VALE OF TEARS
by Bill Bonner
dailyreckoning.com
"Whereas all capitalisms are flawed," wrote economist Hyman Minsky in 1985, "not all capitalisms are equally flawed."
The obvious "flaw" in capitalism is that both the capitalists and the proletariat are all Homo Sapiens, not Homo Economicus, the mythical species of economists' dreams. They do not coldly measure the risk and calculate the return. Instead, they make their most important decisions - such as where to live, what to do, and with whom they will do it - not with their heads, but with their hearts. A man gets married, for example, not after carefully toting up the pluses and minuses. He goes about it not as a machine might - but as a dumb beast of burden...following instincts he will never understand. Thus yoked and harnessed, he lumbers into church as if he were going to war - that is, without a clue. Men do not usually go to the altar or to war after much rational calculation and reflection. Instead, they are swept along by whatever emotional currents come their way...and risk their lives and their comforts for causes which, in the calm of retrospect, usually seem absurd.
"The head is just the heart's dupe," as La Rochfoucauld put it. Thinking with their hearts...and caught up in whatever collective madness is fashionable...men do the most amazing things. But that is this vale of tears that we live in. And here at the Daily Reckoning we rather like it.
Minsky's "Financial Instability Hypothesis" set out to show how capitalism is inherently unstable. He might as well have set out to show that beer goes bad if you leave it sitting out too long or that children get cross if they don't get enough sleep. For capitalism is a natural thing, like life and death, and like all things natural, naturally it is unstable.
But what is interesting in Minsky's oeuvre is a little insight that might have been useful in the late '90s. Readers will recall that among the delusions suffered by investors at the time was the idea that American capitalism had reached a stage of dynamic equilibrium - where it was constantly inventing new and more exciting means of making people rich. Boom and busts were thought to be a thing of the past, first because better information made it possible for businesses to avoid inventory build-ups...and second, because the science of central bank management had attained a new level of enlightenment, wherein it could figure out precisely how much credit the economy wanted at any moment and make sure it got what it needed.
In the absence of the normal 'down' parts of the business and credit cycles, the economy seemed more stable than ever before. But Minsky noted that profit- seeking firms always try to leverage their assets as much as possible. He might have added that consumers might do the same thing. Without fear of a recession or credit crunch, Homo Sapiens, whether in the office or the den, were likely to over-do it. "Stability is destabilizing," Minsky concluded.
Minsky refers to Keynes' concept of a 'veil of money' between real assets and the ultimate owner of the wealth. Assets are often mortgaged...financed... leveraged or otherwise encumbered. This 'veil of money' gets thicker as financial life becomes more complex and makes it hard to see who is actually getting rich and who is not. When house prices rise, for example, it seems that the homeowner should be the beneficiary. But homeowners now own much less of their homes than they did a few years ago. Fannie Mae, banks and other intermediaries have a strong stake in home values. In recent years, Fannie Mae has worn a veil of money as sticky as flypaper. The poor homeowner hardly had a chance. He got stuck almost immediately. Now, he's hopelessly glued and won't be able to get away without a lot of ouches. But who will feel the most pain? If home prices go down, who will ultimately be left holding the bag? Hard to say...
Instead of coming up with innovative new ways to make people rich, America's financial intermediaries - notably Wall Street and Fannie Mae - came up with ways to make them poor.
"The financial instability hypothesis," Minsky explains, "is a theory of the impact of debt on system behavior and also incorporates the manner in which debt is validated. In contrast to the orthodox Quantity Theory of money, the financial instability hypothesis takes banking seriously as a profit-seeking activity. Banks seek profits by financing activity and bankers. Like all entrepreneurs in a capitalist economy, bankers are aware that innovation assures profits. Thus, bankers (using the term generically for all intermediaries in finance), whether they be brokers or dealers, are merchants of debt who strive to innovate in the assets they acquire and the liabilities they market..."
In Minsky's mind, capitalism is naturally unstable and needs government to stabilize it. Roughly, this is also the view of the Democratic Party. In the more orthodox economic view, capitalism is naturally stable and government destabilizes it. Traditionally, this is closer to the Republican Party view. But in the 1990s, even Republicans came to appreciate the stabilizing influence of Alan Greenspan. And now, under pressure from the voters, both Republicans and Democrats cry out for "new policies" to fight the bear market and rescue the nation from deflation.
Here at the Daily Reckoning, we agree with Minsky up to a point: capitalism is naturally unstable.
Unfortunately, government only makes it worse.
As we have seen over the last 16 years, public servant Alan Greenspan exerted a stabilizing influence on world markets. When the markets needed credit, he gave it to them. During his watch at the Fed, the Long Term Capital Management blew up. So did the Asian economies. And then, there was the Russian Default...and the Y2k Scare. Finally, there was the collapse of the Nasdaq and the Great Bear Market. Greenspan met each new threat as he met the last one - by offering the market more credit. Each time, his intervention seemed to stabilize the market. And each time, the financial intermediaries found new and innovative ways to pad out the "veil of money" between assets and their beneficial owners. In the end, if this is the end, Greenspan's efforts were so successful that they led to the biggest economic disaster in world history.
"In an effort to stabilize the economy," writes Janelia Tse in the Winter edition of Oeconomicus, "policies are implemented. If policies are successful, the economy booms. Expectations about the expected future returns become increasingly optimistic...riskier behavior is rewarded. This leads to fragility in the economy."
"From time to time," Minsky elaborated in his "Financial Instability Hypothesis," "capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes the economic system's reactions to a movement of the economy amplify the movement - inflation feeds upon inflation and debt-deflation feeds upon debt-deflation. Government interventions aimed to contain the deterioration seem to have been inept in some historical crises.
"In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge [conservative] finance units to a structure in which there is large weight given to units engaged in speculative and Ponzi finance..."
In Japan's boom, Ponzi finance was offered by banks to their favorite corporate customers. More than a dozen years later, the loans still go bad...and now threaten to bring down the banks themselves.
In America's boom, it was consumer lenders - notably Fannie Mae - who played Ponzi's part. Someday, perhaps soon, consumers will regret it. For they must pass through a vale of tears to find their way out.
Your editor, unable to resist...
Bill Bonner
This will end very, very, very, very badly.
I agree with you Patron...evolutionary. |
