Stabilizing an Unstable Economy
Reading this book is like finding the right encryption key to reading every major event in the financial system for the last forty to fifty years. Minsky’s clear thinking and accessible writing stand in stark contract to most economic works as does his serious challenge to much of orthodox economic thought. This is also part of what makes following him such a treasure; he may be the most important economist you’ve never heard of.
Minsky’s quest is to understand why the economy seems to have become so much more volatile (the book was first published in 1986). One part of the answer is that in good times, companies simply stretch further to keep gaining on competition. Good times also facilitate the use of progressively riskier types of financing. Companies can justify riskier financing on the basis of good results, economic stability, and capital gains. Banks, as profit-driven enterprises, continuously seek to circumvent regulatory constraint and rest somewhat comfortably knowing that they will be backstopped by the Fed if anything seriously bad happens. As Minsky notes, “A capitalist economy is inherently flawed because its investment and financing processes introduce endogenous destabilizing forces.” In other words, stability breeds instability.
A couple of hugely important lessons emerge. One implication is that since stability breeds instability, savvy investors should be viewing the abnormally extended period of stability since 2009 with a great deal of suspicion. We should expect the natural forces of capitalist system to push things to an unsustainable extreme. Another is that this work provides clear sight lines into the nature of many public policy and economic problems. Minsky’s position is that “The policy failures since the mid-1960s are related to the banality of orthodox economic analysis.” More specifically, a correct diagnosis demands that the financing system be considered in connection to the economic system rather than in abstraction from it. Any attempt to reduce economic volatility must address the financial system and its inherent tendencies to fuel speculative bubbles. Unfortunately, since none of the key issues of “too big to fail”, regulatory arbitrage, or moral hazard have been dealt with meaningfully, there is no reason to expect the system to operate any differently now than before the financial crisis of 2008.
by David Robertson, CFA
Minsky’s quest is to understand why the economy seems to have become so much more volatile (the book was first published in 1986). One part of the answer is that in good times, companies simply stretch further to keep gaining on competition. Good times also facilitate the use of progressively riskier types of financing. Companies can justify riskier financing on the basis of good results, economic stability, and capital gains. Banks, as profit-driven enterprises, continuously seek to circumvent regulatory constraint and rest somewhat comfortably knowing that they will be backstopped by the Fed if anything seriously bad happens. As Minsky notes, “A capitalist economy is inherently flawed because its investment and financing processes introduce endogenous destabilizing forces.” In other words, stability breeds instability.
A couple of hugely important lessons emerge. One implication is that since stability breeds instability, savvy investors should be viewing the abnormally extended period of stability since 2009 with a great deal of suspicion. We should expect the natural forces of capitalist system to push things to an unsustainable extreme. Another is that this work provides clear sight lines into the nature of many public policy and economic problems. Minsky’s position is that “The policy failures since the mid-1960s are related to the banality of orthodox economic analysis.” More specifically, a correct diagnosis demands that the financing system be considered in connection to the economic system rather than in abstraction from it. Any attempt to reduce economic volatility must address the financial system and its inherent tendencies to fuel speculative bubbles. Unfortunately, since none of the key issues of “too big to fail”, regulatory arbitrage, or moral hazard have been dealt with meaningfully, there is no reason to expect the system to operate any differently now than before the financial crisis of 2008.
by David Robertson, CFA
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