According to Google analytics, a lot of people are interested in the term financial system.
I’ll take it for granted you want to understand it in the same way they do. I’m going to take a stab at explaining it by telling you about Portugal.
That might sound strange. Portugal is an economy on the edge of Europe, mostly irrelevant to world affairs.
But here’s why…
Debt deflation on the edge of Europe
Did you see the news? According to the Financial Times, Portugal’s economy is labouring under one of the heaviest debt burdens of Europe. It’s 370% of GDP.
According to the paper, the Portuguese economy is limping along. It grew 1% in 2014. The debt is a long-term drag on growth.
Here’s why: instead of companies and individuals spending on investments, goods and services, they have to pay off their loans.
That leaves demand in the domestic market anaemic and unemployment high. And of course the government is forced to impose austerity on the population as it slashes public spending.
This is what’s called ‘debt deflation’.
I was actually in Portugal a couple of years ago for a night with my partner. It was one of the strangest evenings of my life. I forget the name of the town but it was in the north, close to the border with Spain.
We arrived around dusk. The town was practically empty. There were no jobs. The population save for a few had left the place. Houses were shuttered, some gutted.
We ate in a restaurant with no other customers. The time of year was close to Christmas, so it was winter. The festive decorations were minimal but also chilling. There was no human warmth in this town.
Mostly there was just dogs listening to the Christmas carols playing in the deserted streets around the central square.
That’s what you get after a ‘rescue’ from the EU and IMF.
Economy #1 and Economy #2
As it stands, Portugal’s current economic growth rate cannot outgrow its debut burden.
In the meantime, the financial sector holding its debts siphons off any surplus the country is capable of producing alongside cost cutting measures. That much is a given, and public knowledge.
Here’s where we get to the heart of the matter. In his recent book Killing the Host, Michael Hudson splits an economy into two halves.
He calls the real, ‘tangible’ economy Economy #1. That’s basically you and I spending on goods and services.
Economy #2 is the Finance, Insurance and Real Estate (FIRE) sector. The main aim of the FIRE sector is to enforce payments of debts and preserve their rent seeking privileges.
In today’s economy, the FIRE sector has hijacked governments and policy to favour it. Here’s the problem. Most its activities produce little genuine wealth.
It’s the parasite, but it’s infected the brain.
Here’s the rub for Portugal: debts that can’t be repaid won’t be repaid. Hudson likes to say that.
It always leaves a binary outcome too. There are only two ways not to pay.
As Hudson writes in the book:
‘The most drastic and disruptive (euphemized as “business as usual”) is for individuals, companies or governments to sell off or forfeit their assets. The second way to resolve matters is to write down debts to a level that can be repaid.
‘Bankers and bondholders prefer the former option, and insist that all debts can be paid, given the “will to do so,” that is, the will to transfer property into their hands.
‘This is the solution that mainstream monetarist economists, government policy and the mass media popularize as basic morality. But it destroys Economy #1 to enrich the 1 percent who dominate Economy #2.’
In other words, for Portugal’s economy to grow strongly again, those debts need to be written off to bring the burden down.
But they won’t be. Here’s why: foreign creditors control Portuguese debt to the tune of 220% of GDP. Portugal will never be permitted to write these debts down.
That’s too bad for the people of Portugal. But as far as their creditors are concerned, they are just serfs to be racked for interest and transfer payments.
We can say there is the unofficial policy of the European Central Bank. The ECB could easily finance jobs and industry in Portugal through its credit creation powers. But it chooses not to.
Certainly no action the European Central Bank has taken is about creating a ‘recovery’. After all, the European Central Bank has no qualms about a stance that’s kept Greece in a depression for years. Why not Portugal too?
And as Hudson further notes, it’s ok for the ECB to authorise 1 trillion euros to buy bonds from banks, but it refuses to lend to any European government on principle. That means those governments have to sell off to the public domain. Meanwhile, the unofficial agenda of the ECB is to protect bondholders and banks. It has no democratic oversight.
In other words, it’s a hijack.
So if you want to understand the financial system, the broader point is this…
It’s about the FIRE sector keeping its host alive, just enough to suck out most of the blood.
Associate Editor, Cycles, Trends and Forecasts