What is inflation? What causes it? What are the problems in how the Federal Reserve and other central banks respond to it?
Economists Radhika Desai and Michael Hudson explain in this episode of Geopolitical Economy Hour.
RADHIKA DESAI: Hello, everyone. Welcome to the second Geopolitical Economy Hour. I’m Radhika Desai.
MICHAEL HUDSON: And I’m Michael Hudson.
RADHIKA DESAI: Thanks to all our viewers for making our inaugural show such a success. As many of you know, in this collaboration with Ben Norton’s Geopolitical Economy Report, Michael and I will present every two weeks a discussion of the major developments and trends that are so radically and rapidly reshaping the world order.
Issues that involve not just politics and economics but, rather, as Michael and I like to put it, political economy, and, as my 2013 book had it, Geopolitical Economy.
MICHAEL HUDSON: Well, [there are two kinds] of inflation. I think most people are expecting us to talk about consumer price inflation because that’s what the media talks about. I’m going to give you my punchline first because that’s how we’re going to end up in this discussion.
What has really been inflated, since 2008, has not been consumer prices, but asset prices — [that is,] real estate prices, stocks and bond prices, things that the 1% hold. Wealth has been inflated much more than goods and services. [This is especially true] for real estate.
This debt has been inflated not by government debt, not by government deficits, but by the Federal Reserve creating a $9 trillion subsidy to the banks to support real estate prices, and hence the value of bank-held mortgages and stock and bond prices.
This is not discussed, or even recognized, in the mainstream economic models. Instead, we have a kind of mythology by right-wing anti-labor financial lobbyists.
This mythology is about what I think most of the listeners are expecting us to discuss: the inflation of rising consumer prices. That’s the only kind of inflation that the Federal Reserve talks about. This is all blamed on increasing the money supply, as if somehow money is creating the inflation.
They are not talking about inflation as the result of monopoly pricing. They are not talking about inflation as a result of NATO’s sanctions against Russia. They are just talking about money [as if] somehow, if we [could] just stop money supply, if we could stop the government spending so much money on Social Security and Medicare, and other social spending (not military spending) then everything would be over.
We’re actually going to be talking about the relationship between, [on the one hand,] the inflation of housing and asset prices [and,] on the other hand, how this actually affects the inflation of consumer prices, and how debt and inflation all go together.
RADHIKA DESAI: Thanks Michael. I think I’m also going to follow suit and give people a sort of little preview of the way we are going to end up.
I think Michael is absolutely right. There are actually two distinct inflations to be talked about.
One is asset price inflation. [The] other — which is real, it’s happening right now, people are feeling it in their pocketbooks and their bank accounts and so on — is consumer price inflation.
Nevertheless there are some very interesting relationships between them. One part of the relationship is that of course, as Michael said, the Federal Reserve constantly talks about consumer price inflation. But in reality, its actions are geared towards asset price inflation. Not towards dampening it — on the contrary, towards keeping it going.
This is going to be, from my point of view, from various things that I’ve written, including an article called “Vectors of Inflation” that I published in the New Left Review blog Sidecar a few months ago. In this I argue that, precisely because the Federal Reserve actually wants to keep asset price inflation going, because that is the financial house of cards on which the wealth of so many extremely wealthy people, big financial corporations, high-net-worth individuals, depends in order to preserve this wealth, the Federal Reserve is actually also not going to be able to tackle inflation in the only way it can, using the sledge hammer of high interest rates.
This might be a little bit of good news for some of us, but nevertheless it still means that the underlying problems are not being solved. So let me, with that, [return to] the question of: What is inflation?
Generally speaking, the textbook definition of inflation involves, essentially, too much money chasing too few goods. There is a decrease in the purchasing power of money, there is a devaluation of money, and so on. And of course, the Federal Reserve, and most people, as Michael already pointed out, believe that.
So the textbook definition of [inflation] is one in which money loses purchasing power, it is devalued, [and] it happens due to money printing.
[This] conventional view, which Michael has pointed out the Federal Reserve generally tends to subscribe to, was expressed by Milton Friedman and Anna Schwartz in a book they wrote back in 1963, titled A Monetary History of the United States, 1867-1960, in which they claimed that inflation is, everywhere, always a monetary phenomenon.
Which means [in their view] it is [essentially] caused by the Federal Reserve and other central banks supplying too much money into the system. And this can only be quashed by restricting the money supply — by raising interest rates, by employing other means such as [so-called] Quantitative Tightening, in order to restrict the supply of money.
And of course everybody remembers, or not everybody but some people (some people are old enough) will remember that back [at] the end of the 1970s and the early 1980s Paul Volcker imposed precisely such a “shock” on the American economy essentially to quell inflation.
So the textbook definition is this. But Michael, how would we criticize the textbook definition?
MICHAEL HUDSON: Well, it only looks at money, as you just said, from the Milton Friedman quote. But it doesn’t look at all the non-monetary causes of inflation.
For instance, we’ve seen oil prices and food prices rise simply as a result of the sanctions against Russia. We’ve seen the pharmaceutical prices rising, especially from Martin Shkreli, who vastly increased the prices.
All across the board in the United States companies have been saying, “We’re raising the prices because we think there’s going to be inflation, and we’re just trying to raise it in advance.”
Since the Democrats took power in the 1990s under Clinton, they’ve stopped the anti-monopoly regulation. They’ve stopped the antitrust laws from being enforced, and you have a great concentration of monopolies, and they can raise prices for whatever they want, as much as they want. For agricultural goods, the distributors have simply raised the prices without paying the farmers and the dairy farmers any more.
So when you say that inflation is only a monetary phenomenon, what Milton Friedman is saying is, “Don’t look at the power structure. Don’t look at how markets are structured. Don’t look at monopolies. Don’t look at how the wealthy corporations are inflating [prices]. Look at something that we can blame on labor.”
The inflation that Milton Friedman talks about — and you just mentioned my old boss’s boss Paul Volcker — is wages. So when the Federal Reserve talks about inflation, they say, “It’s really wages rising.” Well, we know that wages have not risen anywhere near as fast as the cost of living, so that can’t be the reason — that wages are rising.
But if you can claim that inflation is only caused by labor making too much money and hurting other workers as consumers, then you have the Federal Reserve able to come in and say, “We’ve got to have a depression. We’ve got to have unemployment. We’re going to raise interest rates because we want more unemployment to increase the reserve army of the unemployed so that wage earners will be so desperate for a job that they’ll work for less. And if only they worked for less, then prices will come down, if somehow the companies are going to lower their prices because they can pay their labor less.”
The pretense is that it’s all labor’s fault.
RADHIKA DESAI: You know, Michael, I completely agree with you, and I would actually go a step further.
Basically by insisting that inflation is a monetary phenomenon — and you know in that original work by Friedman and Schwartz and later on in many other pronouncements — Milton Friedman has even said, “It’s not even about the unions.” He’s not saying that because he particularly cares about the unions. [Rather,] the reason he’s saying that is basically because people like him insist that the only way to deal with inflation is, as you said, to cause a recession.
By restricting money supply sufficiently, and in fact money supply has to be restricted to a point where interest rates go above the rate of inflation. For example, that would have meant [that last] June , in the United States, [when] inflation was above 9%, that [interest rates] would have [had] to go above [9%] in order to dampen inflation.
So the point is, that by insisting on monetary authority’s causing inflation, what you’re doing is, you’re saying, “The only way of dealing with this is to cause a recession, to cause unemployment which is sufficiently high that it will drive down prices (wages, that is to say, the price of labor) and also therefore the price of everything else.”
You simply quash demand to such an extent. And therefore you’re [essentially] saying that you [will] restrict people’s consumption.
And by the way, at the present moment, it may be difficult to say that wages are causing inflation — although strike activity has been going up in the United States and in many other countries. [Wages] are only running to catch up with the extent to which workers wages have gone [down].
But nevertheless what they are doing is [pointing] to the stimulus that the U.S. government has given — which they say has now gone into the pockets of people and is causing inflation — [and saying that the stimulus money] is basically pushing up demand.
But in reality, if we look at the studies that have shown exactly where the stimulus went, again most of the stimulus never even ended up in the pockets of people, and the little bit that did more or less immediately left those bank accounts to go to the bank accounts of the big financial institutions, because ordinary people are so indebted that they were essentially deleveraging, they were reducing that debt.
So anyway, that’s an interesting initial take on the first question, which is how the textbook definition is such a misunderstanding of inflation.
Maybe we can move towards how inflation is understood, and also experienced historically.
Maybe I should just start by saying that essentially, historically we’ve seen that inflation has typically been the result of major disruptions. Wars cause inflation. Various obvious economic crises have caused inflation. And yes, it’s not entirely untrue that it’s possible that an influx of money material — as happened in the 15th, 16th, and 17th centuries in Europe due to the discovery of gold [and silver] in the new world — this influx of money did cause a rise in prices.
But the fact of the matter is, very interestingly, it was directly connected with the birth of capitalism. The rise in prices actually encouraged the economic activity that gave rise to capitalism in these centuries.
MICHAEL HUDSON: Well, you mentioned the inflow of money. That is another area where Milton Friedman went wrong.
Milton Friedman and Anna Schwartz had no concept at all of what money is. They actually put forth a great falsification that has been leading to confused people for more than half a century — ever since I had to go through school and actually read the book.
Money is — most people think of it as an asset: what you have in your pocket. All monetary assets have debt on the other side of the balance sheet. All money is debt. The currency in your pockets is actually, technically, a debt to you.
Most [physical] currency is hundred-dollar bills, and they are shrink-wrapped and sent in airplanes to pay Al-Qaeda, to Ukraine, to pay Mr. Zelensky, to pay kleptocrats — they are used by drug dealers, they are put in mattresses all over the world. They have nothing to do with American inflation.
By far [though], most money is bank credit. And bank credit is debt. And if you look at debt, then you have a whole different perspective, not only on inflation, but on how wealth is created and how the economy is polarizing.
You have to look at the whole economy as an economic system, which you and I have been talking about for years. The purpose of the mainstream media talking about inflation is to prevent you from looking at how the economy is working, to prevent you from looking at how corporations are raising prices, and to prevent you from looking at monopolies and war.
People talk about hyperinflation and again and again you will see the New York Times, the Washington Post, the Wall Street Journal, saying that, “Well, if we keep running budget deficits to spend on Social Security and Medicare we are going to end up like Zimbabwe. Or like Germany in the 1920s.”
Well, as I’ve shown in Super Imperialism, and Killing the Host, every hyperinflation in history has resulted from trying to pay foreign debt — it’s by dumping your currency on the foreign exchange markets to pay debts denominated in another currency.
Germany was saddled with a war debt far beyond its ability to pay, and the Reichsbank kept throwing German marks onto the foreign exchange [until] the currency collapsed.
[In the] United States, [the] inflation of the 1970s [was] caused by the balance-of-payments deficit for the war in Vietnam and Southeast Asia, and the almost 800 military bases the United States had. But you’re not going to have any of the media saying, “Well, it’s the war debts and the war spending that is causing inflation.” [Instead, they say,] “Well, look what happened in the 1970s. Wages went up. That must be what caused inflation.”
Paul Volcker, who you mentioned, walked around with a table — a chart — in his pocket, of construction industry wages, and he said, “Until we can bring down construction industry wages,” largely by the poorest sector of the population, “then we are not going to fight inflation.”
He didn’t say, “We’ve got to bring down housing prices, or stock or bond prices.”
[He only said,] “We’ve only got to bring down wages, and increase profits, because the profits will be used to spend on more investment and that will save us all.”
All of this is a fairy tale, and shows a lack of understanding of what money is.
RADHIKA DESAI: Absolutely. And you know, this is very interesting, Michael.
One thing I wanted to pick up on from what you [said] is that the Federal Reserve can print a lot of money. The Federal Reserve has been printing money hand over fist essentially throughout this century, and particularly after the 2008 Financial Crisis. So if there was going to be inflation, how come it didn’t happen earlier?
For the simple reason that, as you mentioned earlier, when the Federal Reserve prints money, it can go in one of two directions.
It can either go into the financial system, where it is hoarded, where it is used for speculation, precisely in order to drive up the asset prices that you are so emphasizing, Michael, totally correctly.
Or it can go into the economy, leading to productive investment, etc. — and that is what it has not been doing.
[Basically,] every period of economic growth is actually connected with at least mild inflation. Because, essentially — and rising prices are actually a boost to the economy.
I remember reading, many years ago, Pierre Vilar’s A History of Gold and Money: 1450-1920 in which he points out that, had it not been for the effects of the inflation in the early centuries of the emergence of capitalism, capitalism would not have emerged.
Because, you see, left to itself, if capitalism functions as it’s supposed to — which is to constantly bring down the prices of things — capitalism would suffer from a deflationary environment which would be a curb on investment.
So mild inflation — there’s nothing wrong with it. Of course, in the neoliberal period, it’s precisely — people may remember, central banks were aiming for 0% inflation, which is essentially very deflationary. It’s basically saying that we are not going to allow for any productive investment, any productive growth, etc.
So absolutely, if the money is not going towards productive investment, then it’s not going to cause consumer price inflation. As it had not been, when you had all this money printing that went on throughout the 21st century in the United States.
So this also brings us to another question. I guess we have now slipped into talking about the third question, which is: What really causes inflation, both the demand and supply side?
I want to talk about both consumer price inflation and asset price inflation. But I maybe want to open up with a certain point
[The] Federal Reserve’s policies — and the policies of many other central banks that have drunk the neoliberal Kool-Aid, the monetarist Kool-Aid and so on — essentially is to claim that the only way to deal with inflation is to have high interest rates. And this is essentially a class war. It’s a class war in at least two senses. At both ends of it it’s a class war.
[On] the one hand, by causing high levels of unemployment, what you’re doing is, you’re devaluing labor, which is the only thing we have to sell. Most of us — the majority of working people — all they have to sell is their labor. So, by causing a recession by increasing interest rates, you’re devaluing labor.
On the other hand, by increasing interest rates, by keeping asset prices high, you are preserving the wealth of the wealthy, and this is not the least reason why this century has seen such a great shift in income from labor to capital, and particularly to financial capital. And that is why we have seen inequality rise to such obscene levels.
MICHAEL HUDSON: Well, the result has been what has been called the “Hudson Paradox,” and I’ve described that in my book Killing the Host.
More money and credit is used to bid up asset prices for housing, and retirement income, and that puts downward pressure on consumer spending. Because if you have to spend more money on paying a mortgage, on a house that’s rising in price, if you have to spend more money on rent, if you have to spend money on monopolized healthcare services, on monopoly goods in general, then you are going to have less and less income to spend on goods and services.
Again, what’s deflated is [the] spending of 99% — well certainly 90% — of the population on goods and services, because their spending is diverted to pay for access to assets and to monopolized goods, and to goods that are subject to protectionism or warfare.
So the irony is that asset price inflation leads to rising housing prices and consumer income deflation. You have to look at the economy as an economic system, [not simply as] two variables ( consumer prices and money).
You have to look at who owns the wealth, who owes what to whom, how much debt is diverting money away from consumer spending to the upper asset holders (the 1%, the 10%), who owns most of the stocks and bonds and real estate, and who are now buying up private capital investment in medical practices, and almost every kind of consumer goods, and taking them private, and sharply raising the prices.
If you don’t look at how the economy is structured, and how the ownership is changing, and the relationship between ownership and non-ownership, and consumption and labor, you’re going to miss all of the variables that are really necessary to explain how the economy works. Most discussions of inflation are designed to avoid talking about how the economy works.
RADHIKA DESAI: Precisely. And how it’s structured.
I think the Hudson Paradox is absolutely fascinating, and on top of that I would perhaps add a — shall we say — Desai Corollary to the Hudson Paradox.
That would be that, in its own way, asset price inflation actually adds to consumer inflation, for the simple reason that when you have asset price inflation, some people of course are getting very rich, and they can afford to pay widely inflated prices for various goods and services and so on. And so, because they can easily pay, they end up driving the prices up further because they can pay, so enough people are making money by selling at those prices. So in that sense they can also keep inflation going.
Now, this brings us of course to the discussion of what causes inflation, and perhaps, Michael, if I can kick it off by presenting a very simple scenario. The simple scenario is: Imagine that — saying that “Inflation is too much money chasing too few goods,” is essentially reading the symptom. [It’s] a bit like saying, “You have a fever.” [The response would be:] “But doctor, why do I have a fever? Is it because I have an infection? Is it because I have some other illness, a more serious illness? ” You have to examine why too much money is chasing too few goods.
In any healthy capitalist economy, or any healthy market economy, you would expect that [if] prices are rising [for] certain goods, or maybe many goods, there would be a supply response. An energetic intrepid capitalist would invest in precisely those kinds of production where there are rising prices. And once, of course, they start increasing the production of those goods, prices would normally come down. So in any decently organized capitalist economy, in any reasonably productive capitalist economy, there should be a supply response and, therefore, if inflation does occur it would be temporary, it would be in certain goods and services.
So why [have] there been general rises in consumer prices over time? What have been the causes?
So I would say that certainly there can be rises particularly in the prices of two sorts of commodities, which are quite special. And then of course there can be mismanagement of money. So yes of course there can be oversupply, yes there can also be rising wages if unions are strong, and we hope that they would be, that they can in fact increase wages and that can add to the price of things, and it has happened historically at various points — I would definitely say that was an element in the 1970s when unions were indeed strong.
And there is [another] very key reason why you can have inflation and that is commodity price inflation. Both sorts of primary commodities — the products of agriculture, as well as the products of mining — can have big lags in production, so you can have rising prices, but it takes a long time before additional supply can come on the market. In agriculture because of course you have to wait until the next season for the production of that commodity, or in the case of mining because a lot of investment has to go into mining before the new supplies can come on the market. So there are many other issues involved with this. But these are some of the common reasons why you can have inflation.
But Michael, maybe you wanted to add something.
MICHAEL HUDSON: You’ve been focusing so far, and quite correctly, on physical output, but the main inflation has been on infrastructure services. Education — getting the cost of education has gone up much more than other things. Medical care.
What’s caused this is the privatization of what used to be social infrastructure services. The whole dynamic of industrial capitalism, a century ago, was to lower the cost of basic needs, of retirement income, of healthcare, of education, because if you could provide these basic needs freely, or at subsidized prices, then you wouldn’t have to pay labor more wages to buy a high-priced education, or high-priced healthcare. You would make your industry more productive because you [lowered] the cost of living by socializing the cost of education, medicine, transportation, communications.
Look at what happened in England after Margaret Thatcher. Privatizing council housing pushed housing prices way up, tripling, doubling, ten times as high. Same thing for medical care — way, way up. Privatization of infrastructure has been probably the single major cause of price inflation squeezing the budgets of the 99%.
RADHIKA DESAI: And Michael I’d add something to that. You already mentioned this, and of course a lot of left-wing economists are pointing out — people like Robert Reich — quite correctly, that definitely a very large part, a very large contribution has been made to the current inflation precisely by these sorts of privatizations, which is not just privatization in a competitive market, but practically every one of these privatizations has been a form of privatization in which they have created private monopolies. And so the contribution of private monopolies to rising prices has definitely been very high.
MICHAEL HUDSON: The prices of these monopolized services have increased not only because of higher debt service, but because of higher dividends, higher managerial payments. None of this would occur under the previous public sector services. So you have a transformation of the organization of industry as a result of privatization that builds huge financial costs to the banks and to the financial sector into the pricing of goods and services. So the whole character of what the prices consist of is transformed and expanded and inflated.
RADHIKA DESAI: So Michael, what you’re saying is really fascinating.
On the one hand, of course by diverting so much income towards these high-priced goods, [this] should [obviously] lead to inflation in the prices of these goods and so on, but [on the other hand] it should also — by depressing consumer demand as well — actually have a depressive effect on the prices of other things. But we are seeing the prices of all these things going up anyway, which brings us to the next question.
You know, everywhere we look, in most of the literature, even in much of the so-called Marxist literature, we find a depiction of capitalism where capitalism is the best thing since sliced bread as far as the productive system is concerned. Capitalism continuously expands production, it is the only system that is capable of doing so.
In fact, indeed, back in the 1950s or 1960s, I think the Hungarian economist János Kornai had actually argued that socialism can be understood as a supply-constraint system, whereas capitalism should be understood as a demand-constraint system. Which implies that in capitalism there are no constraints on supply.
But the fact of the matter is that we are today witnessing a pervasive rise in prices across the board — prices of all those monopoly services — and of course the financial services that Michael rightly pointed out — rising rents, to which Michael has also pointed, but also rises in the prices of ordinary commodities — not just food and fuel, which can conveniently be blamed on the war in Ukraine, but also other things. Core inflation is very high, which tends to measure inflation net of volatile prices like food and fuel. So why is that? If capitalism is supposed to be so wonderfully productive, why are we experiencing this problem?
Michael, what do you think?
MICHAEL HUDSON: Well, there’s obviously two kinds of capitalism. The textbooks like to talk about industrial capitalism, especially industrial capitalism as it seemed to be evolving in the 19th century into socialism.
But what we’ve had instead is something very different, and that’s finance capitalism, that’s based on basically rentier income: land rent, monopoly rent, natural resource rent, and financial debt charges. So when you talk about demand, the textbooks think, “Well, workers pay their wages on buying goods and services.” But that’s not what they do at all. That’s not how it works. Before they have any money to spend at all, they have to pay their taxes that are taken off, and their medical care. That’s taken off the top of their paycheck, and they are given after-tax income.
Milton Friedman developed this anti-labor policy during WWII when he was working for the War Department. But also, before the wage earner can spend the money on goods and services, [they] have to pay rent for the house, they have to pay medical care, they have to pay the credit card debt, they have to pay the auto-loan debt, they have to pay their education debt.
So the actual disposable personal income is not simply what they can spend after paying taxes, but what they can spend after paying taxes and rentier services. And [the] increase in these various forms of economic rent has widened so much that it squeezes what’s actually available out of the worker’s paycheck to spend on goods and services.
And if you don’t look at this rentier overhead, then you’re not going to understand why finance capitalism today doesn’t produce the rosy results that advocates of industrialism talked about. They are 100 years behind the times. They are not looking at the transformation into finance capitalism and how it’s transformed the economy.
RADHIKA DESAI: Indeed. And this exactly ties back into our inaugural conversation, Michael, because one of the things we emphasized in that conversation is that when neoliberalism was sort of the neoliberal policy paradigm — [when it] was ushered in as sort of the thing that was going to restore capitalism’s mojo, restore its productive dynamism — it did nothing of the sort, for the simple reason that capitalism is no longer competitive. It’s monopoly capitalism and monopoly firms are price makers, they are not price takers.
Essentially they don’t have to react to rising prices by supplying more. They can simply react to it by keeping prices high, which is kind of what we are looking at right now.
Neoliberalism did not resolve this issue, but, on the contrary, it has vastly inflated financialization. So neoliberalism, rather than restoring capitalism’s productive dynamism, has actually unleashed the storms of financialization which bring us regular financial crises, which bring us all these other problems we’re talking about, and which have also gone into weakening the productive economy.
MICHAEL HUDSON: Neoliberalism really is financialization. Neoliberalism is financial lobbying for a financier’s view of the world. It’s Wall Street’s view of the world. [It’s] the central bank’s view of the world. It’s not the industrialist’s view of the world, and it’s certainly not the wage-earner’s view of the world.
The question is: Whose perspective are you going to use in looking at how the economy works?
RADHIKA DESAI: If we may round up this part of the discussion, because we have a couple of really important further questions to discuss, I would say that what’s causing the current inflation is a combination of things. Yes, of course the war, the conflict over Ukraine, which by the way the United States is doing nothing to stop, and we will be discussing this at a later date as well. Secondly, yes, monopoly is certainly contributing to it. Financialization is contributing to it. All of these things are contributing.
But there are two things which are definitely not contributing to it.
Number one, the stimulus did not contribute to it, because the overwhelming majority of the stimulus never ended up in the pockets of ordinary Americans.
And number two, yes, even though there may be a wave of strike activity — which absolutely needs to happen, which workers need in order to catch up with the loss of income, real wages, they’ve had for a long time — [it] is not contributing to inflation. If anything it is only mildly mitigating the effects of inflation on the lives of workers.
But ultimately, I would say that the reason that core inflation is high and is likely, in my humble opinion, to remain high, particularly in the very neoliberal financialized capitalisms like the United States and the United Kingdom, is because of the productive debility, the underlying productive problems of the economy. This is the main thing that is causing inflation and, as I’ve argued in my “Vectors of Inflation,” unfortunately while the Federal Reserve, while talking about employment levels and economic activity levels and so on, is actually really concerned about keeping asset inflation going. It is going to fail to deal with it. So that’s how I want to sum up this aspect.
So we can now shift, perhaps, Michael, to talking about what the Federal Reserve is doing, how we [are] to understand it, and what’s wrong with it.
MICHAEL HUDSON: Well, the Federal Reserve was created in 1913 to take monetary policy out of the hands of government. The idea was, actions that the Treasury used to do — managing the economy — would be transferred to Wall Street and other centers. The Treasury Secretary was not even allowed to be a member of the Federal Reserve Board.
J.P. Morgan organized the bankers and said, “We’re going to take the twelve Treasury districts and we’re going to make them into Federal Reserve districts. Basically we’re going to shift economic planning away from Washington and put it in the hands of Wall Street in New York, Boston, Philadelphia, Chicago, San Francisco. But we’re not going to let the government do the planning. The problem is that people vote for politicians. And you don’t vote for who’s going to be on the Federal Reserve Board. We’ve got to take planning away from democracy and put it where it belongs: in the hands of the 1% and the bankers.”
That was the purpose of central banks in every country. Central banks were the alternative to socialism. Central banks were to prevent industrial capitalism from developing into socialism, but [rather] to develop into a financialized capitalism that instead of being productive was predatory.
That explains why, if you look at what Janet Yellen and other anti-labor economists are saying, she’ll say, “Our job is to prevent wages from keeping up with the cost of living. We have to keep wages down to keep our businesses’ profits high. Because corporations are our customers. Our customers are real estate people. Our customers are people buying houses, and if we can raise the debt necessary to buy a house, then we’ve got an enormous amount of economic rent that has ended up paying interest instead of being used as the tax base.”
Which [by the way] is what Adam Smith and John Stuart Mill and the first line of the Communist Manifesto urged, to treat land as a public utility.
RADHIKA DESAI: Absolutely. You know, Michael, all that reminds me of a really interesting strand of the story that you’re telling. You know, you rightly reminded us that the Federal Reserve was created in 1913, that J.P. Morgan insisted that even the Treasury Secretary could not be a member of the Federal Reserve Board.
So you know, particularly in the very era when this financialization really got going, it was accompanied by the rise of a myth. The Myth of Independent Central Banks. The idea was that central banks were to be made independent, which means that there should be no political interference in the central banks, and the idea was that this would allow central banks to set monetary policy independently for the good of the economy to keep employment high and inflation low.
In reality of course central banks have behaved in ways that have only benefited the financial sector — the financial sector which produces nothing, which makes profit without production. But nevertheless these are the sectors of the economy whose interests have been minded by the central banks, not the interests of the productive economy.
From this point of view, it’s really very interesting that it is precisely in the era when labor was very powerful, up to the 1970s, it was only the late 1970s that the Federal Reserve was given a new mandate. Up until then, the Federal Reserve’s mandate was only to keep inflation low. But with the strength of labor and the Democratic Party being in power, and Carter and so on, they passed legislation which added a new mandate for the Federal Reserve. Which is that the Federal Reserve should also organize monetary policy in such a way as to keep employment levels up.
Of course, no sooner had they passed this legislation then the Federal Reserve acted in precisely the opposite way. Rather than worrying about [employment] levels, the Federal Reserve focused only on bringing down inflation.
Paul Volcker was made the Federal Reserve chairman because he was known as a “sound money man,” a man who was willing to restrict money supply to such an extent, and allow interest rates to go as high as they wanted, in order to curb inflation. Eventually, as some of the older ones of you may remember, or the rest of you may have read, interest rates went to 18% — double digits, high teens — before they brought inflation down.
Ultimately the Federal Reserve didn’t bring inflation down. The Federal Reserve imposed such a deep recession — some people will remember the W-shaped recession of the early 1980s — [on] the American economy and the rest of the world economy as well, as to essentially bring prices down.
So in that sense, even though employment was added as a mandate, and today the Federal Reserve chairpeople, whether Janet Yellen, Alan Greenspan, Jerome Powell, Ben Bernanke, have all continued to use the rhetoric of, “Oh, we are looking at employment levels. We are going to calibrate our monetary policy to these things.”
In reality they have only been concerned about keeping asset inflation going, because, as I’ve said before, and as Michael says, these are the markets on which the assets of the really rich Americans rely for their wealth.
MICHAEL HUDSON: Two comments, Radhika.
First of all, you said the financial sector is not productive. What does it produce? It produces debt. Debt is what it produces. That is what yields interest. Its product is debt, even though it’s really an anti-product, that is what it produces.
Debt is a form of overhead. So the financial sector produces overhead, and the effect is to polarize the economy.
Secondly, you talked about the shift in the Federal Reserve’s purpose towards inflation, not towards full employment. It’s actually much more subtle than that, and much more sinister.
Listen to Janet Yellen and she’ll say, “Well of course the Federal Reserve is trying to increase employment. How do we increase employment? Wages have to fall by 20%. We’ve got to pay those greedy workers less. And if we pay them less, then there will be more employment. So the solution to make more employment is to create unemployment. And if we can create enough unemployment, then workers will become so desperate to eat that they will have to avoid homelessness by actually taking minimum wage jobs, which we are not going to raise in keeping with inflation, because inflation is what’s squeezing the budgets, basically, to this whole economic system designed to transfer wealth from the goods-and-services-producing sector, to the rentier, debt, and monopoly sector.”
That’s the irony. They’ve twisted all the meanings into an Orwellian Doublethink.
RADHIKA DESAI: Very interesting. So Michael, what would you say the Federal Reserve is doing, and what is right and wrong with it?
MICHAEL HUDSON: Well, what’s wrong with it is that it believes that the way to make an economy grow is to make it poorer.
This is the doctrine that the International Monetary Fund tells all of its borrowers. Latin America, Africa, Asia. [The IMF says to them,] “If you can only prevent labor unionization. If you can only cut social spending. If you can lower wages, you’ll be more competitive and you will grow. So yes, we will bail you out of debt so you can pay the bondholders in the United States and other dollar bondholders, and the foreigners who’ve lent you money, because the World Bank has pushed you into dependency on the creditor nations. If you can pay them by being poorer.”
That’s the financial philosophy. The financial philosophy in a nutshell, is: Pay labor less, leave the economic surplus for the owners of wealth, the owners of money, and most of all the owners of [monopolies on] creating credit and creating money. That’s what makes Western capitalism different from the Chinese system, where it’s the central bank of China that creates the credit, not the commercial banks that end up turning all of this rent into interest and economic overhead that is responsible for most of the cost increases.
RADHIKA DESAI: This is very important.
We should probably wrap up our discussion now because we are getting close to an hour. But let me just say a couple of things.
To add to what you are saying, as I said earlier, the Federal Reserve has been acting in the interests of the financial sector throughout the neoliberal period. This period I would divide into two distinct parts.
[First,] we had the 1980s and 1990s where, beginning with the Volcker Shock, interest rates became very high. And then later on they did come down a bit, but they remained at historically quite high levels during these decades, so basically banks were making a lot of money simply by buying bonds and earning relatively high interest.
[Second,] particularly after the 2000s bursting of the dot-com bubble, we had the Federal Reserve changing course and adopting — changing course, by the way, I should add, for a very interesting reason, they realized that the only thing that was keeping the dollar’s value up, and the economy going, even at a weak rate, was basically the [housing] price bubble that had been brewing in the U.S. economy since the 1990s. So in order to keep it going, the Federal Reserve adopted a radically low monetary policy, a paradigm which allowed the inflation of those huge asset bubbles which we saw which ultimately burst in 2008. Of course, even after that the Federal Reserve kept up the easy money policy.
So there are these two distinct periods. But in both cases, they are looking after, in one way or [another], the interests of the financial sector.
Now [therefore], at the present moment, when inflation really began to hit, the Federal Reserve basically first of all reacted to it — Jerome Powell first reacted to it by saying, “Oh, we don’t have to worry about it, we are going to continue low monetary policy, because inflation is going to be transitory.”
Remember, I’m not endorsing the Federal Reserve raising interest rates. What I’m saying is, they didn’t raise interest rates, which is what they would have willingly done if they thought the threat of inflation was higher, because they first of all dismissed it as transitory because they couldn’t afford to accept that they would need to increase interest rates, because increasing interest rates will prick all these asset bubbles, beginning with the weakest asset bubbles.
So, first they tried to pretend that inflation [was] going to be transitory. Then, by early 2022, they were forced to admit that inflation was there — it was proving persistent, it was not going to go away easily, so the Federal Reserve began a series of rate hikes.
Now, the thing about these rate hikes is, yes of course they have been quite amazing. At various points they have been going up, not only by the normal 25 basis points, but by 50 basis points and 75 basis points, and so on. But the fact of the matter is that the Federal Reserve is going to have to find some way of stopping raising interest rates because it is already entering that danger level.
Let me give you a comparison. Back in 2005, 2006, 2007 — the Federal Reserve was forced to start raising interest rates because the dollar was declining. There was downward pressure on the dollar. Oil prices were rising, and so on. So the Federal Reserve started raising interest rates, ever so gently, incrementally, in a series of steps, 25 basis points at a time. It brought the interest rates up to something like 5.25%.
That was enough to burst the financial bubble, essentially. And the Federal Reserve, if it allowed that to happen, it would essentially bring down all these asset bubbles. Today, you know, we don’t have one or two asset bubbles, you know, credit bubble, housing bubble, we now have an Everything Bubble.
And already, many of these bubbles are bursting in many areas where money has been going. The bubbles have been bursting. So now what you are going to see is, the Federal Reserve is going to fight shy of raising interest rates very much. So the sledgehammer of high interest rates will not be used. The Federal Reserve has no other way of dealing with inflation
The point is that, from our point of view, what needs to be done in order to both combat inflation but also to remedy a whole host of other ills that ail the U.S. economy, is in fact to move away from financialization and create the sort of industrially-focused, productively-focused economy that Americans needs.
But the Federal Reserve is loath to do it. The elites are loath to do it, because it involves a level of financial regulation, and regulation of capital, which really brings it very close to what they fear; — namely, some sort of socialism. And this is my argument in the article I wrote, “Vectors of Inflation,” and also of course what I continue to argue today.
MICHAEL HUDSON: What you’re advocating is just what the central banks are unable to do. The fact is that the debt that has been run up can’t be paid. There is no way that the Federal Reserve can cope with the fact that every recovery since WWII, every recovery since 1945, has started from a higher and higher and higher debt level, until, now, there’s so much debt that the economy cannot compete, and cannot avoid homelessness and polarization, unless the debt is wiped out.
And that is what the Federal Reserve doesn’t do. The Federal Reserve can’t change the financial system and say, “Well, for the last 100 years, actually for centuries, commercial banks, when they make a loan, they make it against collateral. Banks do not make loans in order to create new means of production. The stock market may do that, for seed capital. But banks don’t lend for assets that are not already in place. They only lend against assets that are already there that they can foreclose on if the debt can’t be paid.”
Well, we’re now in a mass foreclosure period, and the reason that all this $9 trillion was created when Obama bailed out the banks, was that the banks were insolvent. They had made so many bad loans that, as the FDIC had pointed out, Citibank was bankrupt, all the big banks were broke. We spoke about that in the very first show. And the financial system is still basically insolvent. It’s being kept alive — it’s a zombie-bank system, keeping zombie corporations afloat by more and more debt that ultimately is going to have to be written down.
But banks don’t do that. And the only solution is beyond the Federal Reserve’s policy. Number one, [it has to] write off the bad debts. This is certainly obvious for many Global South countries. But you also have to have a different financial system. You have to make credit a public utility, as it is in China. A public utility that actually is designed to create money and credit, to create new means of production, without adding to the overhead costs and debt service.
This requires de-privatization as well as making credit a public utility. Economic rent should be socialized and used as the basic tax base so you don’t have rent being used to pay interest. You have rent to prevent housing prices from being bid up on credit by a financial sector whose job is to inflate asset prices to keep the Ponzi scheme going so the economy doesn’t —
RADHIKA DESAI: Precisely. Maybe in closing, actually, I just remembered a couple of points that are really worth making before we close today, so we may go a tad over an hour.
The first thing is, you know, earlier I mentioned the mystique of independent central banks, and of course, throughout this period, from the 1990s onwards, for more than two decades, we have been living through a sort of mystification of the role of central banks, and particularly of the Federal Reserve.
There was a book written about Alan Greenspan whose work was portrayed as though, when he was the chairman of the Federal Reserve, he was like a maestro who was conducting the complex orchestra of the U.S. economy and even the world economy merely with deft little movements of his monetary policy baton.
In reality, of course, if we ask ourselves what really kept inflation low — because you see the central banks are lauded for having defeated the dragon of inflation over the last two or three decades — in reality what has really kept inflation low over the last many decades is basically an attack on labor. It is basically an attack on Third World countries, particularly their ability to develop, which we saw particularly strongly in the 1980s and 1990s.
As you know, the economists Utsa Patnaik and Prabhat Patnaik have argued in their book A Theory of Imperialism, a key to keeping the value of the money of First World countries is to keep the development of Third World countries low. Because if Third World countries started developing, they would demand and buy more of the commodities that First World countries have been so used to getting for next to nothing.
Whether it is copper or oil or lithium or whatever, now one of the reasons we are looking at inflation is, despite the best efforts of the United States and Western countries, at least some Third World countries, led by China, but also many others, are beginning to develop — they are making policy choices, and they will say, “We also want our share of commodities and products,” and this is also going to create a very different scenario.
Finally I just want to add, just give you a little preview for our next discussion — Michael and I have agreed that our next discussion will be about de-dollarization. These financial asset bubbles are deeply connected with the reason why the dollar has appeared to remain the world’s money — which is, essentially, these asset bubbles have been drawing money into the dollar-denominated financial system, but this is also rapidly changing.
One of the things that Michael mentioned is, the inflation of the balance sheet of the Federal Reserve, doubling with the 2008 Financial Crisis, and then again under Q.E., and then again with the recent pandemic crisis and so on. So today it stands close to $9 trillion. What is all this money doing?
[The Federal Reserve] is essentially printing money. It has not contributed to rising prices, rising consumer prices, because it has not gone into the pockets of ordinary people. It has basically kept the asset inflation going.
This asset inflation now has artificial support. The Federal Reserve is propping up asset markets. This is just one of the signs of the weaknesses which [are] going to doom the dollar. That is what we are going to be talking about next time.
MICHAEL HUDSON: As preparation, I’ve discussed dollarization in my book Super Imperialism, and a scenario for de-dollarization in The Destiny of Civilization, [which] is all about that. Both Radhika and I have written much about de-dollarization, and it would help if you could take a look at what we’ve written in the past so we can start from there in saying what’s actually unfolding today.
RADHIKA DESAI: If you would also look at Michael and my paper, “Beyond the Dollar Creditocracy,” and also my book from 2013, Geopolitical Economy, which is very much focused on the dollar as well.
Hopefully you have a chance to take a look at some of these things now or later, and next time we will return with a discussion of de-dollarization.
Thank you for now, and goodbye.