14   …And the Madness of Crowds

Keith Wilde

We recently characterized popular understanding of economic affairs as a delusion, alluding to the title of an old book.1 It began by saying that "everything you thought you knew about economics is probably wrong. Worse, it is a deliberate lie. And worst of all, the people who persuaded you to believe in the lie are not even fully conscious of it themselves." We identified this disturbing analysis as our interpretation of writings by Dr. Michael Hudson, a specialist in not only financial markets but also in the history of financial institutions and the economic theories that have been brought to bear on them over the centuries. (Readers can check out Hudson’s authority of knowledge for these and other criticisms of policy and ideology via the Internet. Go to

In commenting further about financial delusions Dr. Hudson observes that "the true madness of crowds does not lie in their alleged propensity to get excited with greed, but just the opposite: a passive tendency to accept the status quo as natural and hence inevitable." For even when they have the apparent freedom under democratic political constitutions to press for reforms that would enhance general prosperity and distributive fairness, they sit by and watch their legislators dispense the national wealth to favored constituents. This has been especially blatant over the past couple of decades as North Americans have had regularly reported news of increased concentration of wealth and income distribution, legislated tax breaks mainly to the most wealthy, and monumental frauds permitted by lax regulations and complicit regulators.

The Origins of Poverty in Servitude

Hudson notes that, "on an economy-wide scale, some 90 percent of the population is indebted to the wealthiest 10 percent." His analysis of why this servitude is accepted in apparent passivity focuses on why and how indebtedness originates and grows.2 The earliest indications of it for Occidental civilization are in the agricultural societies of the ancient near east, where farmers paid shares of their crops to rulers who provided some degree of territorial protection and also made loans of seed from the collective granaries. If crops failed or were seized by invaders, debts could accumulate, resulting in seizure of property or various forms of servitude for the debtor and his children. Furthermore, debts accumulated at compound interest rates. "Formulae for calculating how savings accumulate (i.e., what debtors owed) date to some four thousand years ago when mathematics played a major role in training Sumerian and Babylonian scribes. Ever since then the doublings and re-doublings of public and private debts have outstripped the growth in output of agriculture and industry. This has always meant that large numbers of debtors have had to settle their obligations by selling or forfeiting their property, often leading to property turnovers so widespread as to transform the distribution of land and other wealth."

Someone could therefore be born under an obligation to pay or to serve an over-lord from whom he received no equivalent exchange. And even if not oppressed by inherited debt, many were born to serfdom on land that had been forcibly seized by the owner’s ancestors. From at least the beginnings of historical records, "free lunch" has been provided by the many to the few. "The tendency of debts to grow more rapidly than the collective ability to pay has been especially insidious, leading to wealth and political power concentrating at the top of the economic pyramid." As should be expected, there has always been at least a degree of resistance to this dynamic. "From ancient Babylonia, Judah, Sparta and Athens, Rome and Byzantium down through the Enlightenment and into modern times, economic wisdom and traditional morality have sought to save society from the dead hand of the past."

Political Economy Fought Back

The "free lunches" and other remnants of serfdom were recognized as barriers to economic progress by the classical economic thinkers of the 18th and 19th centuries, and their approach was carried forward by institutional reformers in the first half of the twentieth. They examined the property ownership and debt relationships that form the context in which production and distribution take place. "Their perspective was long-term, conceiving economies as evolving systems based on institutions, including laws, tax policies, government spending, the regulation of credit creation and the disposition of bankruptcies." Their purpose was to design national policies that would best promote higher productivity and more general prosperity. What kinds of money-making activities should be encouraged? What kinds of productive facilities should be provided collectively, as public services? How should taxes be levied to be most productive of revenue and least burdensome or inhibiting to desirable enterprise? The general answer to these kinds of questions was that sources of "free lunch" (collectively defined as rents in economics terminology) should be primary targets for taxation – not only for reasons of fairness in the distribution of inherited wealth but also to encourage productive investment and enterprise. "This focus on institutions and policy was the thrust of classical 19th-century British political economy as developed from Adam Smith through Ricardo, John Stuart Mill, and even Karl Marx and Henry George. Although it might be called "socialistic" today, their aim was to promote industrial capitalism." They perceived that this goal was frustrated by property rights and financial obligations left over from Europe’s feudal past. Hereditary estates and permanent public debts reflected military seizure of territory and sovereign grants of land and revenues.

The classical approach was applied in the United States following the "gilded age" of financial excesses, and in line with progressive economic thinkers such as Thorstein Veblen and Simon Patten. Reforms of financial institutions and more strict regulation were part of the ground work for the prosperity of mid-century. Since the 1960s, however, there has been a regression from those institutional structures, and a parallel deterioration in the individual financial status of most Americans. Hudson attributes it to a successful counter-attack on classical political economy by proponents of rentier claims.

The successful counter-attack of the rentier class has financialized what was once a vigorous industrial economy. A rising share of business income these days is not from the classic idea of profits earned by employing labor to produce goods and services to sell at a higher price than it cost to produce them. Instead, it comes from rents – that is from payments that do not have a counterpart in costs of production. It applies not only to payments for the use of real estate, as in common parlance, but also to any revenue stream that is secured by law as a property right. Examples include patents, copyrights, production quotas, licenses to use the broadcasting spectrum, to engage in certain kinds of professional practice – in short, any monopoly privilege that is not a direct part of the cost of producing goods and services. The bulk of these property claims is held by only 1 percent of the population.

The approach of political economy has been usurped by financial managers who steer the economy to polarize and concentrate wealth in ways that impoverish most people. One reason for the passivity of the public in accepting this arrangement is that national accounting conventions define every income as a payment for services rendered. That helps mainstream economists to get away with their assertion that "there is no such thing as a free lunch." Gullibility is therefore partly due to deliberately fostered ignorance. Furthermore, even for the curious who are motivated to get a better grasp on reality, "mainstream economics has narrowed so tightly as to leave no room to fit a critique of finance and property into the curriculum. Today’s economic models are based on assumptions that prevent them from addressing the most important real-world problems. They take existing political and legal structures as given and examine the economy from the vantage point of politically passive parts – individuals and small firms." This neo-classical approach is called marginalism, and Hudson scorns it as merely marginal, for it "asks only how income is earned in a presumably unchanging environment. This assumption of no institutional change is mathematically necessary for probability statistics and trend analysis to be deemed scientific."

The Complicity of Economics

The claim of economists that there is no free lunch and that everyone’s income is a fair reflection of his or her contribution to the collective wealth and income is a fraud. "The reality is that the economy is all about how to get a free lunch." It is set up to give special tax breaks to financial and property claims on the one hand, and to then expand credit creation so that people become more and more deeply indebted. In this way the Wall Street crowd gain control of everyone’s savings. This enables financial houses to rake off management fees while at the same time using these savings to inflate the prices of the assets they hold. "The reason that saving are reported to be low these days is that people borrow to buy property hoping that it will rise in price more rapidly than the interest rate they must pay. Without realizing it, people engage in arbitrage, that is borrowing at one rate to invest at a higher rate. And many imagine themselves to be sophisticated for doing this."

There is thus a degree in which people these days are participating in a kind of financial mania. Hudson’s treatment suggests an element of sympathy for their madness, however, for in the bubble environment created by the dominance of financial interests over government policy, most kinds of assets are inflating and it is difficult to know where one can safely park some savings.

Keith Wilde

1. Mackay, Charles (first published in 1841). Extraordinary Popular Delusions and the Madness of Crowds. See ER of March, 2007.

2. The content of this short article is selected from various papers and books by Dr. Hudson. Quotation marks indicate direct borrowings and very close paraphrasing.

– from Economic Reform, July 2007