Why Capitalism fails ?

The man who saw the meltdown coming had

another troubling insight: it will happen again

By Stephen Mihm   Globe Correspondent 

Since the global financial system started

unraveling in dramatic fashion two years ago,

distinguished economists have suffered

a crisis of their own.

Ivy League professors who had trumpeted

the dawn of a new era of stability have

scrambled to explain how, exactly, the worst

financial crisis since the Great Depression

had ambushed their entire profession.

Amid the hand-wringing and the self-flagellation,
a few more cerebral commentators started
to speak about the arrival of a "Minsky moment,
" and a growing number of insiders began
to warn of a coming "Minsky meltdown."

"Minsky" was shorthand for Hyman Minsky,

a hitherto obscure macroeconomist who died

over a decade ago.

Many economists had never heard of him

when the crisis struck, and he remains

a shadowy figure in the profession.

But lately he has begun emerging as perhaps

the most prescient big-picture thinker

about what, exactly, we are going through.

A contrarian amid the conformity of

postwar America, an expert in the

then-unfashionable subfields of finance and crisis,

Minsky was one economist who saw

what was coming.

He predicted, decades ago, almost exactly

the kind of meltdown that recently

hammered the global economy.

In recent months Minsky's star has only risen.

Nobel Prize-winning economists talk about

incorporating his insights, and copies of his books

are back in print and selling well.

He's gone from being a nearly forgotten figure

to a key player in the debate over

how to fix the financial system.

But if Minsky was as right as he seems

to have been, the news is not

exactly encouraging.

He believed in capitalism, but also believed

it had almost a genetic weakness.

Modern finance, he argued, was far

from the stabilizing force that mainstream

economics portrayed: rather, it was a system

that created the illusion of stability

while simultaneously creating the conditions

for an inevitable and dramatic collapse.

In other words, the one person who foresaw

the crisis also believed that our whole

financial system contains the seeds of

its own destruction.

"Instability," he wrote, "is an inherent

and inescapable flaw of capitalism."

Minsky's vision might have been dark, but he was

not a fatalist; he believed it was possible

to craft policies that could blunt the collateral

damage caused by financial crises.

But with a growing number of economists eager

to declare the recession over, and the crisis

itself apparently behind us,

these policies may prove as discomforting

as the theories that prompted them

in the first place.

Indeed, as economists re-embrace

Minsky's prophetic insights, it is far from

clear that they're ready to reckon

with the full implications of what he saw.

In an ideal world, a profession dedicated to
the study of capitalism would be
as freewheeling and innovative
as its ostensible subject.
But economics has often been subject
to powerful orthodoxies, and never
more so than when Minsky arrived on the scene.

That orthodoxy, born in the years

after World War II, was known as

the neoclassical synthesis.

The older belief in a self-regulating,

self-stabilizing free market had

selectively absorbed a few insights

from John Maynard Keynes,

the great economist of the 1930s

who wrote extensively of the ways

that capitalism might fail

to maintain full employment.

Most economists still believed that

free-market capitalism was a fundamentally

stable basis for an economy,

though thanks to Keynes, some now

acknowledged that government might

under certain circumstances play

a role in keeping the economy - and

employment - on an even keel.

Economists like Paul Samuelson became
the public face of the new establishment; he
and others at a handful of top universities
became deeply influential in Washington.
In theory, Minsky could have been
an academic star in this
new establishment: Like Samuelson, he earned
his doctorate in economics at Harvard University,
where he studied with legendary Austrian
economist Joseph Schumpeter,
as well as future Nobel laureate Wassily Leontief.

But Minsky was cut from different cloth

than many of the other big names.

The descendent of immigrants from Minsk,

in modern-day Belarus, Minsky was

a red-diaper baby, the son of Menshevik socialists.

While most economists spent the 1950s

and 1960s toiling over mathematical models,

Minsky pursued research on poverty,

hardly the hottest subfield of economics.

With long, wild, white hair, Minsky

was closer to the counterculture

than to mainstream economics.

He was, recalls the economist

L. Randall Wray, a former student, a "character."

So while his colleagues from graduate school

went on to win Nobel prizes and

rise to the top of academia, Minsky languished.

He drifted from Brown to Berkeley and

eventually to Washington University.

Indeed, many economists weren't even

aware of his work.

One assessment of Minsky published in 1997

simply noted that his "work has not

had a major influence in

the macroeconomic discussions

of the last thirty years."

Yet he was busy. In addition to poverty,

Minsky began to delve into the field of finance,

which despite its seeming importance

had no place in the theories formulated

by Samuelson and others.

He also began to ask a simple,

if disturbing question: "Can 'it' happen

again?" - where "it" was, like Harry

Potter's nemesis Voldemort, the thing

that could not

be named: the Great Depression.

In his writings, Minsky looked
to his intellectual hero, Keynes, arguably
the greatest economist of the 20th century.
But where most economists drew a single,
simplistic lesson from Keynes - that government
could step in and micromanage the economy,
smooth out the business cycle,
and keep things on an even keel - Minsky
had no interest in what he and a handful
of other dissident economists
came to call "bastard Keynesianism."

Instead, Minsky drew his own, far darker,

lessons from Keynes's landmark writings,

which dealt not only with the problem

of unemployment, but with money

and banking.

Although Keynes had never

stated this explicitly, Minsky argued

that Keynes's collective work amounted

to a powerful argument that capitalism

was by its very nature unstable

and prone to collapse.

Far from trending toward some magical

state of equilibrium, capitalism

would inevitably do the opposite.

It would lurch over a cliff.

This insight bore the stamp of his advisor

Joseph Schumpeter, the noted Austrian

economist now famous for documenting

capitalism's ceaseless process

of "creative destruction."

But Minsky spent more time thinking

about destruction than creation.

In doing so, he formulated

an intriguing theory: not only was capitalism

prone to collapse, he argued,

it was precisely its periods of economic

stability that would set

the stage for monumental crises.

Minsky called his idea the "Financial

Instability Hypothesis."

In the wake of a depression,

he noted, financial institutions

are extraordinarily conservative,

as are businesses.

With the borrowers and the lenders

who fuel the economy all

steering clear of high-risk deals,

things go smoothly: loans are

almost always paid on time,

businesses generally succeed,

and everyone does well.

That success, however, inevitably

encourages borrowers and lenders

to take on more risk

in the reasonable hope

of making more money.

As Minsky observed, "Success breeds

a disregard of the possibility of failure."

As people forget that failure is a possibility,

a "euphoric economy" eventually develops,

fueled by the rise of

far riskier borrowers - what he called

speculative borrowers, those

whose income would cover interest payments

but not the principal; and those

he called "Ponzi borrowers," those

whose income could cover neither,

and could only pay their bills

by borrowing still further.

As these latter categories grew,

the overall economy would shift

from a conservative but profitable environment

to a much more freewheeling system

dominated by players whose survival

depended not on sound business plans,

but on borrowed money

and freely available credit.

Once that kind of economy had developed,
any panic could wreck the market.
The failure of a single firm, for example,
or the revelation of a staggering fraud
could trigger fear and a sudden,
economy-wide attempt to shed debt.
This watershed moment - what was later
dubbed the "Minsky moment" - would
create an environment deeply
inhospitable to all borrowers.
The speculators and Ponzi borrowers
would collapse first, as they lost access
to the credit they needed to survive.
Even the more stable players might find
themselves unable to pay their debt
without selling off assets; their forced sales
would send asset prices spiraling downward,
and inevitably, the entire rickety financial edifice
would start to collapse.
Businesses would falter, and the crisis
would spill over to the "real" economy
that depended on the now-collapsing
financial system.-

From the 1960s onward, Minsky elaborated

on this hypothesis.

At the time he believed that this shift

was already underway: postwar stability,

financial innovation, and the receding

memory of the Great Depression

were gradually setting the stage

for a crisis of epic proportions.

Most of what he had to say

fell on deaf ears.

The 1960s were an era of solid growth,

and although the economic stagnation

of the 1970s was a blow to

mainstream neo-Keynesian economics,

it did not send policymakers scurrying

to Minsky.

Instead, a new free market fundamentalism

took root: government was the problem,

not the solution.

 Moreover, the new dogma coincided
with a remarkable era of stability.
The period from the late 1980s onward
has been dubbed the "Great Moderation,
" a time of shallow recessions and great
resilience among
most major industrial economies.
Things had never been more stable.
The likelihood that "it" could
happen again now seemed laughable.

Yet throughout this period,

the financial system - not the economy,

but finance as an industry - was

growing by leaps and bounds.

Minsky spent the last years of his life,

in the early 1990s, warning of

the dangers of securitization

and other forms of financial innovation,

but few economists listened.

Nor did they pay attention to consumers'

and companies' growing dependence

on debt, and the growing

use of leverage within the financial system.

By the end of the 20th century,

the financial system that Minsky

had warned about had materialized,

complete with speculative borrowers,

Ponzi borrowers, and precious few

of the conservative borrowers

who were the bedrock

of a truly stable economy.

Over decades, we really had forgotten

the meaning of risk.

When storied financial firms started to fall,

sending shockwaves through

the "real" economy, his predictions

started to look a lot like a road map.

"This wasn't a Minsky moment,

" explains Randall Wray.

"It was a Minsky half-century."

Minsky is now all the rage.

A year ago, an influential Financial Times

columnist confided to readers

that rereading Minsky's 1986

"masterpiece" - "Stabilizing an

Unstable Economy" - "helped clear

my mind on this crisis."

Others joined the chorus.

Earlier this year, two economic

heavyweights - Paul Krugman and

Brad DeLong - both tipped their hats

to him in public forums.

Indeed, the Nobel Prize-winning Krugman

titled one of the Robbins lectures

at the London School of Economics

"The Night They Re-read Minsky."

Today most economists, it's safe to say,

are probably reading Minsky for the first time,

trying to fit his unconventional insights

into the theoretical scaffolding

of their profession.

If Minsky were alive today,

he would no doubt applaud

this belated acknowledgment,

even if it has come at a terrible cost.

As he once wryly observed,

"There is nothing wrong

with macroeconomics

that another depression [won't] cure."

But does Minsky's work offer us

any practical help?

If capitalism is inherently

self-destructive and unstable - never mind

that it produces inequality

and unemployment,

as Keynes had observed - now what?

After spending his life warning
of the perils of the complacency
that comes with stability - and having
it fall on deaf ears - Minsky
was understandably pessimistic
about the ability to short-circuit
the tragic cycle of boom and bust.
But he did believe
that much could be done
to ameliorate the damage.

To prevent the Minsky moment

from becoming a national calamity,

part of his solution (which was

shared with other economists)

was to have the Federal Reserve - what

he liked to call the "Big Bank" - step

into the breach and act as a lender

of last resort to firms under siege.

By throwing lines of liquidity

to foundering firms, the Federal Reserve

could break the cycle and

stabilize the financial system.

It failed to do so during the

Great Depression, when it stood by

and let a banking crisis spiral

out of control.

This time, under the leadership

of Ben Bernanke - like Minsky,

a scholar of the Depression - it took

a very different approach,

becoming a lender of last resort

to everything from hedge funds

to investment banks

to money market funds.

Minsky's other solution, however,

was considerably more radical

and less palatable politically.

The preferred mainstream tactic

for pulling the economy out of

a crisis was - and is - based on

the Keynesian notion

of "priming the pump" by sending money

that will employ lots of high-skilled,

unionized labor - by building

a new high-speed train line, for example.

Minsky, however, argued for

a "bubble-up" approach,

sending money to the poor

and unskilled first.

The government - or what he

liked to call "Big Government" - should

become the "employer of last resort,

" he said, offering a job to anyone

who wanted one at

a set minimum wage.

It would be paid to workers who

would supply child care, clean streets,

and provide services

that would give taxpayers

a visible return on their dollars.

In being available to everyone,

it would be even more ambitious

than the New Deal, sharply reducing

the welfare rolls by guaranteeing

a job for anyone who was able to work.

Such a program would not only

help the poor and unskilled,

he believed, but would put

a floor beneath everyone

else's wages too, preventing salaries

of more skilled workers

from falling too precipitously,

and sending benefits up

the socioeconomic ladder.

While economists may be acknowledging

some of Minsky's points on financial instability,

it's safe to say that even liberal policymakers

are still a long way from thinking

about such an expanded role

for the American government.

If nothing else, an expensive

full-employment program would veer far

too close to socialism

for the comfort of politicians.

For his part, Wray thinks that the critics

are apt to misunderstand Minsky.

"He saw these ideas as perfectly

consistent with capitalism," says Wray.

"They would make capitalism better."

But not perfect. Indeed, if there's anything

to be drawn from Minsky's collected work,

it's that perfection, like stability

and equilibrium, are mirages.

Minsky did not share his profession's quaint

belief that everything could be reduced

to a tidy model, or a pat theory.

His was a kind of

existential economics: capitalism,

like life itself, is difficult, even tragic.

"There is no simple answer to

the problems of our capitalism,

" wrote Minsky.

"There is no solution that can be

transformed into a catchy phrase

and carried on banners."

It's a sentiment that may limit

the extent to which Minsky becomes

part of any new orthodoxy.

But that's probably how he would

have preferred it, believes liberal

economist James Galbraith.

"I think he would resist

being domesticated," says Galbraith.

"He spent his career in professional isolation."

Stephen Mihm is a history professor at
the University of Georgia
and author of "A Nation of
Counterfeiters" (Harvard, 2007).

Link here

             J-L K.
Procurement Consultant
Gsm:    (250) (0) 78-847-0205 (Mtn Rwanda)
Gsm:    (250) (0) 75-079-9819 (Rwandatel)
Home:  (250) (0) 25-510-4140
    P.O. Box 3867
  Kigali - RWANDA
    East AFRICA
Blog: http://cepgl.blogspot.com
Skype ID: kayisa66

No comments:

Post a Comment