intrinsic value and market price led to socialist and progressive theories of a just society free of economic privilege, free of prices in excess of socially necessary costs of production and of rentier income and wealth without effort.

The common thread in these ideas is that people deserve to receive the fruits of their labor. This means bringing prices in line with actual labor-costs of production. It also means that one’s wealth should be limited to only what one creates – not land and natural resources, or monopoly privileges to extract income via control of roads, the right to create money and other natural monopolies. The aim of social reform for many centuries has been to purge capitalism of its legacy of absentee rentier property ownership patterns and creditor-oriented laws inherited from medieval times. The way to do this is to treat banking like transportation and the broadcasting spectrum, as a public utility to form a just fiscal base, not something to be privatized so that individual rentiers can tax society at large for what rightly is a public utility.

Beyond creating a travesty of international law, rentier interests have turned seemingly empirical statistics into a fictitious set of accounts that understate actual returns to the finance, insurance and real estate (FIRE) sector and the magnitude and information on land and other wealth ownership and distribution. Recent U.S. news has seen a fight by Wall Street to count short-term trading gains in stocks, bonds and financial derivatives as “capital” gains taxed at only a fraction of wages and profits. The financial managers in charge of national statistics likewise describe economy’s largest asset category, real estate, in largely fictitious economic terms. U.S. Federal Reserve statistics on asset values meanwhile depict the rise in real estate prices not as higher land valuation – which the land-price maps of major cities show to be the cause of rising prices, fueled by an exponentially expanding pyramid of credit relative to a fairly fixed land area – but as “replacement cost” of buildings. The inflation of real estate prices is assigned to “capital,” not land. This enables real estate owners to avoid paying income tax by depreciating their property as if it is wearing out, not rising in value. Buyers can start writing off the price of an already written-off building as soon as they buy it, treating its “wearing out” as a tax credit – even though older buildings bring a premium over today’s cost-cutting construction practices. This write-off, of course, is not granted to homeowners, only to absentee owners.

In the sphere of financial wealth, banks have fought truth-in-lending regulations for years in order to conceal the real interest rate their customers are having to pay when all the fees and other charges are added on. They are fighting tooth-and-nail against “mark to market” accounting practices that would oblige them to let depositors and investors know how much their assets actually are worth – and hence, how much they have lost by irresponsible gambling. Whereas economic textbooks claim that a precondition of market efficiency is full knowledge of the market (otherwise, how can a market be deemed to be provide informed choice?), the financial sector always has fought tooth and nail against realizing this condition in practice.

Today the financial sector claims that the U.S. crisis was brought on not by bad investments by bank conglomerates and pension funds or misleadingly high credit ratings given to securities belatedly admitted to be junk, but by banks having to admit that the collateralized debt obligations (CDOs) and credit-default swaps they had been selling to global investments were in fact worthless from the outset. On March 12, 2009, the U.S. Congressional subcommittee in charge of financial reporting backed the bank lobbyists in “freeing” them from having to reveal their actual condition and (lack of) value of the securities they have been pawning off. As a New York Times reporter summed up the issue: “Next time you hear a banker denounce mark-to-market rules, ask if he runs his business that way. Will he offer you a mortgage loan based on what you think your home should be worth, which you can repay only if you make a lot more money than anyone will pay you? … maybe that is not such a good idea. The banks already tried that, with liars’ loans. Those loans did not work out so well.”[1]

This helps explain why every new press release of bad financial news is greeted with the adjectives “unexpected,” “surprising,” “unforeseeable,” “once-in-a-century” and kindred terms. The financial sector seeks to free itself from criticism rather than taking the blame for having plunged headlong over the debt cliff. It can succeed in this economic fiction in proportion to the degree to which the public can be blocked from understanding just what is going on and how the financial sector gains at the expense of the economy at large. Shaping popular perception becomes the name of the game, and statistics are depicted as “empirical” reality rather than the result of intensive lobbying to promote politicians willing to back a distorted economic roadmap.

The problem goes to the very foundation of economic theory. Any set of statistics reflects categories in economic theory, and in recent years the Chicago School has taken the lead in what is now a nationwide trend to exclude the history of economic thought from the academic curriculum. One can get all the way through a Ph.D. without having surveyed the evolution of classical economics from the Physiocrats through Adam Smith, John Stuart Mill and the Progressive Era reformers. The essence of social reform throughout the Enlightenment, and indeed extending all the way back to the Church Schoolmen is no longer taught – the distinctions between earned and unearned income and wealth, and productive and unproductive (or “sterile”) employment and investment. Post-classical thought insists that all income is productive in proportion to whatever it earns – including the collection of economic rent or extortion of monopoly super-profit, or financial charges for interest and credit card fees, and the exorbitant salaries and bonuses that financial managers pay themselves. All revenue – and therefore, all wealth – appears to be “earned.” By their definition. This denies the concept of “investment in zero-sum activities that merely transfer income into the unproductive sector’s pockets, in contrast to creating income.

As a guide to policy reform, classical economics aimed at creating an economic and fiscal system that would bring market prices in line with technologically necessary costs of production. All such costs ultimately are reducible to labor. The necessary complement to the labor theory of value (adjusted for different grades of labor, the cost of their education and the linkage between wage levels and productivity) was the analysis of economic rent – an institutional add-on reflecting property ownership patterns, financial charges and taxes, not inherent costs of production. The classical reform program was to minimize the cost of production and of living, making economies more competitive by purifying industrial capitalism and removing its remaining feudal legacies, above all the right of hereditary absentee owners (landlords) to siphon off a rental charge for access to land for sites supplied by nature and given value by local public spending (e.g., “location, location, and location,” as real estate agents explain matters to prospective buyers) – and the right of bankers to charge for creating credit that governments could freely create themselves.

Fighting against progressive reforms, banks and other financial institutions have sought to preserve their special privileges by law, minimizing taxes on themselves by shifting the burden onto labor and industry. What they have achieved by financializing economies is (1) to raise the cost of living and the cost of doing business; (2) to free their major customers – mortgage borrowers – from taxation so as to leave as much surplus as possible available to be paid as interest; (3) to collect revenue hitherto used to finance the public sector by capitalizing it into interest charges and to inflate the price of housing and other real estate and privatized monopolies; (4) to effectively shift taxes onto labor and industry, thereby raising prices and undermining the competitive power of financialized economies. This is a travesty of classical “free market” policy. It is a policy for predators that mainly burdens economies with high interest and fees while also making the tax burden more oppressive while they reap the benefits.

John Maynard Keynes believed that the proper task of governments was to prevent over-indebtedness from leading to economic depression. He concluded his General Theory (1936) with a call for “euthanasia of the rentier.” Hoping to make credit productive, not extractive, his followers have advocated making banking a public utility so as to steer debt creation to fund growth in the means of production, not economic overhead by inflating property bubbles. Radical as this may appear today, this was the aim of the 19th century classical economists, and underlay the financial reforms that shaped the 20th-century economic takeoff. Only quite recently has the global financial press rediscovered this logic in the wake of today’s bubble meltdown. In a recent Financial Times column, Martin Wolf pointed out that in view of the huge bailouts that banks are demanding from the government to make the industrial economy and labor force pay for their losses, “banks are not commercial operations; they are expensive wards of the state and must be treated as such.” He concludes: “The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. The UK cannot afford it.”[2] Neither can Iceland or any other country.

Backed by global creditors, the IMF wants to keep its power

But the financial sector is fighting back. Its global lobbyist, the International Monetary Fund, has sought to consolidate financial control of economies irreversibly. Article VIII of its charter, drawn up in a period of reaction against the blocked currency practices and tariff protectionism of the 1930s, rules that once a country has removed controls on its “current account” transactions, it is not legal to re-impose any new controls. The current account is defined to include not only import and export trade in goods and services, but also interest on foreign debt and the remittance of profits on foreign-owned investment. In the 1930s, interest payments were conceptually integrated with credit and debts on capital account. But in the 1940s the IMF and other countries changed their balance-of-payments accounting formats away from this logic.

Ostensibly aimed at freeing trade, the IMF’s Article VIII in reality created “free capital movements,” that is, the ability of financial gangs to freely raid currencies such as occurred in the 1997 Asian crisis and similar speculations. Governments were not permitted to protect their currency and exchange rates by limiting such raids or erecting barriers to predatory credit and destructive debt (or from U.S.-subsidized agricultural exports, for that matter). The legal effect of the IMF’s ruling was to block governments from regulating their financial sector, despite its rentier role as a public utility. For Iceland, this means that the government cannot keep the nation’s international debt within the economy’s ability to carry. The most basic criterion for national sovereignty thus is ruled illegal!

In practice, nearly every country has simply added the interest accrual onto its national debt balance each year. Nominally, it “borrows the interest,” but the effect is more like an accrual than a true new loan. Over time these public debts grow at an exponential rate – far in excess of the “real” economy’s rate of growth, a recurring theme in today’s post-classical economies.

Lessons for Icelandic financial policy

The first thing that Iceland needs to do is to realize that it is under financial attack from outside as well as from within – by foreigners supported by a domestic banking class. To succeed, these creditors are trying to convince the population that all debt is productive, and that the economy benefits to the extent that its net worth rises (the price of assets in excess of debt). The fatal error is the assumption that prices will never go down, and if they do, debts should be left in place even when this causes negative equity. To their erroneous way of thinking, a price plunge (recession or depression) is an accident that happens once in a century, not the inevitable result of debts growing at compound interest without a concurrent increase in earning power to pay higher prices and interest.

This deceptive mythology is capped by a mind game being played with Icelandic voters. The game is to promote the myth that there is no alternative but to pay the debts that a few insiders have rung up, debts that accrue interest when they go unpaid. This myth can be dispelled by recognizing that the volume of debt payments being demanded is beyond the country’s capacity to pay. The financial strategy is to postpone awareness of this fact as long as is possible, so as to proceed with the foreclosure and voluntary pre-bankruptcy sell-off of national assets to pay creditors. The one question that creditors do not want to be asked is, “Just how do you propose that we should pay you?” Creditors hesitate to come right out and answer, “By shrinking your economy, by shifting your wealth and property into the hands of a small and shrinking financial oligarchy, and by pricing your labor and industry out of world markets as a result of the heavy financial charges built into your pricing system.” They prefer to act “surprised” when economic force majeur obliges economies to replace defined-benefit pension programs with “defined contribution” plans in which all that workers know is how much they pay into the plan, not what they will end up with.

Iceland as a model test case for economic justice

The realization of the impossibility of paying its debts while maintaining a fair society with a financially level playing field in which people live by what they produce (rather than a debt peonage society headed by creditors) will help Iceland confront reality sooner rather than later. Some form of Clean Slate moratorium should be inevitable. The extent cannot be known until an accounting of who owes what to whom is made. But as a sovereign nation, Iceland can apply whatever economic laws it wishes, as long as these do not discriminate specifically against foreigners. (That can be the result of a general law, as long as foreigners are subject to the same laws as domestic citizens.)

Global creditors will complain mightily, hoping to convince Iceland to let finance make itself an extra-legal sector, beyond the scope of national law to regulate – or to tax. The aim is to place financial dynamics beyond the ability of legal systems throughout the world to contain or otherwise control, so as to make debt collection autonomous from democratic regulation. To achieve this victory, financial interests seek to dismantle the power of governments to limit the ability of creditors to engage in predatory lending and foreclosure. Financial lobbyists accuse government power of being a “road to serfdom,” whereas in reality only governments can protect populations from creditor-imposed debt peonage.

As another tactic in today’s debt crisis, creditors are trying to rush matters. The United States provides an object lesson in the pitfalls of not giving the government enough time to reason things through so as trace how the losses came to be suffered. Treasury Secretary Paulson represented the interest of his own firm, Goldman Sachs, in ramming through an $800 billion “bailout” giveaway package to Wall Street’s leading investment bankers. The sum included $180 billion dispersed so far to A.I.G. to pay speculators in derivatives (including $12 billion to its largest counterparty, Paulson’s own firm,), and $45 billion for Citigroup to pay its counterparty gamblers on the winning side of casino-style bets.

95% of American voters opposed this giveaway. The Treasury Secretary made the usual glib promises that this package would be used largely for debt relief and mortgage renegotiation. It was all a lie –which Mr. Paulson clearly knew to be a lie, because the terse three-page draft law he sent to Congress demanded that no government or law enforcement agency could punish financial lying under his program. The bankers took the money and ran. They used the money to pay themselves enormous bonuses and dividends to stockholders in a vain effort to support the stock price – and to buy smaller banks so as to create yet more giant financial conglomerates “too big to fail,” that is, too big to fail without bringing the entire U.S. financial system crashing down.

Unfortunately, a rush to judgment will give money to bankers irrecoverably. They then will do like U.S. Federal Reserve Chairman Ben Bernanke has done, and wring their hands and offer crocodile tears of apology. Such talk is costly! American voters are now angrier than ever at the government for voting this giveaway.

On national television on March 15, Mr. Bernanke used a false analogy already popularized by President Obama. He asked what people should do if an irresponsible smoker let his bed catch fire so that the house burn down. Should the neighbor say, “it’s his fault, let the house burn”? This would threaten the whole neighborhood, Mr. Bernanke said. The implication, he said, was that economic recovery required a strong banking and financial system.

But banking houses are not in the same neighborhood where most people live. In effect the United States is taking over houses that have not burned down, throwing out their owners and occupants to turn over to the culprits who burned down their own house. To Mr. Bernanke the “solution” to the debt problem is to get the banks lending again. They are to lend enough money so that their clients can borrow the money to pay them the stipulated interest charges. The aim is a return to “normalcy,” defined as new exponential growth in the volume of debt – more of the bubble economics that has just crashed all around us!

Iceland can lead the way

This clearly is not something that Iceland can afford. In fact, the United States cannot afford it either, as much real estate already has sunk into negative equity so that banks are not going to be willing to lend in any event. Fortunately, Iceland’s situation is so extreme that it may be saved even from the thought of creating yet new debt. It can face the financial problem and start to write down the debt overhead, to bring it in line with the economy’s ability to pay or in many cases simply write it off altogether.

First, Iceland needs to take a census of the magnitude of debts owed at home and abroad, and of the institutions to which these debts are owed. Second, it needs to assess the economy’s ability to pay these debts. This was the principle on which the world’s creditor nations founded the Bank for International Settlements in 1931, to assess Germany’s capacity to pay. Reference must be made both to the magnitude of debt relative to current price trends for the collateral supposedly backing this debt, and to the economy’s ability to produce a domestic-currency and foreign-exchange surplus over and above basic needs, including capital replenishment to grow at historical rates over time.

By insisting on a fully transparent financial analysis of who owes how much to whom, Iceland can toss the ball back into the creditors’ court and ask the bankers to explain just how they propose that Iceland should pay – and what they anticipate will be the economy-wide effect of such payment. How much can Iceland afford to pay in the next few years without losing its democratic home ownership and property ownership patterns and without abandoning its social democratic public policies? How can Iceland pay its debts without bankrupting itself, abandoning its social democracy and polarizing its hitherto homogeneous population between a tiny creditor oligarchy and the rest of the population? The island is in danger of creating a new ruling class that will control its destiny for the next century. Again, Adam Smith warned that financial oligarchies act with concern only for how much they can extract, not what they can help produce. They are not good forward planners and do not act responsibly because it is easier for creditors to strip assets than to create new capital.

In taking this position Iceland will simply be following the moral philosophy laid down by every major religion and every body of ancient and modern law as a core principle: the idea that credit must be kept within the ability to pay. It is obvious enough that global lenders have extended credit far beyond Iceland’s ability to pay. For over two centuries the United States has an excellent tradition in how to deal with this problem. Already in the colonial period New York State enacted the Fraudulent Conveyance law, which has remained on the books ever since New York joined the new nation. The problem it faced was British creditors and speculators coming to upstate New York to cheat local farmers out of their rich, well-situated land. The ploy was to extend a loan to a needy farmer, and then call it in just before harvest-time when the debtor lacked the money to pay. Alternatively, the speculator might simply lend more than the farmer could afford to pay even under normal conditions. So New York blocked this predatory practice by passing a law saying that if a bank or other creditor made a loan without knowing just how the debtor was to repay it, the loan would be declared null and void. It would be wiped off the books.

This law received considerable attention in the 1980s when Drexel Burnham and its emulators began providing junk-bond credit to corporate raiders. Companies defended themselves by pointing out that the only way that these high-interest bonds could be paid was by breaking up the target company and downsizing its labor force. But most of all, the law has international relevance. Most U.S. bank consortia have a New York City lead bank negotiate with Third World governments and other foreign borrowers. So far, none of these debtors have sought to annul their loans on the ground that the only way they can pay is to sell off their public enterprises and other government assets. But the enabling legislation is there, and provides an excellent model for Iceland to emulate. By pursuing this policy Iceland would achieve the kind of economic freedom defined by the classical economists – a market free of technologically unnecessary overhead charges, headed by surplus extraction by a vested oligarchy.

For financial interests, by contrast, their idea free market is one that leaves them free to do the economic planning “free” from government regulation and democratic constraint on their extractive, predatory credit and foreclosure practices. Wherever they have gained sway they have shrunk economies. Since the 1960s their proxies at the IMF and World Bank have imposed austerity programs on Third World countries, extending foreign-currency loans whose effect has been to make these countries more dependent and driven them even deeper into debt. In the post-Soviet economies since 1991, financial strategists have focused on prying away public enterprise, selling it off or using it as collateral for loans. The result of “financializing” these economies has been to provide a free field for predatory vested interests in league with globalized domestic financial oligarchies. In sum, the neoliberal model victimizes debtors, preventing them from paying their debts. Instead of funding new capital formation, it strips economies of their assets and empties them out. Ultimately this drags down the creditor economies themselves, as occurred in ancient Rome, medieval Spain, and the United States and Britain in the Great Depression (not to mention what is unfolding today).

Iceland is facing a bold con job. Should it feel obliged to pay countries that have no intention of ever paying their own debts? To get paid, creditors must convince their prey to accept the falsehood that debts can and indeed should be paid. The lie is that they can be paid without dismantling social democracy, selling off the public domain and polarizing society between creditors and debtors.

The point of reference should be Iceland’s broad long-term picture – the economy’s survival and growth prospects for the future. Foreign-currency loans should be denominated in domestic currency at written-down (and de-indexed) interest rates, or repudiated outright. The guiding principle should be to annul debts taken out under terms that are destructive and extractive.

As for the nitty-gritty of negotiating a resolution to Iceland’s debt crisis, the nation needs to re-frame the terms of the debate by removing fictitious assumptions that have no basis in reality. The first trammel of the mind is the assumption that Iceland needs to negotiate in a way that wins the creditors’ approval in a compromise. It is not possible for any fair agreement to be reached in this way. Any negotiation between creditors and debtors is adversarial, and creditors have spent many decades refining demagogic public relations ploys to divert attention to abstractions about “fairness.” A typical ploy is to ask whether it is fair for some debtors to receive larger write-offs than others. Is it fair for the most highly indebted individuals to gain the most – more than people who were more responsible? The aim here is to inflame popular resentment that some debtors will get a bigger write-off than others (and some debtors are indeed as as guilty as the perpetrators who sold them on the idea that home prices only go up), so as to blame the poor and most highly indebted rather than reckless creditors.

The real issue is the health of the overall economy. The parties seeking the most are not the most indebted individuals, but the largest creditors. Their aim is to increase their dominion over the rest of society. Above all, their aim is to maximize the power of debt over labor. The worse the economy does, the stronger the creditor position will grow. This is a recipe for economic suicide that will lead to outright debt peonage as domestic depression intensifies. Creditors everywhere else in the world are writing down their claims for payment to reflect plunging property values. Iceland has an opportunity to make itself a model test case for economic justice. What better time to post the basic principle of what is to be saved – an unsupportable debt burden that must collapse in the end, or a society’s survival? Will the government defend its citizens from financial predators, or turn the economy over to them? That is the question.


[1] Floyd Norris, “The Problem? Bankers Point to the Rules,” The New York Times, March 13, 2009.

[2] Martin Wolf, “Big risks for the insurer of last resort,” Financial Times, March 6, 2009.

Global Research Articles by Michael Hudson

© Copyright Michael Hudson , Global Research, 2009

Disclaimer: The views expressed in this article are the sole responsibility of the author and do not necessarily reflect those of the Centre for Research on Globalization. The contents of this article are of sole responsibility of the author(s). The Centre for Research on Globalization will not be responsible or liable for any inaccurate or incorrect statements contained in this article.

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