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November 18, 2009

The Minsky Moment

By Spear's

The fight to stop Great Depression 2 is far from over. In 2008, we saw the Keynesian Stimulus Cure and the Friedmanite QE Cure deployed around the world, but the next two economists to enter the world stage are the Irving Fisher Reality Check and the Hyman Minsky Moment.

Stephen Hill on how we’ve had enough of Keynes and Friedman: bring on Fisher and Minksy
THE FIGHT TO stop Great Depression 2 is far from over. In 2008, we saw the Keynesian Stimulus Cure and the Friedmanite QE Cure deployed around the world, but the next two economists to enter the world stage are the Irving Fisher Reality Check and the Hyman Minsky Moment.

In a nutshell, Keynes said the public purse should take over the role of the private sector in a downturn and maintain employment, but Friedman said Keynes was wrong and that expansion of the money supply would alone have prevented the Great Depression of the 1930s. The governments of the Anglo-sphere world weren’t sure which of these deceased economists was right, so went for both options.

Ben Bernanke, a confirmed Friedmanite who organized the latter’s 2002 birthday party, got in his helicopter and showered money around like no tomorrow, doubling the Fed’s balance sheet by $1.0 trillion to $2.0 trillion (actually by $12.0 trillion when guarantees and insurances are added in), while Obama threw $700.0 billion at ‘shovel-ready’ Keynesian infrastructure projects.

In the UK, Mervyn King was given £200.0 billion for his QE pot, amounting to one-sixth of GDP, and the government engaged in several stimulus programmes. And both governments engaged in massive bank bail-outs as well.

Did these cures work? Unfortunately, it’s impossible to measure the results. On the Keynesian side, the ‘Cash-for-Clunkers’ scheme in the US gave a much-needed shot in the arm for the beleaguered motor industry and sent liquidity down the biggest industrial artery in the economy. The QE definitely propped up the busted banking system, which saved its life, but it’s still full of walking wounded.

Charles Bean, Deputy-Governor of the Bank of England, said about QE’s effectiveness: ‘The truth is that we will probably never know exactly how effective the policy … has been, for the simple reason that we can never know with precision what would have happened in its absence.’ Try doing the maths on that one.

THE EVIDENCE OF success to date is still not gathered in: the US Q3 GDP showed economic expansion of 0.9 per cent, but don’t believe one quarter’s figures – the ‘Cash-for-Clunkers’ scheme and other distortions could have caused this and now that scheme is over – and the UK Q3 GDP was still in contraction at 0.3 per cent. This promptly caused a quivering Mervyn King to shower his final £25.0 billion of QE magic dust over the limp economy.

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None of this, however, has reversed the upward rise in unemployment, which is the key indicator, as it’s also the harbinger of bank losses to come, from mortgage, auto, credit card and certain loans, which are all still hurting and causing huge Q3 write-offs: $9.0 billion at Citigroup and $8.0 billion at BoA, with Barclays at £4.0 billion year-to-date.

At this point, enter the late Irving Fisher with his Debt-deflation Theory, which says that when debts can no longer be repaid by rising asset values, this causes excessive debts to be extinguished either by inflation or renegotiation or by being reneged on or by bankruptcy. This means the collapse of the whole system when the bond market ends up being buried.

The fact that the money supply in the US and the UK is now contracting plays into Fisher’s theory, but is hardly surprising as the banks are deleveraging after their grotesque binge during the noughties. This indicates to the Friedmanites that more QE is still required, and the same could be said of Keynesian stimulus programmes.

At some point we might hit a tipping point (a term that is eminently suitable but which no one can calculate), where the new fiat money creates no forward momentum in the economy but just adds to the public sector’s bloated indebtedness. It points instead to inflation rearing its ugly head down the pike, when interest rates have to rise and harm any prospects of recovery. The hangover comes at a cost too, you see.

AND WHAT ABOUT the late Hyman Minsky and his Moment? Minsky hypothesised that Big Government and an increasingly Big Banking and Financial Services Sector would simply self-implode on account of their interaction and size, and the number and complexity of their financial products. Today we call this systemic risk and refer to the ‘Too-Big-To-Fail’ syndrome, when governments ignore moral hazard and prop up busted banks.

Minsky loved maths but even he couldn’t do the maths on this one, no doubt because it was just about impossible. He was writing back in 1985, before derivatives and structured finance and new mortgage rules existed, and before bankers geared their balance sheets out of sight and governments borrowed many times their countries’ GDP. His theory, nevertheless, has credence simply because he formulated it and there’s nothing else in the economists’ locker to describe how Great Depression 2 could come about.

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