Why We May Be Headed For Another "Minsky Moment"

Authored by Jesse Fedler via TheFedlerReport.com,

I recently ran across a terrific chart in Grant’s Interest Rate Observer that got me thinking about Hyman Minsky and The Financial Instability Hypothesis. After remaining relatively unknown during the course of his lifetime, Minsky really came to fame in the immediate aftermath of the financial crisis as his hypothesis helped to explain what left most economists baffled: the fundamental cause of the crisis.

Clearly, though, he has been forgotten just as quickly because, considering where we stand today, it’s obvious the economists with the greatest power to prevent another crisis have still not adopted his insights into their frameworks.

To begin to understand the current situation in Minsky terms we must first understand the hypothesis:

The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system. In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance.

Next we need to understand what these financing units are:

Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows… Speculative finance units are units that can meet their payment commitments on “income account” on their liabilities, even as they cannot repay the principle out of income cash flows… For Ponzi units, the cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations.

And this is what reminded me of Minsky when I read the recent article in Grant’s with the accompanying chart below. It shows the percent of companies in the S&P 500 that would fall into Minsky’s “Ponzi unit” category. Specifically, Bianco Research defines these “zombies” as companies whose interest expense is greater than their 3-year average EBIT (earnings before interest and taxes). Currently, we face the greatest percentage of “Ponzi units” in at least 20 years.

This should be worrisome to investors and even more so to those managing monetary policy because it suggests that financial instability within the economy may be greater than any other time over the past couple of decades. Minsky again:

It can be shown that if hedge financing dominates, then the economy may well be an equilibrium seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system.

Those last three words are critical. “A deviation amplifying system,” simply means an economy built on a virtuous cycle that risks evolving into a vicious one. So long as interest rates remain low and investor risk appetites remain strong zombies will thrive and the economy will, as well, relatively speaking of course. However, should interest rates rise and risk appetites reverse course the risk of a self-reinforcing downturn grows. Minsky explains:

In particular… if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.

Interest rates have been rising for nearly two years now and the Fed seems to have turned its attention from cultivating a wealth effect in the economy by supporting asset prices via quantitative easing to reining in inflation by unwinding those policies and raising the Fed Funds rate. In the process, by way of the Minsky Hypothesis, they may end up undoing everything they strove so hard to achieve over the better part of the past decade.

It’s not hard to imagine just how vulnerable these zombies might be to rising interest rates and waning risk appetites. Should they be forced into liquidation a resulting collapse in asset values could present a major problems for the economy as there are plenty of reasons to believe the wealth effect may be even more powerful to the downside than it was to the upside. Either way, the threat to the economy posed by the greatest corporate zombie army in history is surely enough to make Minsky roll over in his grave.

Comments

DownWithYogaPants wisehiney Sat, 04/14/2018 - 14:00 Permalink

Although I love math and in particular I specialized in designing oscillators / amplifiers I feel this Minsky theory is just another cover story for the Private Central Banking Cartel to install Barack Obama as president. Obama himself was yet another cover story.  After Bush Jr they figured they could really throw a curve ball with the Black Jesus.  That was successful distraction.  Many still have not figured out that Obama was the 3rd and 4th term of Bush Jr for all the differences between them. Quite in fact he was Bush Jr with a tan.  Insouciant! - Two can play that game Paul Craig Roberto!

In reply to by wisehiney

Ghost who Walks DownWithYogaPants Sat, 04/14/2018 - 17:15 Permalink

There are various design programs that can be used to check and size component values for electric circuits and that provide graphs of the circuit output, Wolfram's System Modeller is one such program.

Steve Keen has organised  the development of a similar program to model dynamic system instability and it is un-surprisingly called "Minsky"; http://www.ideaeconomics.org/minsky/

He can get outputs that match real world data and previous events with a small number of inputs and without requiring a deep conspiracy theory. That is not to say that there is no conspiracy, just that the past economic collapses and economic cycles can have simple causes.

 

In reply to by DownWithYogaPants

Sudden Debt wisehiney Sat, 04/14/2018 - 14:16 Permalink

I recently tried to explain to somebody who just got into the stockmarket that the market could actually go down quite a lot.

the eyes... as always... large, wide open and that said "what the hell are you talking about?"

 

same thing if you try to explain to people who go all in into the real estate market what "demographics" mean and why it doesn't favor their view of getting rich in the next couple of years.

 

Most in the stock market don't have a single clue how to read the financial reports, they just buy because it's gone up bigtime and surely it will repeat itself. Yeah...

 

I'm sure most won't see it comming when the markets turn and they all deserve it.

 

In reply to by wisehiney

Sudden Debt wisehiney Sat, 04/14/2018 - 14:16 Permalink

I recently tried to explain to somebody who just got into the stockmarket that the market could actually go down quite a lot.

the eyes... as always... large, wide open and that said "what the hell are you talking about?"

 

same thing if you try to explain to people who go all in into the real estate market what "demographics" mean and why it doesn't favor their view of getting rich in the next couple of years.

 

Most in the stock market don't have a single clue how to read the financial reports, they just buy because it's gone up bigtime and surely it will repeat itself. Yeah...

 

I'm sure most won't see it comming when the markets turn and they all deserve it.

 

In reply to by wisehiney

gregga777 Sat, 04/14/2018 - 13:58 Permalink

Interest rates have been rising for nearly two years now and the Fed seems to have turned its attention from cultivating a wealth effect in the economy by supporting asset prices via quantitative easing to reining in inflation by unwinding those policies and raising the Fed Funds rate. In the process, by way of the Minsky Hypothesis, they may end up undoing everything they strove so hard to achieve over the better part of the past decade.

The only surprise here is that the author seems to think that the "undoing everything" process by the Golem Suchs Feral Reserve System is in any way an accident. It's actually quite deliberate. It's how they periodically siphon money away from the productive economy to the unproductive financialization CON Street Swindlers. This will be the third bubble that they have deliberately inflated and then popped this Century. 

VWAndy Sat, 04/14/2018 - 14:12 Permalink

 The monopolies are the zombies. How many of them are only kept from sinking under the waves by fiat magic?

 Blustering bullies bullshit.

franzpick Sat, 04/14/2018 - 16:10 Permalink

Equities might well start discounting the upcoming Minsky moment this Monday. After 15 days and 4-5000 Dow points going nowhere, DJIA and SPX are still merely 1.4% and 2.2% over their NOV upside breakouts, their Feb closing lows and their Mar 22 collapse, at 24,000 and 2600, as well as just 3% and 2% above their 200 day MAs. One or two bad days minus 1-2% Mon-Tues or soon can quickly lead to a bear market confirmation and lower lows down 5%-6% to 23,000 and 2500, see here for example, likely hiding in plain sight:

http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=djia&insttype=&freq=1&show=&time=7

Batman11 Sat, 04/14/2018 - 16:49 Permalink

The economics used for globalisation had a known flaw.

The 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression. No one realised the problems that were building up in the economy as they used an economics that doesn’t look at private debt, neoclassical economics.

https://cdn.opendemocracy.net/neweconomics/wp-content/uploads/sites/5/2017/04/Screen-Shot-2017-04-21-at-13.52.41.png

The “black swan” was obvious all along and it was pretty much the same as 1929.

1929 – Inflating US stock prices with debt (margin lending)

2008 - Inflating US real estate prices with debt (mortgage lending)

What’s the difference?

We still have a huge debt overhang and the repayments on that debt will keep dragging the economy down just like it did in Japan after its 1980s real estate boom.

Richard Koo explains (he has had decades to study it and knew what would happen after 2008 in the West).

https://www.youtube.com/watch?v=8YTyJzmiHGk

Adair Turner can see the problems.

  1. We are trying to go back to a normal we can’t go back to
  2. The debt overhang is dragging economies down

Adair Turner has looked at the situation prior to the crisis where advanced economies were growing by 4 - 5%, but the debt was rising at 10 – 15%.

This always was an unsustainable growth model; it had no long term future.

https://www.youtube.com/watch?v=LCX3qPq0JDA

Neoliberalism ran on debt and appeared to work because its neoclassical economists don’t even consider debt. Most of it went into real estate.

Batman11 Batman11 Sat, 04/14/2018 - 16:50 Permalink

The other known flaw:

“Stocks have reached what looks like a permanently high plateau.” Irving Fisher 1929.

An earlier neoclassical economist believed in price discovery, stable equilibriums and the rational decisions of market participants.

The neoclassical economist believes in the markets and can’t even imagine there could be a bubble.

In reply to by Batman11

Batman11 Batman11 Sat, 04/14/2018 - 17:01 Permalink

Neoclassical economics was the gold standard for globalisation and it doesn’t consider debt so you get the same problem everywhere.

Steve Keen saw 2008 coming in 2005 by looking at the US debt-to-GDP ratio.

He has been looking at this for a long time and has now seen the same thing occurring everywhere

At 25.30 mins he has super imposed the debt-to-GDP ratios.

https://www.youtube.com/watch?v=vAStZJCKmbU&list=PLmtuEaMvhDZZQLxg24CAiFgZYldtoCR-R&index=6

They used an economics that didn’t consider debt for globalisation; probably the stupidest idea in the history of mankind.

 

Irving Fisher looked into his mistakes and in the 1930s came up with a theory of debt deflation.

Hyman Minsky carried on with Irving Fisher’s work and came up with the “Financial instability Hypothesis” in 1974.

Steve Keen built on Hyman Minsky’s work and saw 2008 coming in 2005 by looking at the debt-to-GDP ratio.

Steve Keen is more advanced Minsky.

In reply to by Batman11

Ghost who Walks Batman11 Sat, 04/14/2018 - 17:33 Permalink

I agree with your opinion, but Steve Keen is also not a mainstream economist. His work is not popular with the bulk of government and academic economists, who he continues to lampoon.

So the people who have the ears of the decision makers, (and who are regarded as experts) are operating to different economic theories that are more ideologically acceptable to their paymasters. Perhaps Down with Yoga Pants is right with his conspiracy theory. Deliberately uninformed decision making that pushes  the political agendas of various politicians is obvious at present.

What does it take for the "true believers" to see that their theories are not working and do a re-evaluation?

The answer unfortunately is that "true believers" often die of old-age before yielding their positions. "Evidence" may be evidence that we have not applied their theories hard enough or often enough. The current state of Greece and the plans for Greece are a good example of this type of thinking.

In reply to by Batman11

Batman11 Ghost who Walks Sun, 04/15/2018 - 02:08 Permalink

The mainstream are neoclassical economists that don't know what they are doing.

Even George Soros thinks mainstream economics need to be rebuilt from the bottom up.

George Soros realised economics was wrong due to his experience with the markets.

What the neoclassical economists said about markets and his experience just didn’t compare, and he knew it was so wrong he never even bothered to look into what the economics said.

George Soros ”I am not well qualified to criticize those theories, because as a market participant, I considered them so unrealistic that I never bothered to study them”

Here is George Soros on the bad economics we have used for globalisation.

https://www.youtube.com/watch?v=etP0t7WlK_4

He had been complaining for years and at last in 2008 the bankruptcy of the economics proved itself. With more widespread support, he set up INET (The Institute for New Economic Thinking) to try and put things right.

The INET economists talk about Minsky alot.

Commission on Global Economic Transformation (CGET)

https://www.youtube.com/watch?v=zDAWyAc7NtY&index=1&list=PLmtuEaMvhDZZQ…

Hurry up George, we need to restructure the global economy.

Globalisation’s technocrats, trained in bad economics, never stood a chance.

 

In reply to by Ghost who Walks

Last of the Mi… Sun, 04/15/2018 - 09:17 Permalink

You either have a free economy or a managed economy. The more the economy is "managed" (read 10 trillion in QE here), the greater the chance of catastrophic failure. An economy, by definition has unknowns which cannot b accounted for by even the greatest minds. The laws of chance simply cannot be managed out of an economy. At some point the "unplanned" happens and the farther down the cosmic bunnyhole path of "management" you have gone the worse the reset is going to be.

As you go farther and farther into a managed economy you have to plan more and more for eventualities that could have happened and avoid each one of their effects with respect to time. In effect, you cannot manage part of the economy for your desired outcome. As a function of time your management must increase logarithmically  in order to maintain the status quo. The end is always devastating.