Tuesday 25 March 2014

Crashonomics

I listened to a very interesting programme about Hyman Minsky and his theory which explains why market crashes are inevitable. The programme claimed that the reason why Minsky was never awarded a Nobel Prize for his work is that his theory was descriptive, not mathematical, so it was unsuited to the building of
models.

If Gordon Brown had listened to Minsky he would never have claimed that there would be "no return to boom and bust". And Bernanke would have been far more cautious about leaving the brakes off as the US economy careered towards the busting of Lehman Brothers and the subsequent crash.

Minsky's theory is simple. He claims that in prosperous times, when money is freely available as companies generate more cash than they need to pay back debt, a speculative euphoria develops. Asset prices inflate and banks lend at a rate where, first, borrowers can only afford to pay the interest on their loans but cannot repay the capital; and,second, banks lend to borrowers who can neither repay capital nor interest and debts are rolled up. The expectation is that the profits made from the inflation of the value of assets will eventually clear debts.

The denouement of this euphoric lending by banks drives the seemingly stable and prosperous economy towards the inevitable "Minsky moment." The fragility of the banks is finally revealed, the customers to whom they lent so freely are unable to pay their debts, and the economy falls off the cliff.

Since this process is intrinsic to market economies, Central Bank intervention is essential. The impulse for banks to lend to ever more risky projects needs to be curbed by regulation.

My fear is that, following the latest banking crisis, it is the Central Banks themselves that have indulged in euphoric lending through the process of Quantitative Easing. I have said many times before that I believe that stock market values have been inflated by an excess of cash in the system. An excess that has been deliberately created by the authorities. When, I wonder, will the fragility of the central banks be revealed? Who then will bail us all out?



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