Recovering from Neoliberal Disaster

Why Iceland and Latvia Won’t (and Can’t) Pay the EU for the Kleptocrats’ Ripoffs

Linked with Michael Hudson – USA, and its links.

Published on Global Research.ca, by Prof. Michael Hudson, August 17, 2009.

Can Iceland and Latvia pay the foreign debts run up by a fairly narrow layer of their population?

The European Union and International Monetary Fund have told them to replace private debts with public obligations, and to pay by raising taxes, slashing public spending and obliging citizens to deplete their savings …

… Why Iceland’s move is so important for international financial restructuring:  

For the past decade Iceland has been a kind of controlled experiment, an extreme test case of neoliberal free-market ideology. What has been tested has been whether there is a limit to how far a population can be pushed into debt-dependency. Is there a limit, a point at which government will draw a line against by taking on public responsibility for private debts beyond any reasonable capacity to pay without drastically slashing public spending on education, health care and other basic services?

At issue is the relationship between the financial sector and the “real” economy. From the perspective of the “real” economy, the proper role of credit – that is, debt – is to fund tangible capital investment and economic growth. The objective is to create a tax system and financial regulatory system to maximize the latter.

After all, it is out of the economic surplus that interest is to be paid, if it is not to be extractive and outright predatory. But creditors have not shown much interest in economy-wide wellbeing. Bank managers and subprime mortgage brokers, corporate raiders and their bondholders, and especially the new breed of kleptocratic privatizers applauded so loudly by neoliberal economic ideologues simply (and crassly, I have found) ask how much of a surplus can be squeezed out and capitalized into debt service. From their perspective, an economy’s wealth is measured by the magnitude of debt obligations – mortgages, bonds and packaged bank loans – that capitalize income and even hoped-for capital gains at the going rate of interest.

Iceland has decided that it was wrong to turn over its banking to a few domestic oligarchs without any real oversight or regulation, on the by-now discredited assumption that their self-dealing somehow will benefit the economy. From the vantage point of economic theory, was it not madness to imagine that Adam Smith’s quip about not relying on the benevolence of the butcher, brewer or baker for their products but on their self-interest is applicable to bankers. Their “product” is not a tangible consumption good, but debt – indeed, interest-bearing debt. And debts are a claim on output, revenue and wealth, not wealth itself.

This is what pro-financial neoliberals fail to understand. For them, debt creation is “wealth creation” (Alan Greenspan’s favorite euphemism), because it is credit – that is, debt – that bids up prices for property, stocks and bonds and thus increases financial balance sheets. The mathematically convoluted “equilibrium theory” that underlies neoliberal orthodoxy treats asset prices (wealth in the financial sense of the term) as reflecting prospective income. But in today’s Bubble Economy, asset prices reflect whatever bankers will lend – and rather than being based on rational calculation their loans are based merely on what investment bankers are able to package and sell to gullible financial institutions trying to pay pensions out of the process of running economies into debt, or otherwise disposing of credit that banks freely create.

There amount of debt that can be paid is limited by the size of the economic surplus – corporate profits and personal income for the private sector, and the net fiscal revenue paid to the tax collector for the public sector. But for the past generation neither financial theory nor global practice has recognized any capacity-to-pay constraint. So debt service has been permitted to eat into capital formation and reduce living standards.

As an alternative is to such financial lawlessness, the Althing asserts the principle of sovereign debt at the outset in responding to British and Dutch demands for Iceland’s government to guarantee payment of the Icesave bailout: The preconditions for the extension of government guarantee according to this Act are:

  • 1. That …account shall be taken of the difficult and unprecedented circumstances with which Iceland is faced with and the necessity of deciding on measures which enable it to reconstruct its financial and economic system. This implies among other things that the contracting parties will agree to a reasoned and objective request by Iceland for a review of the agreements in accordance with their provisions.
  • 2. That Iceland’s position as a sovereign state precludes legal process against its assets which are necessary for it to discharge in an acceptable manner its functions as a sovereign state.

Instead of imposing the kind of austerity programs that devastated Third World countries from the 1970s to the 1990s and led them to avoid the IMF like a plague, the Althing is changing the rules of the financial system. It is subordinating Iceland’s reimbursement of Britain and Holland to the ability of Iceland’s economy to pay:

  • In evaluating the preconditions for a review of the agreements, account shall also be taken to the position of the national economy and government finances at any given time and the prospects in this respect, with special attention being given to foreign exchange issues, exchange rate developments and the balance on current account, economic growth and changes in gross domestic product as well as developments with respect to the size of the population and job market participation.
  • This weekend’s pushback is a quantum leap that promises (or to creditors, threatens) to change the world’s financial environment. For the first time since the 1920s the capacity-to-pay principle is being made the explicit legal basis for international debt service. The amount to be paid is to be limited to a specific proportion of the growth in Iceland’s GDP (on the assumption that this can indeed be converted into export earnings). After Iceland recovers, the payment that the Treasury guarantees for Britain for the period 2017-2023 will be limited to no more than 4% of the growth of GDP since 2008, plus another 2% for the Dutch. If there is no growth in GDP, there will be no debt service. This means that if creditors take punitive actions whose effect is to strangle Iceland’s economy, they won’t get paid.

The moral is that Newton’s Third Law of motion – that every action has an equal and opposite reaction – is applicable to politics and economics as well as to physics. As the most thoroughly neoliberalized disaster area, Iceland is understandably the first economy to push back. The past two years have seen its status plunge from having the West’s highest living standards (debt-financed, as matters turn out) to the most deeply debt-leveraged. In such circumstances it is natural for a population and its elected officials to experience a culture shock – in this case, an awareness of the destructive ideology of neoliberal “free market” euphemisms that led to privatization of the nation’s banks and the ensuing debt binge.

Iceland promises to be merely the first sovereign nation to lead the pendulum swing away from an ostensibly “real economy” ideology of free markets to an awareness that in practice, this rhetoric turns out to be a junk economics favorable to banks and global creditors. Interest-bearing debt is the “product” that banks sell, after all. What seemed at first blush to be “wealth creation” was more accurately debt-creation, in which banks took no responsibility for the ability to pay. The resulting crash led the financial sector to suddenly believe that it did love centralized government control after all – to the extent of demanding public-sector bailouts that would reduce indebted economies to a generation of fiscal debt peonage and the resulting economic shrinkage.

As far as I am aware, this agreement is the first since the Young Plan for Germany’s reparations debt to subordinate international debt obligations to the capacity-to-pay principle. The Althing’s proposal spells this out in clear legal terms as an alternative to the neoliberal idea that economies must pay willy-nilly (as Keynes would say), sacrificing their future and driving their population to emigrate in what turns out to be a vain attempt to pay debts that, in the end, can’t be paid but merely leave debtor economies hopelessly dependent on their creditors. In the end, democratic nations are not willing to relinquish political planning authority to an emerging financial oligarchy.

No doubt the post-Soviet countries are watching, along with Latin American, African and other sovereign debtors whose growth has been stunted by the predatory austerity programs that IMF, World Bank and EU neoliberals imposed in recent decades. The post-Bretton Woods era is over. We should all celebrate.

Notes 1 – 4: … (full long text).

(Dr. Hudson is Distinguished Prof. of Economics at UMKC. In 2006 he was Prof. of Economics and Director of Economic Research at the Riga Graduate School of Law in Latvia. See his website.
Michael Hudson is a frequent contributor to Global Research. Global Research Articles by Michael Hudson
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