Minsky Financial Instability Hypothesis
Looking back, I see that I have mentioned the name Hyman Minsky in no fewer than ten Thoughts from the Frontline letters in just the past two years; and his name has popped up in all four letters so far this month, most notably on March 1, when we brought back one of my most popular pieces, “Black Swans and Endogenous Uncertainty” (the “sandpile” letter) and last week, when the letter was titled “China’s Minksy Moment?”
I wasn’t consciously aware of how often I had trotted Minsky out as I sat (somewhat unstably, I have to admit) atop a headstrong horse in the foothills of the Argentine Andes the other day; but my precarious situation did somehow get me thinking of Minsky’s Financial Instability Hypothesis, and it occurred to me that both you and I might learn something by going right back to its source, which turns out to be a rather unprepossessing five-page paper Dr. Minsky published at Bard College in 1992.
Minsky’s work was roundly ignored by the economics profession and policy makers alike … until all hell broke loose in the financial industry and then the global economy in 2008. At the time (in Dec. 2007), I described Minsky’s thesis like this:
[E]conomist Dr. Hyman Minsky points out that stability leads to instability. The more comfortable we get with a given condition or trend, the longer it will persist and then when the trend fails, the more dramatic the correction. The problem with long-term macroeconomic stability is that it tends to produce unstable financial arrangements. If we believe that tomorrow and next year will be the same as last week and last year, we are more willing to add debt or postpone savings in favor of current consumption. Thus, says Minsky, the longer the period of stability, the higher the potential risk for even greater instability when market participants must change their behavior.
The term Minsky moment was coined in 1998 by my good friend Paul McCulley (who, by the way, will once again entertain and enlighten us at the upcoming Strategic Investment Conference, May 13-16). He was characterizing the Russian default and ensuing Long Term Capital Management debacle, but he got to reprise the term (and how!) in ’08. And then everybody jumped on the “Minsky moment” bandwagon.
So today, let’s harken to the words of the man himself, in his “Financial Instability Hypothesis” paper from 1992.
I write tonight from my condo in La Estancia de Cafayate. Last Saturday we spent seven hours trekking the Andes highlands to spend a few days with my friend Bill Bonner (of Daily Reckoning fame). He and his wife Elizabeth are gracious hosts. His South American home is in the middle of 500,000 acres of some extraordinarily godforsaken land in the backside of the middle of nowhere. It comes complete with real-life gauchos, who have lived on the property for dozens of generations, and a herd of some 1000 sand-fed cattle. (In the dry season there is not much else for them to eat.) The area was settled from Peru in the 1500s. It is as remote as any place I’ve ever been, but it also shines with some of the most majestic beauty this writer has ever seen. If Montana is Big Sky Country, then this part of the world has to be called Muy Grande Cielo Campo. The valleys and surrounding mountains are larger and grander than any I have seen in my far-flung travels.
What passes for a road to Bill’s estancia is sometimes a dry, sandy riverbed but often just a track cut and mended by road graders from time to time through very rocky terrain and and over and through mountain passes.
But it was worth all the effort. I treasure the moments I get with Bill (and this time I was accompanied by David Galland, Olivier Garret, and Frank Trotter). I never know quite what to expect when I come to one of Bill’s “homes,” which are really just very large and very time-consuming projects, but he and Elizabeth seem to love it. As we arrived, one of the gauchos had discovered a few dead calves (otherwise healthy a few days before), and there was concern there might be a contagious disease, so they spent the next few days gathering what they could find of the herd, which was of course scattered all over heck and gone. Getting them into the pen and vaccinating them – and since they had them there, branding and gelding them as appropriate – was all in a very long day’s work. It had been many decades since I was anywhere close to that sort of work.
Some of you prone to wincing might want to avoid the following sentences. They had one young bull calf pushed into a chute where he was immobilized, and the head gaucho dropped into the chute behind him. The calf thereupon met his own Minsky moment. The gaucho, swear to God, pulled out a Swiss Army knife and proceeded to geld the unfortunate creature. It was not the clean, swift procedure I remember as a kid. I had no idea they made Swiss Army knives with that attachment. It seems to be missing in mine. The next time I go to Bill’s estancia, I am going to bring the gaucho a set of purpose-built clippers. I may even have them plated in stainless steel. It’s what you get for the man who has everything.
Our conversation at 10,000 feet in the Andes ranged far and wide but kept coming back to the intersection of economics, politics, and philosophy. And being basically off the grid for a couple days, we had plenty of time in the evening for conversation and even a little singing. Bill has written yet another book and writes daily for his own blog. After 30 years, we always have a lot to talk about. I live for days like this.
It is time to hit the send button, as there is a large group waiting at a local café for a reception. It is a beautiful night with perfect weather. It’s hard to think of place better suited for working vacation. Until this weekend…
Your glad he makes his living riding a computer analyst,
John Mauldin, Editor
Outside the Box
The Financial Instability Hypothesis
By Hyman P. Minsky
The Jerome Levy Economics Institute of Bard College
The financial instability hypothesis has both empirical and theoretical aspects. The readily observed empirical aspect is that, from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out ofcontrol. 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 of the historical crises.â€¨These historical episodes are evidence supporting the view that the economy does not always conform to the classic precepts of Smith and Walras: they implied that the economy can best be understood by assuming that it is constantly an equilibrium seeking and sustaining system.
The classic description of a debt deflation was offered by Irving Fisher (1933) and that of a self-sustaining disequilibrating processes by Charles Kindleberger (1978). Martin