April 17, 2009

Horizon Scanning in Government

Concept, Country Experiences, and Models for Switzerland
Author(s): Beat Habegger Publisher(s): Center for Security Studies (CSS), ETH Zurich Date of publication: Feb 2009 Pages: 36

Description: Confronted with an increasingly interconnected and dynamically changing world, governments are developing new ways of thinking ahead and planning strategically to cope better with future threats and opportunities. This report on Horizon Scanning in Government presents an innovative approach to support governments in dealing with uncertainties and in envisaging and realizing the policies they desire. It outlines the concept and purpose of horizon scanning, reviews the experiences of the United Kingdom, Singapore, and the Netherlands, and develops perspectives for the establishment of horizon scanning in Switzerland.

Document Download: English Version

Are the northern sea routes really the shortest?

Source: diis.dk

Maybe a too rose-coloured picture of a blue Arctic Ocean

Is the world trade soon going to use routes through the Arctic for large amounts of transit shipping?

DOWNLOAD complete report

No, that is much too early, says senior researcher Svend Aage Christensen in a new DIIS Brief. Reading the headlines, it is easy to get the impression that the Arctic Ocean will soon be ice-free, but what grabs the headlines is the few weeks at the end of August and the beginning of September where new opportunities are developing. However, a few weeks’ reduction of the ice cover will not lead to a massive reorientation of the global transit routes. Supposing that large scale Arctic transit becomes physically possible some day, it still has to be economically viable as well.

However, the purpose of the attached brief is not to discuss climate issues, but to deal with the more mundane questions of the distances involved on the northern sea routes as well as the alternative southern sea routes and the expectations of the shipping companies. The brief was inspired by professor Frédéric Lasserre’s presentation at a conference in Reykjavik in January 2009.

As of the first week of September 2008, Arctic sea ice extent had not fallen below the record low observed in 2007, but the season set a new kind of record. For the first time in probably half a century - and definitely since satellite observations began about three decades ago - sea ice retreated enough to create open (not ice-free) waters all the way around the northern ice pack. Open water is defined by the World Meteorological Organization for the purposes of navigation as areas where the ice covers less than one-tenth of the surface. See maps and description below.

Arctic sea ice concentration on September 8, 2008. Image Credit: NASA/Jesse Allen, using data obtained courtesy of the National Snow and Ice Data Center (NSIDC). Text Credit for image description: Rebecca Lindsey, NASA’s Earth Observatory

The above image shows Arctic sea ice concentration on September 8, 2008, as observed by the Advanced Microwave Scanning Radiometer–Earth Observing System (AMSR-E) sensor on NASA’s Aqua satellite. The observations are collected on a pixel by pixel basis over the Arctic. The percentage of a 12.5-square-kilometer pixel covered by ice is shown in shades of dark blue (no ice) to white (100 percent ice). The gray line around the Arctic basin shows the median minimum extent of sea ice from 1979-2000. (The median of a data set is the middle value if you arrange the numbers in order from smallest to largest.)

The southern portions of the Northwest Passage through the Arctic (the western route from Europe to Asia through the islands of northern Canada) opened in early August. Then in early September, ice scientists confirmed that the waters around the Russian coastline—the Northern Sea Route— were navigable, but still treacherous, with shifting floes of thick, multi-year ice, that could coalesce rapidly. The image shows that the widest avenue through the Northwest Passage, Parry Channel, still harbored some ice, but the more circuitous, southern waterways were clear. On the other side of the Arctic Ocean, the passage around Russia’s Taymyr Peninsula, normally locked in by ice, was similarly open. According to a press release from the U.S. National Ice Center, “This is the first recorded occurrence of the Northwest Passage and Northern Sea Route both being open at the same time.”

However, only a few weeks later, in November 2008, the situation was completely different as shown on the following map:

Arctic sea ice extent for November 2008 was 10.63 million square kilometers (4.10 million square miles). The magenta line shows the 1979 to 2000 average extent for November. The black cross indicates the geographic North Pole. Sea Ice Index data. About the data. Credit: National Snow and Ice Data Center

Economic Crisis and Russia’s Defense Industry

Moscow Defence Briefs

Konstantin Makienko

Russia’s economy has been deeply affected by the global economic crisis, and its defense industry is no exception. That said, in addition to its severely negative consequences, the crisis also promises to create new opportunities to improve the efficiency of the sector.


The most serious threats to the defense industry arise from the following circumstances.

Credit Crunch

The availability of financing for the defense-industrial complex began to tighten in the summer of 2008, when banks began to demand higher interest rates and shorter terms.

The average rate for ruble loans rose from 10% in July to 18–20% in September. By the Fall of 2008, bank loans became practically impossible to secure. If firms lost the ability to secure long-term, relative cheap loans in the summer, by the Fall they could hardly even get expensive loans. The financial crisis threatened to become a crisis of production.

This has already hastened the nationalization of the defense industry, a process underway since 2005. Two of the largest private defense companies: the Saturn engine building corporation and the Ufa Engine Building Production Association, which had resisted prior attempts at nationalization, were forced to agree to state control in exchange for financial assistance from the government.

Drop of Demand for Civilian Production

The financial crisis has also led to a sharp decline in demand for the civilian production of Russian defense industry plants. According to the Russian Statistical Service, 38.6% of the production of Russia’s defense plants go to civilian customers. This segment thus accounts for about 10-15% of the drop in earnings for the defense sector as a whole.

Defense plants doing business with state-owned monopolies like Gazprom, Rosneft and Russian Railways will be hit the hardest, as these companies cut back on ambitious investment programs. For example, the reduction of orders from Russian Railways is having a severe effect on Uralvagonzavod, where the production of military hardware (the T-90 main battle tanks) accounts for just 18–20% of the plant’s overall production.

Likewise, the United Aircraft Corporation has had to review production downwards in response to the decline in air traffic and the bankruptcy of several airline companies.

Erosion of Production Chains

The crisis threatens to destroy established production chains due to the collapse of several enterprises. The bankruptcy of a few key enterprises, even of those not part of the defense industry, can lead to the collapse of a production process and have a severely negative effect on finishing companies.

For example, if a metallurgical plant ceases to produce a specific type of metal, due to falling civilian demand, this could lead to a delay or the complete cessation of work at a defense plant that needs this metal. Companies with less dependence on supplier inputs are more likely to survive in this environment. Thus, design bureaus and other enterprises whose production is valued largely in terms of their own intellectual efforts, such as parts producers, are in a better position than shipbuilders, who depend on suppliers for up to 90% of the value of their final product.

Possible Reductions to State Defense Procurement

In response to the growing budget deficit, now forecast at 8% of GDP, the government is taking measures to reduce spending by 15%. President Dmitry Medvedev and Prime Minister Vladimir Putin have both said that state defense procurement would not be affected by this reduction. However, should prices for hydrocarbons continue to fall, the possibility cannot be excluded. Moreover, it is likely that any future reductions will affect the producers and developers of conventional arms first and foremost, while nuclear weapons enterprises will be least affected.

Declining Export Volumes

As the global economic crisis pushes down prices for raw materials, energy and the volume of the global arms market will fall. Historical data point to a correlation between the price of oil and the volume of the global trade in weapons: during periods of high oil prices, the demand for weapons increases, and vice-versa. Now, the weak price structure is likely to lead to fewer and smaller defense orders from developing countries. There is probably no threat of cancellation of the Algerian, Venezuelan and Iranian orders already secured by Rosoboroneksport, but new orders from oil producing states will be harder to nail down.


Every crisis promises new opportunities for business development. The following is a list of just some of the most obvious.

Lower Costs of Production

The cost of defense production has grown quickly over the past two years, due mainly to explosive growth in the cost of metals and labor. As a result, many enterprises suffered losses on state procurement and long-term export contracts, for which prices had been set three or four years earlier. Currently, metal prices are falling and labor costs are at a standstill. This should, in theory, increase the profitability of production.

Weaker Ruble

The growing strength of the ruble, until recently, has been another significant factor undermining the financial strength of Russian defense enterprises. Most export contracts are nominated in dollars, and so the US dollar’s decline to 23 rubles by July 2008 had severely eroded potential profits. Combined with rising costs, the strength of the ruble led to the clear degradation of the financial health of the entire defense industry in the two years leading to the Summer of 2008. But now that the exchange rate has dropped to about 36 rubles to the dollar, long-term export contracts now stand a chance to be quite profitable.

Government Intervention

The defense industry may lack the lobbying power of the oil and gas industries or the construction sector, but on October 16, 2008, President Medvedev ordered Finance Minister Kudrin to take this issue personally in hand. After a few days, an interdepartmental commission was formed under the direction of deputy minister of Finance, Anton Siluanov. Providing assistance for loans was the top priority, and to date the government has set aside 50 billion rubles to subsidize interest payments on bank loans by up to two thirds of the Central Bank’s refinancing rate. This rate is currently 13%, meaning that the government will subsidize the commercial rate charged to a defense enterprise (as noted above, ranging from 18–20%) by about 9%.

All of this assumes, of course, that the banks are in a position to make loans. To encourage banks to restart lending, the commission is also seeking to simplify the issuance of state guarantees for bank loans to the defense industry. This requires amendments to budget legislation, which can only be passed next year. Discussions are underway in the Ministry of Finance to set up to 100 billion rubles aside for this purpose.

Meanwhile, access to export financing from Vneshekonombank and Vneshtorgbank (VTB) will prove critical to the sector’s recovery. VTB head Andrey Kostin announced in November 2008 that his bank has already lent 55.3 billion rubles to the defense industry and is currently reviewing applications for another 20 billion rubles.

Uncertain access to commercial loans increases the importance of timely payments for state defense procurement contracts. Currently, however, such payments to enterprises are often made in the second half of the year, and sometimes as late as October or November. Before the crisis, enterprises were able to take out bridging loans to pay for inputs and salaries. However, these are no longer available, and so delays in payments for state procurement may lead to disruptions in production. Rosoboroneksport chief Sergey Chemezov’s has thus quite sensibly proposed that 80% of the payment for state procurement orders be provided to enterprises in advance

Nordic Countries Must Take Care of Each Other

Nordic Countries Must Take Care of Each Other - A Time for New Nordic Cooperation in Security and Defence?

Open seminar - registration required
Tue 21.4.2009 at 13:00-15:00

the Auditorium of the new Annex Building of the Parliament
Arkadiankatu 3

In June 2008 the Norwegian Foreign Ministry asked Thorvald Stoltenberg, previous Norwegian Foreign and Defense Minister, to prepare a report on how Nordic countries could develop their foreign and defense cooperation. The report, published in February 2009, consists of thirteen concrete proposals. They cover topics such as crisis management, air and sea surveillance, arctic cooperation, societal security, as well as other forms of military cooperation, including a suggestion for a Nordic solidarity declaration. The proposed areas of cooperation are open to all Nordic countries, but initially it is enough if two or three states begin cooperation, which would allow for other Nordic states to join in later on.

Key Note Speaker:
Mr. Thorvald Stoltenberg, Chair, Nordic Foreign and Security Policy Working Group

Mr. Stoltenberg has been Minister of Foreign Affairs as well as Minister of Defence of Norway. He also acted as a UN High Commissioner for Refugees 1989-1991, and UN Ambassador in 1989. He was Chief Negotiator for the UN and Co-Chairman of the International Conference for the Former Yugoslavia 1993-1996 after which he proceeded to be Ambassador to Denmark in 1995-1999 and President of the Norwegian Red Cross 1999-2008.


Ms. Ulla Anttila, Researcher, National Defence University

Ms. Anttila acted as a Member of Parliament from 1991 to 2007. She is today a Doctoral student at the National Defence University, specializing in crisis management under the theme of "New conflicts, human security and challenges in evolving crisis management ? opportunities for learning". She was a member of Mr. Stoltenberg's expert group on Nordic security policy.

Col. Erik Erroll, Director, Department of Strategy and Defence Studies, National Defence University

Colonel Erroll is Director of the Department of Strategy and Defence Studies at the National Defence University. Previously he has worked as Defence Attache in Stockohlm (2005-2008), Chief of Staff at the Uusimaa Brigade (2001-2005) and Senior Military Adviser at the Ministry of Defence (1997-2001). Erroll has served in Bosnia (KFOR-99) and holds a Master of Political Science from Åbo Akademi.

Mr. Juha Korkeaoja, Member of Parliament, Chair of the Defense Committee

Mr. Korkeaoja has been a member of the Finnish Parliament since 1991. He was the Minister of Agriculture and Forestry 2003-2007. Since May 2007 he has chaired the Defence Committee. Mr. Korkeaoja was also the Chairman of the Parliamentary Security Policy Monitoring Group in 2007-2008, which gave the parliamentry input to the Government report on the Security and Defence Policy of Finland 2009.

Dr. Hanna Ojanen, Programme Director, Finnish Institute of International Affairs

Interpretation from Norwegian into English will be provided.

What to do About Piracy?

by Mackubin Thomas Owens

Source: http://www.fpri.org/enotes/200904.owens.piracy.html......Foreign Policy Research Institute

April 2009

Mackubin T. Owens is a Senior Fellow of FPRI, editor of Orbis, and Associate Dean of Academics for Electives and Directed Research and Professor of National Security Affairs at the Naval War College, Newport, Rhode Island.

Piracy, a scourge that had been stamped out in the 19th century, still flourishes in those Hobbesian areas of the world where order and the “rule of law” do not exist. The seizure of a U.S.-flagged vessel, the MaerskAlabama, earlier this month and the subsequent rescue of the ship’s captain by the U.S. Navy has alerted Americans to the fact that Somalia and its coast is such an area. Ever since the collapse of the Somali government in 1991, it has been a particularly stark example of what is now called a “failed state.”

According to statistics provided by the International Maritime Bureau, there were 293 incidents of piracy or armed robbery in 2008, of which 130 occurred off the coast of Somalia and in the nearby Gulf of Aden. Of these, about 50 were successful. With the exception of the United States (in the Maersk Alabama incident) and the French, most governments, shipping companies, and insurers have opted to pay ransoms amounting to millions of dollars to free crews and vessels.

What is to be done? One school of thought argues that we should do little or nothing because the cost of stamping out piracy again is too high. They point out that some 21,000 ships transit the Gulf of Aden every year and maintain that 50 successful pirate attacks doesn’t really constitute much of a threat, certainly not one worth expending the resources necessary to eliminate it. Ideas on how we might do so include arming crews or providing specialized armed detachments. As Derek Reveron, my Naval War College colleague, observes, the costs of providing security teams aboard merchant vessels or arming crews and training them to defend the ship probably exceed the costs of paying ransom for the rare ship taken.

In addition, Reveron argues, piracy in this part of the world isn't an American problem. He contends that piracy is an annoyance, but other than offending our sense of freedom of the seas, it doesn't for the most part affect American shipping. Thus focusing on piracy is an example of the tail wagging the strategic dog. He argues that the Europeans and Asians, who are quick to demand U.S. leadership on the one hand and criticize the United States for its actions on the other, ought to be responsible for dealing with pirates here.

But others point out that piracy is a threat to a peaceful, commercial “liberal world order.” For instance, the threat of piracy has a dampening effect on commerce, raising insurance rates and other costs of transporting goods by sea. Such increases in the cost of commerce are not good any time, but especially during a recession.

Experience seems to indicate that a “liberal world order” does not arise spontaneously as the result of some global “invisible hand” but requires the actions of a powerful state willing and able to provide the world with the “collective goods” of economic stability and international security. Today, the United States is the only state able to provide either of these beyond its own territory, especially on the great “commons” of the sea. Thus, according to this view, the United States today must lead the other maritime commercial states in an effort to end piracy, just as Great Britain did during the 19th century.

But there are major practical problems with doing so. The first is the vast sea area, about four times the size of Texas, in which the Somali pirates operate. Patrolling an area with about 1300 nautical miles of coastline requires a huge commitment of naval resources. In fact, at any one time, the U.S. 5th Fleet has 5-10 ships in the area. That commitment is complemented by both an EU naval force and a NATO fleet. Several other countries, including China, Russia, India, Saudi Arabia, and Malaysia, have provided naval assets for anti-piracy operations in the area or will soon do so. But the area is simply too large for a continuous naval presence sufficient to deter or defeat the pirates.

Then there is the political economy of Somali piracy, which has created a network that provides intelligence, sanctuary, funding, and the “mother ships” that provide the pirates with the “reach” they need for their depredations. Additionally, the pirates have demonstrated a remarkable ability to adapt to changing circumstances, avoiding the Somali coast in order to thwart anti-piracy patrols, docking at ports in other countries to refuel and lay on supplies.

But the elimination of piracy is more a question of will than of resources per se. Piracy (along with the slave trade) was crushed in the 19th century when the states of Europe, rather than tolerating the practice as they had done in the 17th and 18th centuries, decided to take action. The effort was led by Great Britain, with the Royal Navy as the primary instrument. What made the actions successful was the determination of Great Britain and others to attack the source of piracy. The Royal Navy in particular not only captured and sank pirate ships, but also attacked pirate sanctuaries, destroying their bases.

In the 19th century, the United States also played a role in ending the piratical forays of the Barbary States of North Africa. This is one of the reasons why it has been nearly two centuries since pirates last attempted to seize a vessel flying the American flag.

After losing the protection of Great Britain as a result of America’s Declaration of Independence, American ships were preyed upon by the Barbary States—Algiers, Tunis, Morocco, and Tripoli (today's Libya). Like the Europeans during the same period (and most maritime states today), the Americans deemed the cost of military action too high and opted to pay “tribute” to the Barbary States. But the demands for these bribes kept growing while the seizure of U.S. ships only increased.

Congress authorized the construction of several frigates and President Thomas Jefferson dispatched them in 1801 for “policing actions” in the Mediterranean after the pasha of Tripoli declared war on the United States. During the next several years, the fledgling American Navy bombarded the harbors of Algiers, Morocco, and Tunis or threatened them with bombardment. As a result of these actions, these states agreed to cease cooperating with Tripoli. But the pasha remained defiant.

In 1804, a naval force under Captain Stephen Decatur boldly sailed into Tripoli harbor, where he set fire to the captured USS Philadelphia, later rescuing its crew, bombarding the fortified town, and boarding the pasha's own fleet where it lay at anchor. In April 1805, Captain William Eaton led an expedition consisting of U.S. Marines, mercenaries, and Arab rebels across many miles of desert to take Tripoli's second city, Derna, by surprise, largely ending the depredations of the Barbary pirates against U.S. ships in the Mediterranean.

To adopt such an approach to piracy today, however, would require a return to a distinction in the traditional understanding of international law, one that did not extend legal protections to individuals who do not deserve them. This distinction was first made by the Romans and subsequently incorporated into international law by way of medieval and early modern European jurisprudence, e.g. writings on the law of nations by such authors as Hugo Grotius and Emer de Vattel.

The Romans distinguished between bellum, war against legitimus hostis, a legitimate enemy, and guerra, war against latrunculi—pirates, robbers, brigands, and outlaws—“the common enemies of mankind.” The former, bellum, became the standard for interstate conflict, and it is here that the Geneva Conventions and other legal protections were meant to apply. They do not apply to the latter, Guerra—indeed, punishment for latrunculi traditionally has been summary execution, although the extreme punishment was not always exacted. The point is that until recently, no international code has extended legal protection to pirates.

As Grotius wrote in Mare Librum (The Free Sea), “all peoples or their princes in common can punish pirates and others, who commit derelicts on the sea against the law of nations.” And more forcefully, Vattel wrote in his 1738 treatise, The Law of Nations, that “legitimate and formal warfare must be carefully distinguished from those illegitimate or informal wars, or rather predatory expeditions, undertaken, either without lawful authority, or without apparent cause, as likewise without the usual formalities, and solely with a view to plunder.”

Once this distinction is revived, it opens the way for the only real way to stamp out piracy, as was done in the 19th century: the use of force to wipe out the pirate lairs. Under the old understanding of international law, a sovereign state has the right to strike the territory of another if that state is not able to curtail the activities of latrunculi.

As John Locke understood, pirates are in a “state of nature” relative to political society. And political society has the right to defend itself against such individuals:

“That, he who has suffered the damage has a right to demand in his own name, and he alone can remit: the damnified person has this power of appropriating to himself the goods or service of the offender, by right of self-preservation, as every man has a power to punish the crime, to prevent its being committed again, by the right he has of preserving all mankind, and doing all reasonable things he can in order to that end: and thus it is, that every man, in the state of nature, has a power to kill a murderer, both to deter others from doing the like injury, which no reparation can compensate, by the example of the punishment that attends it from everybody, and also to secure men from the attempts of a criminal, who having renounced reason, the common rule and measure God hath given to mankind, hath, by the unjust violence and slaughter he hath committed upon one, declared war against all mankind, and therefore may be destroyed as a lyon or a tyger, one of those wild savage beasts, with whom men can have no society nor security: and upon this is grounded that great law of nature, Who so sheddeth man’s blood, by man shall his blood be shed.”

The United States acted in accord with this understanding in the early 19th century. In response to raids from Spanish Florida by Creeks, Seminoles, and escaped slaves, General Andrew Jackson, acting on the basis of questionable authority, invaded Florida, not only attacking and burning Seminole villages but also capturing a Spanish fort at St. Marks. He also executed two British citizens whom he accused of aiding the marauders.

Most of President James Monroe’s cabinet, especially Secretary of War John Calhoun, wanted Jackson’s head, but Secretary of State John Quincy Adams came to Jackson’s defense. He contended that the United States should not apologize for Jackson’s preemptive expedition but should insist that Spain either garrison Florida with enough forces to prevent marauders from entering the United States or “cede to the United States a province, which is in fact a derelict, open to the occupancy of every enemy, civilized or savage, of the United States, and serving no other earthly purpose than as a post of annoyance to them.” As Adams had written earlier, it was his opinion “that the marauding parties ought to be broken up immediately.” As John Gaddis has observed, Adams believed that the United States “could no more entrust [its] security to the cooperation of enfeebled neighboring states than to the restraint of agents controlled, as a result, by no state.”

Unfortunately, we have permitted legalism and moralism to twist our understanding of the “rule of law” into something that Grotius, Vattel, Locke, or the Founders would no longer recognize. For instance, European navies have been advised to avoid capturing Somali pirates since under the European Human Rights Act, any pirate taken into custody would be entitled to claim refugee status in a European state, with attendant legal rights and protections.

Americans must understand that if we really wish to root out piracy today, we must be willing to take strong steps. But these steps will require us to change the current mindset, which does not distinguish between war against legitimate enemies and war against “the common enemies of mankind,” which include not only pirates but also terrorists.

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The Financial War Against Iceland

By Prof Michael Hudson

17 April, 2009
Global Research

Iceland is under attack – not militarily­ but financially. It owes more than it can pay. This threatens debtors with forfeiture of what remains of their homes and other assets. The government is being told to sell off the nation’s public domain, its natural resources and public enterprises to pay the financial gambling debts run up irresponsibly by a new banking class. This class is seeking to increase its wealth and power despite the fact that its debt-leveraging strategy already has plunged the economy into bankruptcy. On top of this, creditors are seeking to enact permanent taxes and sell off public assets to pay for bailouts to themselves.

Being defeated by debt is as deadly as outright military warfare. Faced with loss of their property and means of self-support, many citizens will get sick, lead lives of increasing desperation and die early if they do not repudiate most of the fraudulently offered loans of the past five years. And defending its civil society will not be as easy as it is in a war where the citizenry stands together in coping with a visible aggressor. Iceland is confronted by more powerful nations, headed by the United States and Britain. They are unleashing their propagandists and mobilizing the IMF and World Bank to demand that Iceland not defend itself by wiping out its bad debts. Yet these creditor nations so far have taken no responsibility for the current credit mess. And indeed, the United States and Britain are net debtors on balance. But when it comes to their stance vis-à-vis Iceland, they are demanding that it impoverish its citizens by paying debts in ways that these nations themselves would never follow. They know that it lacks the money to pay, but they are quite willing to take payment in the form of foreclosure on the nation’s natural resources, land and housing, and a mortgage on the next few centuries of its future.

If this sounds like the spoils of war, it is – and always has been. Debt bondage is the name of this game. And the major weapon in this conflict of interest is how people perceive it. Debtors must be convinced to pay voluntarily, to put creditor interests above of the economy’s prosperity as a whole, and even to put foreign demands above their own national interest. This is not a policy that my country, the United States, follows. But popular discussion in Iceland to date has been one-sided in defense of creditor interests, not that of its own domestic debtors.

Ultimately, Iceland’s adversary is not a nation or even a class, but impersonal financial dynamics working globally and domestically. To cope with its current debt pressure, Iceland must recognize how uniquely destructive an economic regime its bankers have created, through self-serving legislation and outright fraud. With eager foreign complicity, its banks have managed to create enough foreign debt to cause chronic currency depreciation and hence domestic price inflation for many decades to come.

To put Iceland’s financial dilemma in perspective, examine how other countries have dealt with huge debt obligations. Historically, the path of least resistance has been to “inflate their way out of debt.” The idea is to pay debts with “cheap money” in terms of its reduced purchasing power. Governments do this by printing money and running budget deficits (spending more than they take in through taxes) large enough to raise prices as this new money chases the same volume of goods. That is how Rome depreciated its currency in antiquity, and how America managed to erode much of its own debt in the 1970s – and how the dollar’s falling international value has wiped out much of the U.S. international debt in recent years. This price inflation reduces the debt burden – as long as wages and other income rise in tandem.

Faced with an unprecedented explosion of debt obligations – many of them apparently fraudulent, and certainly in violation of traditional credit practice – Iceland has turned this inflationary solution inside out. Instead of permitting the classic credit cure of inflating the currency, it has created a dream economy for creditors, preventing the classical escape from debt. Iceland has found a way to inflate its way into debt, not out of it. By indexing debt to the rate of inflation, it has guaranteed a unique windfall for banks that vastly increases what they receive in a “down market,” at the expense of wage earners and industrial profits. Linking mortgage loans to the consumer price index (CPI) in the face of a depreciating currency and heavy balance-of-payments drain to foreigners can have only one result: destruction of Iceland’s society and its traditional way of life.

Iceland needs to repudiate this debt bomb. Under present policy its debts will never lose value, because they are indexed to inflation. This in turn is being caused in large part by foreign debt service collapsing the currency, raising import prices and thus causing even larger debt payments in an endless treadmill. The economy shrinks, wages fall and assets lose value, yet debt obligations continue to grow and grow. The resulting evisceration of wages, living standards and consumer spending will further shrink the economy – a prescription for economic virus that threatens to plague Iceland for many decades if it is not reversed now. Capital formation will plunge as consumers lack money to spend. Many may not have enough to survive. The economy will be “crucified on a cross of gold,” to use William Jennings Bryan’s famous phrase in the 1896 American presidential election when he advocated an inflationary coinage of silver to alleviate debt pressure on U.S. farmers and labor.

Another side to the discussion?

Despite having spent the past half-century focusing on countries with balance-of-payments problems, even I find Iceland’s uniquely self-destructive financial regime shocking. Before you dismiss my candor, I should offer a short personal résumé so that you understand that my conclusions are based mainly on having been an insider to the game of imperial-style plundering of nations for forty years. In the mid-1960s I was the balance-of-payments economist for the Chase Manhattan Bank and then for Arthur Anderson, and later for the United Nations Institute for Training and Research (UNITAR). I have taught international economics at the graduate level since 1969, and now head an international group on economic and financial history based at Harvard. In 1990 at Scudder Stevens and Clark, I organized the world’s first sovereign-debt fund. All these jobs involved analyzing the limited ability of debtor countries to pay – how much could be extracted from them through foreign-currency loans and how much public infrastructure was available to be sold off in a voluntary virtual foreclosure process by countries willing to submit to creditor-dictated rules.

I first wrote about monetary imperialism in the 1970s in my book Super Imperialism. It should have been entitled “Monetary Imperialism” because it detailed how replacing gold with paper dollar IOUs for trade and balance-of-payments deficits in 1971 allowed the United States to exploit the rest of the world without limit. Phasing out gold payments among central banks in favor of fiat paper money allowed the United States to run up massive debts equal to its cumulative payments deficit, far beyond its ability to pay. It currently owes over $4 trillion, while running a chronic trade deficit with enormous overseas military spending, financed entirely by other countries through their central banks. This is euphemized as the “international monetary system.”

I also was an advisor to the Canadian government in the 1970s. My main work was to write a monograph explaining why countries should not borrow in foreign currencies, but should monetize their own credit for domestic spending and investment. In recent years I have taught in Latvia and given this same advice to its officials. I provide this background because it has obvious relevance to Iceland’s financial situation today. It has broken the cardinal rule of international finance: Never borrow in a foreign currency for credit that you can create freely at home. Governments can inflate their way out of domestic debt – but not out of foreign debt. That is a large part of the problem that Iceland now faces.

The main thrust of my comments therefore will focus on the international dimension of Iceland’s debt problem, especially with regard to its relations with Europe. It therefore is relevant to look at what is happening in today’s “expanded Europe.” As the financial press has been reporting, post-Soviet economies have met with disastrous results after having moved to join the European Union during the past decade. The recent riots of debtors, farmers and labor union members from the Baltics to Hungary are symptomatic of the deep economic woes surging over these countries. Resentment is growing that instead of helping them industrialize and become more efficient, Europe and its Lisbon Treaty simply handed matters over to its bankers, who looked at these countries simply as credit customers to be loaded down with debt – not for loans to build up manufacturing and the infrastructure sorely needed by these countries, but loans mainly against existing real estate and infrastructure collateral already in place. That is the quickest way to make money, after all – and finance traditionally has lived in the short run.

This problem was bound to arise, given Europe’s postindustrial faith that whatever increases “wealth” – even by the trick of puffing up real estate and other asset prices – is as productive as building new industrial capacity and infrastructure. The result of this ideology was a set of bubble economies built on debt-financed real estate and stock market inflation. Such bubbles always burst at some point. Only belatedly are nations re-discovering the classical axiom that the only way to pay for imports on a sustainable basis is to produce exports.

Unfortunately, neither foreign banks nor European advisors encouraged this. Their policy de-industrialized the post-Soviet countries, which financed deepening trade deficits by borrowing in foreign currency against their real estate. The Baltic States borrowed euros, sterling and Swiss francs, mainly from Swedish banks to finance a real estate bubble, while Hungary and its Central European neighbors borrowed heavily from Austrian banks. Their economies are shrinking now that their casino economies gambling on asset-price inflation have burst. Rental income and hence property prices are plunging, and exchange rates are following suit. This makes a foreign-currency mortgage cost more than local property is yielding. The result is widespread mortgage default, causing severe losses for Swedish and Austrian banks.

Bad real estate debts also are pulling down banks in the two leading creditor nations, Britain and the United States. Real estate prices, stock market prices and employment are going down in a straight line unprecedented even in the Great Depression of the 1930s. This has turned the neoliberal financial dream of “creating wealth” by inflating asset prices, by creating credit without actually increasing tangible capital formation (wages and living standards) into a nightmare. Just as individuals can’t live off a credit card forever, neither can nations. As any classical economist knows, societies that only manufacture debt are unsustainable. Casinos may be fun places to visit (customers pay by losing their money), but no place to live. The same is true of casino economies.

No help from the EU or the current global economy

The European Union is not in a position to offer much help in solving Iceland’s financial problems. The continent’s integration in the 1950s was pioneered by social democrats and pro-industrial idealistic capitalists such as Konrad Adenauer and Charles de Gaulle hoping to end the continent’s internecine wars forever. They succeeded, by forming the seven-nation Common Market in 1957. But further European expansion occurred largely on the financial sector’s terms. That is the source of problems fracturing “old” and “new” Europe today. It is the context in which Iceland’s debt problem is now being played out.

It seems natural enough for people to pay debts that have been taken on honestly. The normal expectation is that people will borrow – and banks will make loans – only for sound investments, ones that are able make a profit enabling the debtor to pay back the lender with interest. This is how banks have worked for many centuries – hence, the image of the prudent bankers who says “no” to any questionable deals brought before them.

At least that was the old way of doing things. Almost nobody anticipated a world in which bankers would create credit irresponsibly, leading to the massive defaults we are seeing throughout the world today. In the United States, for example, no less than a third of home mortgages have fallen into a state of Negative Equity. That is to say, the mortgage exceeds the market price of the real estate pledged as collateral. The U.S. national debt has tripled during the past year, from $5 trillion to $15 trillion as a result of financial bailouts including the government taking on the $5.2 trillion mortgage-packaging giants, Fannie Mae and Freddie Mac. A single insurance company, A.I.G., has been slated to receive a quarter-trillion dollars of bailout money, and a single bank, Citibank, has received over $70 billion and still counting. The stocks of these hitherto financial giants have fallen to just pennies, and Congress is now debating whether finally to nationalize them and wipe out their stockholders and even their bondholders.

In Britain much the same has occurred. Sitting in the lounge of Heathrow airport last month, I watched the hearings on BBC where members of Parliament expressed amazement that the most seriously affected banks were not led by bankers but by marketing men. Their job was not to calculate prudent loans, but to sell as much debt as possible, without regard for the debtor’s ability to pay. The result is that the Bank of England – like the U.S. Treasury – is printing new bonds whose interest charges will have to be paid by taxes on labor and industry.

How can Iceland be expected to cope in this kind of financial environment? To get a perspective on what would be a dystopian future, one may look at the dress rehearsal for the so-called financial “reforms” played out in the 1990s in Russia and other post-Soviet countries. These are reforms that creditors – including the European banks, I’m sorry to say – now wish to impose on Iceland. In Russia, life expectancies sharply declined, while health, prosperity and hope withered as outside forces imposed austerity measures and high interest rates. Russians woke up to find that the devastation of the reforms foisted on them were as severe as the Second World War in reducing population, destroying industry, spreading disease and losing control of their economy. Living standards plunged, especially for retirees, while employment prospects closed for the young. Much the same occurred throughout the former Soviet Union.

This policy remains the “fix” for debtor countries: Sell off assets for pennies on the dollar to kleptocrats across the globe, and gut the nation’s social welfare programs just at a time they are needed most. By contrast, look at the nations calling most loudly for Iceland to pay the loans made by global speculators and arbitrageurs. They include the largest debtor nations, headed by the United States and Britain, led by politicians who never would dream of imposing such hardship on themselves. While cutting their own taxes and increasing their own government budget deficits, these nations are attempting to extricate financial tribute from smaller, weaker countries that they can bully, as they did to Third World debtors in the 1980s and ‘90s.

Dismantling industrial capitalism

This is a crisis that calls for blunt truths. What creditor nations and their international financial institutions are promoting is not capitalism as traditionally understood. Instead of helping industrialize the countries to which they extended credit so as to make them viable and self-reliant with new means of paying for their imports – and indeed, paying the debts taken on to rebuild their productive capacity – European planners oversaw the dismantling of manufacturing.

Even worse, they did so in a way that empowered a neo-feudal set of financial oligarchs. Indebted economies have been turned into a gaggle of casinos, with special games (e.g., opaque financial instruments such as credit-default swaps) reserved exclusively for insiders. Even to get into this game, one must be at last a millionaire, signing legal releases that one can afford to lose the entire investment and still survive economically. The European Union thus adds insult to injury by presenting its financial agencies euphemistically as donors bringing aid. They turn out to be the same ideologues that have crippled industrial capitalism across the globe by proliferating debt-leveraged gambles that have redistributed wealth upwards wherever they have operated.

This policy creates debt peonage for most citizens, above all in the newer countries seeking to join the European Union. Even in the richest nation on earth – the United States – nearly half of all citizens now have no net worth, and the gulf between the wealthiest 10 percent and the rest of society has widened geometrically since 1980. This is the unfair system that the world’s top creditors would export to Iceland – if they can convince its voters to accept neoliberal debt pyramiding as a way to get rich. The recent riots throughout the post-Soviet states suggest that this plan is not working. Their populations are now feeling how deeply the so-called financial reforms (e.g., financial deregulation) promoted by European banks and the Lisbon Agreements have polarized their economies.

Recognizing the enemy within

The only defense against such disastrous policy is to recognize that there are better alternatives. It simply is not possible for today’s astronomically indebted economies to “work their way out of debt” with the old trick of inflating the money supply. Trying to do so will collapse the currency’s exchange rate and divert so much revenue to pay creditors – and transfer so much property out of local hands – that a new kind of post-capitalist, non-production/consumption economy will be created, one less and less able to be self-reliant and independent, to say nothing about being just and sustainable.

Iceland’s financial crisis today is less an issue of international law as of outright lawlessness perpetrated by the purveyors of so-called free market democracy. Nations pressing Iceland for payment impose one set of laws for others while following quite a different set for themselves. Preaching to Iceland about international law, the United States and Great Britain themselves have broken the clearest of international laws – those against waging aggressive war. Their propagandists are skillful at using the language of capitalism and morality, yet they are neither capitalist nor moral. Their financial strategy is to play an ages-old psychological game. Make countries like Iceland feel guilty about being debtors rather than recognizing they have been victims of an international Ponzi scheme. In a nutshell, the game is to lay down “laws” for debtors in the form of destructive austerity programs fashioned by irresponsible and indeed, parasitic creditors. This “aid advice” ends in outright asset stripping, both public and private.

Asset stripping to pay debts has caused collapse time and again in history, but is strangely downplayed in today’s academic curriculum as an “inconvenient truth” as far as vested financial interests are concerned. Income is siphoned off by a scheme that is elegant and simple. Hapless victims – and now entire economies, not just individuals – are maneuvered onto a debt treadmill from which there is no escape. Creditors pile on credit and let the debts grow at the “magic of compound interest,” knowing that their loans cannot be repaid – except by asset sell-offs. No economy’s productivity can keep pace with exponentially compounding debt. Whatever was owned (and indeed, financed originally by public debt but now paid off) is stripped away for interest payments that never end. The aim is for these payments to absorb as much of the surplus as possible, so that the national economy in effect works to pay tribute to the new global financial class – bankers and money managers of mutual funds, pension funds and hedge funds.

The product they are selling is debt. They build up their own wealth by indebting others, and then forcing sell-offs to buyers who take on their own debt in the hope of making asset-price gains as property prices are impossibly inflated relative to the wages of living labor. This has become the new, euphemistically dubbed post-industrial form of wealth creation – a strategy that is now collapsing economies throughout the world.

The role of the United States

The United States has trapped other countries into a nightmarish system in which they have little practical choice but to recycle their excess balance-of-payments dollar inflows back to the United States, mainly in the form of loans to the U.S. Treasury. When foreign central banks receive dollars for their exports (or for the sale of their companies), they are limited in what they can do with these dollars. The U.S. Congress will not let them buy up important domestic companies or resources, and will not part with U.S. gold holdings. So foreign central banks are obliged to buy Treasury bonds – or, as the supply of these bonds has run out (being limited by the domestic budget deficit), mortgage-backed securities issued by the now-public Fannie Mae and Freddie Mac packagers of subprime mortgages. These two semi-official agencies were formally nationalized last year after a series of financial frauds and disastrous investments wiped out their capital, obliging the U.S. Government to step in and mollify governments from China to Israel whose central banks had been recycling their surplus dollar inflows into these securities.

Icelanders should keep one basic principle uppermost in their minds. The United States is the world’s largest debtor nation, and will never repay its own foreign debt. Over and above its presently outstanding four trillion dollars, its Treasury intends to keep on issuing new paper IOUs in exchange for the goods, services and real assets of China, Japan and other creditor nations – until governments stuck with these paper dollars turn their back on this Madoff-Ponzi scheme (note that these schemes always are named for American operators), recognizing what Adam Smith explained in The Wealth of Nations: No nation has ever repaid its debts. Small nations like Iceland, along with small taxpayers in wealthy countries, may be coerced with propaganda, mind games and outright threats into paying – until they have no assets left to hand over. But the big boys are above the law. They control the courts (which often rule without much regard for the actual law), just as they write history and newspaper coverage – and business school curricula – to serve their own interests.

The second important principle is how radically today’s post-capitalist order has inverted traditional ways of making money. Instead of making profits on new capital investment, the easiest path to quick riches in today’s global financial system is to foreclose at pennies on the dollar, and make a “capital gain” by flipping property onto world financial markets that are being inflated by central banks. While financial spokespersons promise that “there is no such thing as a free lunch,” today’s hit-and-run financial bubble, fraud and insider privatizations culminating in public-sector bailouts (“socializing the risk” while privatizing the profits and capital gains) – has become all about obtaining a free lunch.

Iceland’s zero-sum financial gamble

But it is a zero-sum gambling game, with losers on the other side of the table from the winners. One party’s gain is another’s loss – and indeed, this kind of game ends up shrinking the economy by diverting resources away from real investment in tangible capital formation. Unlike industrial capitalism, which employs labor and invests in capital equipment to turn raw materials into salable commodities, today’s post-industrial financialized system only offers the virtual (and temporary) wealth of asset bubbles. Its financial managers claim to be acting in the tradition of classical economists and share their concept of free markets, but in actuality they have been part of an intellectual fraud that depicts their system as something other than the financialized wealth extraction on the real economy of production and consumption that it is. Financialized wealth is extractive, not productive. That is because loans, stocks and bond securities are claims on wealth, not real wealth itself.

This is the context in which today’s financial war against Iceland is being waged. Homeowners are paying tribute, not in the form of taxes to an invading occupying force, but in interest to local sponsors of the debt pyramiding that has got Iceland into such deep trouble, and to the international creditors and enablers of this over-financialization of the economy. The nation’s public domain, its land and geothermal resources, its tourist industry and public assets are being eyed by foreign creditors as prey to be seized in the way that has occurred in many Third World countries. It is what ruined Turkey and Egypt in the late 19th century and brought down other kingdoms for centuries before that. Yet many Icelanders are heading into this future voluntarily, as if it somehow is fair rather than an exercise in predatory finance led by nations that have shown no willingness (or ability) to pay their own international debts.

Nations know when they are being attacked militarily. Defense forces fight to prevent invaders from seizing their land and imposing tribute. No country would think of welcoming a foreign army to do what William the Conqueror did to England after 1066. He ordered his accountants to compile the Domesday Book within thirty years (it was ready by 1086), calculating the rental value of English land in order to tax it for the Crown.

That is how most of Europe’s kingdoms were created. The rent was paid to the companions of military warlords, and their heirs ruled as absentee Lords for nine centuries. They quickly moved to keep what started out as royal revenue for themselves, celebrating this as the victory for free-market “democracy” in the Magna Carta liberatum (1215) and subsequent Revolt of the Barons (1258-65). Today, these lords of the land and those who have bought their property have run up mortgage debt, paying creditors what formerly was paid first as taxes and then taken as rent.

What took centuries to achieve in feudal Europe is now being threatened in Iceland, compressed into the space of just a decade or so. And in many ways this financial situation doesn’t make sense – unless one looks through history to see how the same tragedy has happened again and again.

The United States, Britain and the International Monetary Fund (“the global investment community”) are couching their demands for draconian austerity policies in the language of capitalism. But what they actually are promoting is a financial system that threatens to end in debt peonage, not democratic capitalism. Across the globe, from the Baltics to Hungary in Europe, and indeed from Russia to China, riots and wildcat strikes recently have broken out to protest this post-capitalist financial dynamic. It already has destroyed the industrial capacity of debtor countries subjected to the cruel austerity programs imposed by the IMF as acting agent for the global financial class. This merely repeats what the British did in India. Industrial growth has been replaced with a financialized real estate bubble. The “final stage” of this dynamic is to foreclose and sell off the assets of debtors at giveaway prices. Talk about democracy from the financial elite is a public-relations cover story. Their “magic of compound interest” sales pitch threatens to destroy entire nations.

Fortunately, this need not happen in countries that do not impose debt leveraging on themselves, but only in countries that let the public utility of money and credit creation be privatized in the hands of a cosmopolitan financial class. Iceland still has an alternative future before it, if voters recognize this in time. But to achieve the better future that most of its citizens want, it must understand the predatory debt trap into which it has fallen – or more accurately, been pushed by believing in the same illegitimate financial doctrine that has ruined Russia and other post-Soviet economies, as well as Third World countries before them under decades of IMF “austerity plans” designed to stifle domestic growth (and competition) and economic stability to pay foreign creditors. History provides tragic examples – the aftermath of World War I, and England itself in the centuries of its seemingly perpetual wars with France.

Industrial economies reverting to “tollbooth economies”

The world is plunging “back to the future,” to an epoch of neo-feudalism and debt peonage. It is a travesty of the promise of industrial capitalism as it seemed to be evolving on the eve of the 20th century and the Progressive Era of social democracy. What was not recognized was the financial time bomb implanted in the DNA of Europe as it evolved out of the Middle Ages.

As European feudalism gave way to the formation of nation-states, most kingdoms became dependent on foreign loans to fight their wars – starting with the Crusades, whose looting of Byzantium provided an enormous influx of gold and silver. This is what broke down Church bans on usury. Once governments paid interest to elite Church orders such as the Templars and Hospitallers, it became permissible for banks to join in lending at interest – to kings, the nobility and the merchant classes as major customers.

The birth of international post-medieval banking proved disastrous for many family banks that foundered on what turned out to be bad loans to the leading powers of early Europe, from Spain to France and England. The historian Richard Ehrenberg notes that Spanish bankruptcies “occurred at intervals of about twenty years – 1557, 1575, 1596, 1607, 1627, 1647,” often being rationalized by pious allusions to Church prohibitions against usury. England declared bankruptcy under Edward III in 1339, and Charles II shut down the Exchequer in 1672 and suspended payment on its floating debt. Wiping out debts was the only way to retain basic economic and political relations and national independence. In view of this long experience, England’s advice to Iceland today is in the character of “Do as we say, not as we ourselves have done and are doing.”

Central banks were formed to advance credit to governments, and commercial banks to help finance the Industrial Revolution’s expanding trade and related infrastructure spending, mining and shipping, capped by infrastructure monopolies such as canals, railroads and ports, and later by fuel and power. The medieval epoch’s “primitive accumulation” – the extraction of revenue by military seizure – was replaced by the more peaceful and seemingly civilized practice of creditors appropriating the economic surplus by making interest-bearing loans, and by foreclosing on property when the interest charges could not be paid.

In recent years financial managers have persuaded many countries to sell off public enterprises like their water or energy supplies, mainly to raise the money to pay debts or to cut taxes on the highest wealth brackets. This sale of the “commons” by naïve, myopic leaders (and the “useful idiots” promoted by financial lobbyists to be their economic advisors) turns debtor countries into “tollbooth economies” in which basic services become a vehicle to extract greater and greater portions of national income and wealth for the benefit of the few. This is the antithesis of “free markets” as classical economists understood the term. They are markets designed and controlled by the financial sector to appropriate for itself the surplus produced by labor and tangible capital investment.

To promote this siphoning off of surplus income, the rich have funded extensive disinformation (propaganda) campaigns around the world. Their tactic is to use familiar and revered ideological terms such as “free markets,” “economic democracy” and “fairness” to win the hearts and minds of the population while actually imposing a set of policies in stark contrast to Enlightenment ideology, classical political economy, Progressive Era reform and 20th century social democracy – the ideals of freedom-loving peoples everywhere. Financial lobbyists have spent billions of dollars spent on public-relations think tanks to achieve this ideological con job. They have endowed business schools and gained control of government agencies to promote their creditor-oriented point of view, headed by central banks to serve as the ideological wedge for today’s anti-democratic forces. This is the ideology that has pushed much of the Third World into poverty since the 1960s, as well as today’s tragically debt-ridden post-Soviet economies.

Financial warfare

Finance seems at first sight to be quite different from outright warfare. Everyone knows well enough that invading armies do not come on friendly terms. Foreign navies and troops are not welcomed, even if they promise to help build up the economy by constructing new roads and bridges (the better for their tanks and troops to travel on), hydropower and geothermal stations to export electricity (keeping the earnings for themselves), hotels and spas for themselves and foreigners to enjoy (and keep the rental incomes and site values), and create detailed statistical analyses (such as the Domesday Book alluded to above) to manage the economy in their favor.

Today this financial strategy has become multilateral. The IMF acts as enforcer for global creditors to appropriate the income of real estate, national infrastructure and industry as a financial boondoggle. What is remarkable is that countries throughout the world are losing their economic and fiscal independence peacefully – at least it is peaceful when target countries do not fight back. (Chile, Cuba and Iran are object lessons for the punitive economic sanctions imposed on countries that do not accept today’s predatory economic ethic.) Financial conquest is thus more covert than military warfare. It relies more on the educational and psychological dimension, and is most successful when the victim does not even realize it is being attacked.

But the effects are as devastating on human life as what Russia suffered at the hands of Western “reformers” in the 1990s. The financial austerity imposed by creditor-run regimes shortens life spans, reduces birth rates, and increases labor flight, suicide rates, disease, alcoholism and drug abuse. Just as war kills an economy’s males of fighting age (25-35), financial austerity drives them to emigrate to find work. This is why U.S. investor Warren Buffett has called collateralized debt obligations (CDOs), credit default swaps and similar debt-leveraging instruments “weapons of mass financial destruction.”

Consider the role of banking in this neo-feudal order. Banks do not create credit to finance manufacturing – that is done mainly out of retained earnings and equity. Banks create credit primarily to lend against collateral already in place – loans that simply extract money from the economy. This is an inherently destructive act, one that is anti-capitalist in the sense that it undercuts industrial growth in favor of interest extraction and short-term speculative gains.

The trick is to get this policy welcomed as if it were progress, as “post-industrial” rather than a lapse backward. Only today is it becoming apparent that the collateral-based lending of banks “creates wealth” mainly by inflating asset-price bubbles, especially in real estate. Bankers calculate how much debt a given flow of residential or commercial real estate income can support, and create enough credit to make a loan large enough to absorb this surplus revenue. Bankers do the same with industry by lending corporate raiders enough money in take-over “junk” bonds to turn profits into a flow of interest payments for themselves, and with capital gains for the raiders. Central banks fuel this process by swamping economies with easy credit (that is, debt) that keeps the financial sector fat while impoverishing the increasingly indebted nation.

Finance thus is the historical antithesis of property, sanctifying its own right to expropriate indebted property owners. Originally denounced by Christianity, Judaism and Islam, interest-bearing debt has sanctified itself as the predominant form of wealth. This is not what the classical economists and democratic political reformers expected to see. They explained how to avoid this economic dystopia by appropriate government tax policy and regulation to minimize the economic role and political power of post-feudal bankers and rentiers. (Rentiers are people who live off interest and rents, that is, off absentee incomes paid on a regular basis. A rente was a French government bond paying interest at regular intervals; the idea was extended to landlords.)

How banks and the financial sector gained dominant power

This supremacy of the banks and the financial sector took thousands of years to achieve. It was not easy to overthrow traditional social values and to impoverish so many economies by subordinating customary property relations with legal priority for creditors. Iceland only recently has come under this kind of financial attack by creditors operating globally. Bankers managed to convince ambitious fortune-seekers that the way to wealth and economic growth lay in debt leveraging, not in staying free of debt. Selling debt as their product, banks and speculators at the world’s financial core needed to prepare for what they must have known would lead to economic collapse and destroyed economies throughout history. They prepared the path to ruin by ideological engineering aimed at shaping how populations think about history, so as to accept debt pyramiding as a good economic strategy.

As an example of their warped thinking, consider an attractively priced home. Would you rather own 100% of a home free of all debt with a market value of 100,000 euros if free of debt – or, would you rather own 60% of the same home at an inflated market price valued at 250,000 euros? In the second scenario you would have 50,000 euros of “surplus wealth” (60% x 250,000 = 150,000 euros, compared to 100,000 in the first example). People across the globe have been convinced that the second scenario represents “wealth creation.” What is overlooked is that the higher-priced home carries interest charges on its higher market price. This charge would amount to 6,000 euros a year, or 500 euros a month, at 6% interest. The same property is worth more, but includes a much larger debt overhead – income for the financial sector.

In Iceland – but nowhere else – home mortgages have a uniquely bad twist. Creditors have managed to protect the weight of their claims on debtors by indexing mortgage loans to the nation’s consumer price inflation (CPI) rate. Each month the debt principal is increased by the CPI increase – and so is the interest charge. During 2008 that index rose by 14.2%, so a 100,000-euro mortgage at the start of 2008 would have grown to 114,230 euros by yearend. These monthly adjustments also would added an entire percentage point onto the interest payment – an extra 100 euros to be paid to creditors monthly, in addition to the growing principal to be amortized. Talk about making money without effort …!

Such heavy debt charges would shrink any economy, and that is what is happening in Iceland. Prices for real estate declined by an estimated 21 percent for housing in 2008. So in the above example, the market price of the house worth 100,000 euros at the beginning of the year would have been worth only 79,000 at yearend, while the mortgage would have grown by 14% to 114,230. This would have plunged the homeowner 35,000 euros into negative equity – a remarkable 35% change.

In every other country, investors lose out when prices decline for real estate, stocks and bonds, while creditors find the purchasing power of their loans eroded by inflation. That is how most countries have “inflated their way out of debt” for many centuries. But Iceland’s creditors have created a system in which their position actually is improved as the rest of the economy suffers inflationary price erosion. Their claims rise in proportion to the rate at which consumer-price inflation eats away at wages and business profits. Where is the sense in this?

What makes this so ironic is that the purpose of calculating the consumer-price index in all countries has been to support consumer income. It was to protect wage earners and retirees against inflation eating away at their ability to maintain their standard of living. That is why in the United States, Social Security retirees receive an annual cost-of-living adjustment based on the CPI. But Iceland inverts this political aim, protecting the claims of creditors against debtors (and hence against most wage-earners). The creditor’s objective is to maximize the power of debt over living labor. That is the literal meaning of “mortgage:” a “dead hand” of the past over the present, of past wealth and credit over the living. For Iceland the debts run up during the “wealth creation” phase of the financial bubble are to be left in place and even grow at an accelerating rate reflecting the pace of currency depreciation and hence import prices and consumer prices generally. Debtors lose out as prices plunge for the homes they own, while creditors maintain their economic grip intact and even strengthen their hand by increasing their take.

Turning economic power into political power

Creditors in most countries have been able to turn their economic power into political power with the aim of shifting the tax burden off themselves and onto labor and industry. The final coup de grace occurs when they get the government to bail them out from their losses on bad loans. In the United States, Congress has tripled the national debt in less than a year to bail out creditors with little thought of helping debtors, or even of prosecuting the massive financial fraud involved in its subprime real estate bubble and the sale of junk mortgages to gullible foreign buyers.

Iceland’s citizens will own a smaller and smaller proportion of their homes as its banks become the main claimants on the nation’s property value. By subjecting Iceland to this unique kind of financial squeeze, Icelandic policy stands in diametrical contrast to that of the United States. The U.S. policy is to stabilize its economy and avoid depression by writing down debts to bring them in line with today’s lower market prices and, more specifically, to bring carrying charges on mortgage debt within the ability of homeowners to pay no more than 32% of their income. Other countries also are writing down their debts to bring them in line with the ability to pay. But Iceland is subjecting its own homeowners and consumers into debt deflation and plunging them into Negative Equity status – by law!

The only way its banks can succeed in this ploy is to keep Iceland’s voters unaware of what is happening in the rest of the world – and indeed, to block the government from drawing up a balance sheet of the nation’s debts, a roster of whom these debts are owed to, and a calculation of the economy’s ability to pay.

Iceland’s present policy will lower disposable income for homeowners and other debtors – the great majority of its citizens – while wealth gushes to the top of the economic pyramid, to those who are creating as much credit as they can find borrowers for. The result is not what former Federal Reserve chairman Alan Greenspan and President George W. Bush claimed to be creating in America – an “ownership” society. It really is a “loanship” society, an economy of ersatz assets in which debt pyramiding – owning less and less of a home or other asset – seemed to be a strategy for growing richer instead of the debt trap it is. Has Iceland fallen into a similar semantic trap?

Pensions and retirement

As in the United States, Iceland has convinced labor to “prefund” its retirement. The idea is to save up in advance, so as to provide for retirement in a purely financial way. Of course, the most important way to support retirees is to see that they can afford the basic goods and services needed to live. To the extent that “financializing” an economy ends up eroding the “real” economy, pension funding – and government Social Security funds (regressive taxes that enable the Treasury to cut taxes for the higher wealth brackets) – tends to shrink the economy rather than provide for the expansion in output needed to support an aging population. As matters stand, pension savings are mobilized to increase the volume of interest-extracting debt and fuel financial bubbles (as in America’s “pension-fund capitalism” that pushed up stock markets in the past). Pension savings works against employment most visibly when they are lent to corporate raiders who pay off their bondholders by downsizing the work force and squeezing more “productivity” out of the remaining employees. Economic “growth” under such circumstances takes the form of a financial and property-sector overhead, not growth or stability in living standards or the capacity to produce.

Allowing economies to be crippled with interest payments was unthinkable until recently. To achieve so radical a break in the public’s idea of prosperity and self-reliance, it has been necessary for creditors to wipe out knowledge of how legal systems have been amended to put creditor interests above those of debtors over the past eight centuries – and how the leading classical economists and Enlightenment cultural and religious leaders sought to subordinate creditor interests to those of growth and prosperity for the economy at large. But the new banking class has been clever enough to hire the best propagandists money can buy while remaining blind to the havoc they are wreaking with people’s lives.

The debt game

Like many people, Icelanders tend to think of debt in personal terms, as if creditors are neighbors much like themselves. The normal thing to do when problems arise would be to sit down and reach a common agreement. But Iceland’s creditors are impersonal billion-dollar financial conglomerates, and creditor-debtor relations under such conditions are inherently adversarial, as anyone who has had a recent disagreement with a bank can attest. Whatever creditors can gain in today’s highly politicized, legalistic and ideological tug-of-war will be the debtor’s loss. And the magnitude of Iceland’s prospective loss threatens to plunge its economy into depression for generations, turning it into a Third World oligarchy, or worse, a dictatorship. The price of paying its debts thus threatens to be loss of its national identity and a loss of its future.

The trick is to fool debtors into thinking that “free markets” means paying one’s debts. Creditors can succeed in letting debt leveraging and “the magic of compound interest” empty out economies only by diverting attention from what Adam Smith and other classical economists warned against. For them, a free market was one free of debt – especially foreign debt. In The Wealth of Nations (especially Book V, chapter 3), Smith warned against creditors becoming “free” enough to disable the ability of governments to protect citizens from creditors – especially the Dutch, who were the major investors in British monopolies created to be sold to pay for that nation’s seemingly eternal wars with France. The problem was that creditors sought to extract the wealth of nations for themselves, not to create wealth. Their greed was destructive to society as a whole, because it was easier to simply strip assets than to create real capital.

That is the problem with creditors historically. They tend to care only about how to extract as much as they can, as quickly as possible. “A creditor of the public, considered merely as such,” wrote Smith, “has no interest in the good condition of any particular portion of land, or in the good management of any particular portion of capital stock. As a creditor of the public he has no knowledge of any such particular portion. He has no inspection of it. He can have no care about it. Its ruin may in some cases be unknown to him, and cannot directly affect him.” The problem obviously is worst with absentee creditors.

Smith concluded: “When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has ever been brought about is by bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.”

Adam Smith’s portrait is engraved on England’s £20-pound note, and Andrew Jackson on the US $20 bill. The irony is that Smith denounced public debts and urged wars to be financed on a pay-as-you-go basis so that people would feel their burden – and stay out of debt. As for Andrew Jackson, he closed down the Second Bank of the United States, accusing bankers of ruining the nation and seeking to destroy democracy. Bankers and finance therefore leave something important out of the account when it comes to the views of their own patron saints of democratic free markets.

As noted above, creditors for many centuries now have suffered bankruptcies when foreign countries default. That is the norm, not the exception. Yet today’s popular media greet every new default as “unanticipated” and “surprising,” as if it were not the bankers’ fault that they failed to understand the market’s inability to pay. Dumbed-down economics textbooks chime in with their inbred ignorance voiced by the financial sector’s proverbial “useful idiots” prattling about “equilibrium” and “automatic stabilizers.” These un-learned academics are useful to the bankers because of the passion with which they proclaim that all debts should and can be paid by suitable “adjustments” (including what turns out to be economic and demographic collapse). The question being asked with a straight face is: If it is the fault of victims rather than the bankers, then is it not proper for governments to bail out the banks?

The tacit assumption is not that bankers’ exorbitant greed is achieved at the expense of the economy at large, but that the financial sector’s prosperity is a precondition for the economy to grow. The bankers try to cap matters by trotting out poor retirees (like the widows and orphans of old – presumably those living on “fixed incomes” in the form of trust funds) whose meager savings should be supported. Doing so just happens to save the financial oligarchy of billionaires at the top of the economic pyramid, but not the proverbial victims.

The use of human shields such as union members concerned about the investments of their pension funds to protect the wealth of the kleptocrats is likewise shameless. Wall Street sages in the United States, for example, shed crocodile tears over the fate of the working people suffering from the stock market collapse, knowing full well that financial assets are heavily concentrated at the top of the economic pyramid, with workers having, only a meager share of those stocks and bonds. Ignored is the fact that the government could bail out failing pension funds (like Social Security) directly at just a small fraction of the cost of propping up the assets of the affluent.

Likewise, the volume of government bailout money for the financial sector ostensibly to deal with the subprime mortgage crisis – about $13 trillion during 2008-09 – clashes with the fact that the total value of mortgage debt owed by all households in the entire United States is only $11 trillion as of yearend 2008! The bailout funds ended up being used mainly to buy other banks to create even larger financial conglomerates “too big to fail,” to pay executives whose greed for short-term gains and bonuses caused the financial meltdown, and to pay dividends to stockholders to support their stock price and hence the value of stock options that financial managers gave themselves. The closest parallel to this scandal is the “watered stock” practices of Wall Street’s railroad barons and other financial manipulators in the late 19th-century Gilded Age.

There was a time when banks hesitated to make loans irresponsibly, that is, beyond the ability of debtors – and entire national economies – to generate a surplus to pay their creditors. My job as balance-of-payments economist for the Chase Manhattan Bank in the 1960s was to calculate how much export earnings and other foreign exchange the major Latin American countries could generate. Their balance-of-payments surplus represented how much they could afford to borrow. The aim of New York banks was to lend Third World countries money to absorb their entire economic surplus. From the bankers’ point of view, that was what a national surplus was for – not to sustain higher living standards or invest in becoming economically self-sufficient, but simply to pay creditors. And “wealth” was defined as the capitalized value of the entire economic surplus they could generate – discounted at the going rate of interest, as if it all could be paid as debt service, so that the entire surplus would be paid to carry the debt.

This certainly is not a model of human progress. But it was that decade’s version of “wealth creation,” and it is the concept of “wealth creation” in terms of the market value of debt-financed asset prices that Alan Greenspan would foist on the United States in the 1990s to convince it that an asset bubble was the path to postindustrial wealth, not the road to debt serfdom.

So Adam Smith was right. Today, creditors and bondholders care about foreign economies only to the extent that they can charge interest that will absorb their entire economic surplus. Until recently, creditors thought that lending more than can be repaid would be “irresponsible.” Not any more.

Political checks and balances on the economy

The best path for nations is to put their own economic growth before the interests of creditors. For many generations this ethic supported a set of political checks and balances that kept the growth of international debt in terms considered to be tolerable – much too heavy by the free-market standards of Smith and John Stuart Mill, but not so high as to prompt widespread defaults and debt repudiation.

This ethic has changed in recent years. Countries have accepted creditor propaganda that debts are a “point of honor,” much as the poor believe that paying their debts – even when they are in negative equity – is the “honest thing to do.” Obviously this ethic is not self-applied to the world’s largest financial institutions or real estate speculators. But Iceland accepted it in what is a characteristic of small, closely-knit communities where the word of neighbors is their bond. The root of Iceland’s ethic is mutual aid and prosperity for all. It is a fine, highly socialized attitude, and therefore tragic that it has helped lead the nation to fall prone to the snake oil of debt peonage.

Political leaders who fail to recognize the fact that checks and balances are a proper function of government are liable to sacrifice their nation’s hope for economic growth and rising living standards in a vain attempt to pay creditors. Such attempts must be in vain, because “the magic of compound interest” is a cruel myth: In reality every rate of interest implies a doubling time, and no economy’s “real” growth ever has been able to grow exponentially at a fast enough rate to pay the debts that keep accruing interest.

In today’s deregulated environment where “the sky’s the limit,” these accruals have been recycled in yet new loans. These then are packaged and resold, loading the economy down with more and more debt that so far has been almost impossible to track. And to cap matters, financial speculators then place trillions of dollars of bets on whether the debts can be paid or not, and how much their market prices are likely to change. What was supposed to be a financial system designed to fund new capital investment to produce more and raise living standards has turned into a casino economy – where gamblers are staked by the bankers to play the debt game, with the government standing by to make the winners “whole” in cases where the debtors have lost too much of their play-money to pay up.

Debts that can’t be paid, won’t be

Every economist who has looked at the mathematics of compound interest has pointed out that in the end, debts cannot be paid. Every rate of interest can be viewed in terms of the time that it takes for a debt to double. At 5%, a debt doubles in 14½ years; at 7 percent, in 10 years; at 10 percent, in 7 years. As early as 2000 BC in Babylonia, scribal accountants were trained to calculate how loans principal doubled in five years at the then-current equivalent of 20% annually (1/60th per month for 60 months). “How long does it take a debt to multiply 64 times?” a student exercise asked. The answer is, 30 years – 6 doubling times.

No economy ever has been able to keep on doubling on a steady basis. Debts grow by purely mathematical principles, but “real” economies taper off in S-curves. This too was known in Babylonia, whose economic models calculated the growth of herds, which normally taper off. A major reason why national economic growth slows in today’s economies is that more and more income must be paid to carry the debt burden that mounts up. By leaving less revenue available for direct investment in capital formation and to fuel rising living standards, interest payments end up plunging economies into recession. For the past century or so, it usually has taken 18 years for the typical real estate cycle to run its course.

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.