The Man Who Knew Too Much

09/23/2011 10:12 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Visionary economist Hyman Minsky predicted so much of what has come to pass that we ignore his advice at our peril, writes MoneyShow.com senior editor Igor Greenwald.

Today would have been the 92nd birthday of the late, great economist Hyman Minsky, who died in relative anonymity 15 years ago, but now defines our era.

Minsky is most famous for conceiving the Minsky moment, which is when the greater fool realizes he is the last and greatest fool, and starts to liquidate speculative holdings to repay debt.

It’s not a happy time, especially when you’re living through a Minsky Decade and wondering whether we’ll have an economy left as imploding markets and untenable debts spread the virus of uncertainty.

Uncertainty is something Minsky seems to have grasped uniquely well, and that understanding enabled his prophetic insights into the critical flaws of modern finance.

Perhaps because he was so mindful of how little we all know about the future, here’s what Minsky successfully predicted:

  • That the very stability of post-Depression capitalism as practiced in the US would introduce risks that would lead to the next great crisis
  • That modern capitalism, like every other economic system, is inherently unstable, because its good stretches promote laxity and neglect in regulation, as well as the unsustainable accumulation of risk and debt
  • That the insertion of money managers focused on the next day’s price between shareholders and the companies they ostensibly own would radically ratchet up the risks for everyone
  • That the increasingly global span of finance would jeopardize effective official response to a future crisis, because governments and central banks were liable to disagree about the proper course of action

At a time when the most highly regarded of his colleagues were crafting equations to model rational markets, Minsky was thinking and writing about how perfectly rational individual responses to the great unknowns can create speculative bubbles and deflationary busts, with ruinous consequences for everyone.

Rational economics posited a common conceptual framework shared by all market participants. Minsky thought in terms of individuals constantly revising their personal theories about the future, and their confidence in those theories, and their confidence that they understand the motivations of others, in response to the latest market moves and other experience.

Are we headed for a deflationary spiral, hyperinflation, or a garden-variety recession? Is the government choking the economy or killing it with neglect?

People holding all of these views in aggregate will try to sell each other assets, products, and services today, and in the course of all this transacting will adjust their own views, as well as guesses about everyone else’s.

And, just to bring everything up to date, if enough individuals conclude that the sovereign powers of Europe and the US are disputed and therefore permanently dysfunctional, if they conclude that holding a variety of productive assets is much less desirable given the accelerating downturn in demand, then they are perfectly capable of wrecking the entire system.

I don’t think we’re having a classic Minsky moment, insofar as short sales have lately been so much more popular than margin debt. But there were big forced liquidations yesterday in the commodity space, and the money hoarding we’re seeing, a symptom of a system under stress, suggests a glaring lack of confidence in our common future.

Minsky foresaw all this, and even hinted at the larger causes of our troubles in a paper written a few months before his death:

“Money manager capitalism has led to a heightening of uncertainty at the firm and plant level…There is an almost chronic need to downsize overhead and to seek the lowest possible variable cost. …Even as the natural barriers to trade have decreased, the willingness and ability of management to accept lower profit margins to sustain domestic production has vanished. These factors have decreased the assurance of continued employment by blue-collar, white-collar and middle-management personnel. Although the aggregate performance of the economy is not bad [those were the days—IG], individual security has diminished.”

You’d think someone who foresaw so much would be a good source of advice on getting out of a systemic crisis, and Minsky had plenty.

But he’s quite dead, and not pontificating on TV about the need to unleash entrepreneurial energies stifled by government, because even 15 years ago it was obvious to Minsky that those entrepreneurial energies would ultimately be channeled by the money managers overseas. (With their insecure former employees flocking, as a result, to the cheapest retailers of cheap imported wares.)

Besides, it’s doubtful that there would be much popular interest in the prescriptions of this one-time socialist and John Maynard Keynes disciple. Minsky believed that in moments of business paralysis government should pick up the slack, and even in “normal” times he believed in the benefits of a policy striving for full employment.

People’s tolerance of uncertainty is limited, Minsky knew. So he argued the role of government was to limit extreme, uncertainty-breeding episodes like the one we’re now experiencing.

Worse still, from a certain vantage point, Minsky believed it was necessary for society to give up a bit of aggregate income from time to time to support economic “losers” who might otherwise undermine democracy.

Yeah, what a loser that guy was. And what winners we all are for neglecting him.

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