Michael Hudson: P is for Ponzi

Yves here. This is the latest entry in Michael Hudson’s Insider’s Economics Dictionary. Enjoy!

By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City, and a research associate at the Levy Economics Institute of Bard College. His latest book is “The Bubble and Beyond.” Originally published at his website

Part P in The Insiders Economic Dictionary.

Panic: The abrupt culminating stage of the business cycle, in which inflated asset prices collapse in price as financial securities and properties are sold to pay off debts.

Parallel Universe: The objective of modern economic methodology. A hypothetical exercise in science fiction depicting a world that conceivably could exist, given a sufficient number of internally consistent assumptions. (See Neoclassical Economics.)

Parasite: A “free luncher,” from the Latin word meaning an uninvited guest brought along to a meal or crashing the party. Parasites avoid detection by camouflaging themselves as part of the host itself, and then disable the host’s brain to prevent it from taking counter-measures to protect its own growth. The economic analogue most often cited as parasitic is rentiers. The objective of such rent-seeking activity is to obtain something for nothing – income or price without real cost-value. Financial parasites tend to ride on the backs of real estate investors monopolists and lobby politically to support and un-tax their rent-seeking activities.

Parasitism: In biology, parasites develop a strategy of gaining control of the host’s brain in order to obtain nourishment by masquerading as its natural progeny or as a part of its body. For economies, the brain in question is the government. The rentier or monopolist masquerades as contributing to the production process so that its revenue appears to be earned rather than siphoned off in a zero-sum activity.

The most successful biological parasites establish a symbiosis with their host in which they actually help the host in seeking nourishment and growth. Unsuccessful parasites devour the host without regard for the consequences, as is the case with most economic parasitism. In the case of financial parasitism, bankers and money managers have become more destructive over the centuries. (See also Debt Pollution.)

Pension-fund capitalism: A term coined in the 1950s to reflect finance capitalism’s new way of exploiting labor by withholding part of its salary to invest in stocks. Early abuses in America (and most notoriously in Chile at the hands of the Pinochet junta with the aid of the Chicago Boys) occurred when companies invested the money in their own stocks, increasing equity prices not so much by raising earnings as by organizing a flow of funds into their purchase. (See Labor Capitalism.)

Pentagon capitalism: A term coined by Seymour Melman in the 1960s to describe the U.S. Government’s practice of drawing up military procurement contracts on a cost-plus basis. Under the terms of these contracts, suppliers make profits by maximizing their production costs, not by minimizing them as in traditional market competition. (See Military Spending.) Under such conditions political lobbying and campaign contributions lead to insider deals, as when Halliburton Vice President Dick Cheney became U.S. Vice President and gave Halliburton contracts in the Iraq War without competitive bidding or meaningful government oversight.

Pension-fund socialism: A system whereby employers (in the public as well as the private sector) pre-fund pension commitments by setting aside funds to invest in stocks and bonds rather than government securities. The effect of these set-asides is to bid up the price of financial assets. The main beneficiaries of the buildup are venture capitalists taking firms public with IPOs, corporate managers exercising their stock options, and speculators. When the demographic dynamics shift and more workers retire than join the labor force, sale of these securities to pay their pensions threatens to reduce stock and bond prices, depriving the retirees of their anticipated gains.

The result is neither especially capitalist nor socialist, as it is primarily a financial phenomenon rather than one based on industrial profits. Attempts by corporate managers and raiders to increase stock prices typically are made at labor’s expense, not for its benefit.

Physiocrats: French followers of Francois Quesnay (1694-1774), who created the first national income account, the Tableau Économique. Hence they were called Les Économistes. As a surgeon to the royal family, Quesnay’s idea of the circular flow of income was inspired by the circulation of blood within the human body. And as the name Physiocrats indicates, the model was primarily physical. Just as the cardiovascular system is different from that of muscle, bone or for that matter fat and parasites in the blood, so the Tableau Économique left out of account depreciation (the replenishment or accumulation of seed and capital goods) and debt service.

What the national income table did focus on was groundrent. The Physiocrats advocated taxing the rentier aristocracy’s estates, on the logic that it was nature in the form of sunlight that produced the entire economic surplus. Later rent theorists inverted this view, pointing out that rather than producing a surplus, property owners simply established a toll-claim for access to the land.

Planned economy: Every economy since the Neolithic Agricultural Revolution has been planned. Most recently, financial managers have replaced elected representatives, under the slogan of rejecting a planned economy under government regulation. The neoliberal tendency is to create even bigger government as a result of Moral Hazard policies designed to bail out savers from bad loans, bank deposits or other investments, while shifting the costs of government away from the property and financial sectors.

Poison pill: A tactic to defend companies against corporate raiders. Potential target companies borrow enough money to absorb all their profit, leaving no net profits for corporate raiders to pledge to their high-interest junk bond financiers. A related ploy is for companies to pass a resolution to pay off their own bondholders immediately in case of an unfriendly takeover. The effect of such defensive tactics is that un-raided as well as raided companies end up paying heavy debt service.

Polarization: The tendency for economies to polarize between rich and poor, typically between creditors and debtors. (See Zero-Sum Activity.) This tendency is countered by enacting progressive tax and regulatory policies, encouraging credit to be extended along productive lines rather than simply to inflate asset prices, and taxing unearned rental income and asset-price gains.

Politics: The duplicitous art of getting votes from the poor and campaign funds from the rich by promising to be an honest broker to protect each from the other – while actually being up for sale as policy-making is made part of the unregulated (“free”) marketplace.

Ponzi scheme: An arrangement whereby early investors in a financial operation are paid out of money put up by new subscribers to the scheme, not out of actual profits. Investor concerns are alleviated by promises of exorbitant and rapid rates of return resulting from a hitherto undiscovered technique of making money. Named for the Italian-American confidence man Carlo Ponzi, who claimed to have found a loophole in international postage-stamp swaps, the term has been applied to financial bubbles expanding at an exponential rate of credit creation with no underlying means of earning enough income to keep them going. Their collapse occurs at the point where new inflows of funds longer continue to grow exponentially. Still, in the mid-1990s, investors in Russia’s MMM scheme and similar pyramiding in Albania wondered why their schemes failed while the U.S. and European bubbles did not, especially as their managers were political insiders, as normally is required for pyramid schemes to attract customers. (See Asset-Price Inflation, Compound Interest and Fragility.)

Post-industrial: A lapse back into the pre-industrial usury-and-rent economy. (See Progress and Stages of Development.)

Postindustrial economy: A euphemism to depict rentier economies as progressing forward, beyond industrialization, rather than a lapse back into the pre-industrial usury-and-rent economy of feudal Europe when military conquest was the major enterprise and economies polarized between creditors and debtors. (See Neo-feudalism.)

Postmodern economy: For over a century the term “modern” referred to progressive economic policies promoting a more egalitarian distribution of wealth, as in progressive income taxation and higher living standards through government regulation and planning. Today’s postmodern economy is reversing this trend, by permitting financial and property dynamics to re-polarize wealth and income. The post-modern economic program is one of deregulation, a tax shift from property and finance onto labor, and abolition of government power except for its role in serving the wealthiest layer of the population by moral hazard.

Predatory behavior: A zero-sum activity in which one party’s gain is another’s loss.

Privatization: The word “private” derives from Latin privatus, meaning “restricted,” and privare, “to deprive” and indeed, “to rob.” Starting with enclosure of the commons – communal grazing lands and forests – Britain’s Enclosures of the 16th through 18th centuries deprived peasants off their land and means of subsistence, driving them into the cities as loom-fodder or into local workhouses to survive. Since 1980 the lever of privatization of the public domain sponsored by Margaret Thatcher and other neoliberal politicians has returned to what it was in antiquity: debt foreclosure, forcing sell-offs of the modern public domain by debt-strapped governments as a conditionality imposed by the IMF in exchange for credit to avoid their defaulting on public debts. Public enterprises are being pried away from the public domain and bought largely with borrowed credit. The prime assets being privatized are those obtaining economic rent, which is turned into interest to pay the creditors and stockholders by raising prices for their hitherto public services.

Privilege: Literally “private law,” a sphere of activity that is not governed by common law, usually exercised by the very wealthy. Economic privilege typically consists of a right to exclude others from one’s own property, a right that often takes the form of a rentier toll-gate demanding government protection without the social obligations that originally were the complement of privilege and property.

Productive loan: A loan extended for commercial enterprise that enables the borrower to earn sufficient income to pay the creditor and still emerge with a profit. On this ground Adam Smith cited as a rule of thumb that the rate of interest tended to settle at half the rate of profit. In such cases borrowers would split their returns 50/50 with their creditors. But interest charges today have expanded to absorb the entirety of profits in real estate and takeovers by corporate raiders who finance their leveraged buy-outs with junk bonds.

Neoclassical economists assume that most loans are granted to finance new direct investment. If this were the case, such credit could be repaid out of profits generated by investing the loan proceeds profitably. But most loans are used to buy assets already in place (real estate, stocks or bonds), or consumer goods. To the extent that their effect is to bid up prices for assets and products, such loans merely add to the economy’s debt overhead – and hence, polarization – rather than expanding the means of production. (See Asset-Price Inflation.)

Profit: Popular usage follows neoclassical economics in trivializing the term “profit” into a synonym for earnings regardless of their source. But for the classical economists the term had a narrower connotation. It was the net return to capital invested in plant, equipment and related outlays whose cost was reducible to the labor time that went into their production. As such, profit was juxtaposed to rentier income. Today, “profits” and “earnings” include rental income, which classical political economy identified with land or other property rights.

Progress: Every process of social decay represents itself as progress, in the sense of moving forward rather than retrogressing. The word “progress” thus has degenerated from its 19th- and 20th-century meaning of egalitarian economic policies (such as the progressive income tax and government welfare policy), to become merely a euphemism as anyone’s political program. Its antithesis is the postindustrial economy. (See Reform and Stages of Development.)

Progressive economic policy: Since the Enlightenment, progressive policy has been defined as public tax and regulatory policy promoting greater equality of opportunity and income, mainly by taxing economic rent and windfall gains to property and finance. The vehicle for such policies is a stronger government in democratic hands. The antithesis is regressive neoliberal ideology favoring rentier income over wage and salary income, leading to economic polarization.

Propensity to save: In Keynesian analysis, the portion of national income that an economy saves rather than spends on consumption. Left ambiguous is interest and rent, which represent spending that neither is saved nor spent on consumer goods, but diverted into the property and asset markets. (See Asset-Price Inflation.)

The Keynesian term refers to net saving, which has fallen to zero for the United States. Gross saving may be high, but if it is all lent out (appearing as debt on the other side of the balance sheet), then net saving appears to be zero. Legitimate macroeconomic analysis requires that both gross and net saving rates be measured. (See General Theory, Keynes and Savings.)

Property: As Bentham pointed out, property is not an object, it is a relationship “the object of a man’s property” a possession “proper” to a man and therefore owned personally or corporately as part of one’s self, as a workman’s tools or a soldier’s weapon. Communities also public own property as part of their identity – temples, palaces and other civic structures, their self-support lands, mineral resources and essential public enterprises. The largest category of property is land, followed by buildings (“immovables”), followed by movables (consumer items and financial securities). It was mainly with land in mind that the French socialist Pierre Joseph Proudhon (1809-65) wrote that “Property is theft.” (See Privilege.)

Less and less property is owned free and clear these days. Debt foreclosure historically has been the major lever to pry private property away from the community, at first by usury charged to personal debtors, and most recently by privatization of the public domain as creditors oblige indebted governments to accept IMF conditionalities. Military conquest has been the second major lever to privatize property.

Protecting Savings: A euphemism for “making savers whole.” In practice this exponential function becomes impossible to maintain, because the volume of savings and debts mounting up at compound interest cannot be carried by the economy ad infinitum. Something must give as economies polarize and bankruptcies wipe out borrowers, so that banks and other creditors (euphemized as “savers”) lose the market value which backs their financial claims. The government is called upon to rescue the most politically powerful debtors, savers, or both at once. (See Moral Hazard.)

It is an impossible job in the end, as the growth of financial claims on debtors exceeds their means to pay. If all credit was as productive as is anticipated and promised, debtors would have the money to pay and there would not be a crash. Financial claims are rather a claim on production and wealth, imposed from above the economic system by the rentier sectors.

Public: Almost every private interest represents its gains as a public benefit, most famously when Charles Wilson proclaimed that “What’s good for General Motors is good for the country.” But as Adam Smith noted, when businessmen get together, they rarely do so but to conspire against the public good. (See Government and Social Market.)

Public domain: The commons, mineral rights, public land and buildings, and government infrastructure in the form of natural monopolies and public enterprises that were the major assets yielding economic rent and hence were long kept out of private hands – canals, railroads, airlines, water and power, radio and television frequencies, telephone systems, roads, forests, airports and naval ports, as well as schools and other educational assets. Simon Patten cited this infrastructure as a fourth factor of production (after labor, capital and land), whose return was calculated not by the profit it made (as in the case of private investment), but by the extent to which this public investment lowered the economy’s overall cost structure.

Privatization of the public domain since 1980 has indeed led prices for hitherto public monopoly services to rise, especially as the buyers of public enterprises have financed their purchases on credit and factor interest charges, dividends, and high managerial salaries and stock options into their prices. (See Watered Costs.)

Pyramiding: Debt pyramiding (called “gearing” in Britain) refers to the investment strategy of putting down as little of one’s own money (“equity”) as possible and using credit in the hope that the total returns (income plus asset-price inflation) will exceed the interest rate that is paid. The limit to pyramiding is the inability of current income to cover the debt-servicing costs of interest and amortization; or, in the case of Ponzi Schemes, the inability of new entrants to cover the pace of cash withdrawals. This would happen to stock market bubbles, for instance, if pension-fund and privatized Social Security contributors started to retire and withdraw more funds than new contributors were putting into the scheme.