Re:A sharp V-shaped economic downturn and recove ry?

["Resende Manuel" <Manuel.Resende@xxxxxxxxxxxxxxxx>]

It could hapen again

Jim Devine says:
>yeah, that's what he (Minsky) said many times.
>But these days, at least in the US, we have a smaller
>government (until recently running a surplus). The Fed
>may be indulgent at times, but until recently it was
>afraid of inflation (sometimes finding itself "between
>a rock and a hard place," in Minsky's phrase, wanting
>to avoid debt defaults but afraid to fuel inflation).
>Further, an indulgent Fed could simply cause! over-indebtedness
>to deepen.
>BTW, I wouldn't call recent Fed rate cuts "indulgent."
>It's more panicked.


I have the pleasure to send you an article published in 1994 by HPMinsky on
that issue.
It is funny, MIJCF means: Milken Institute for Job & Capital Formation.

May I call your attention to the following?

"The institutional developments of the recent past-in part induced by the
belief that "they" will not allow a serious depression to happen-may well have
undermined the ability of the mechanisms that prevented serious recessions and
depressions over the past half century to do so in the future. "


Manel

PS: I am sorry but my other e-mail adress doesn't work. This one causes some
inconveniences to some of you, but it is not my fault.


MIJCF, Jobs & Capital;
Summer 1994, vol 3;
Feature Article 3
Business
Cycles in
Capitalist Economies
by Hyman P. Minsky

As the twentieth century winds down, the financial structures of capitalist
economies have become increasingly complex and more closely linked than in the
past. One aspect of the heightened financial complexity is a decline in the
importance of organizations chartered as banks in the financial system. This is
not a result of an absolute decline in banking; it is due instead to the
increased importance of alternative forms of financial intermediation, such as
mutual and retirement/pension funds, and the creation of new financial
instruments, such as financial derivatives.
The electronic revolution in communications, computation, and access to
information and the earlier jet plane revolution in transportation have led to
closer financial integration of national economies. This has increased the need
for international consistency of financial regulation and supervision, as well
as for the coordination of economic policies. However, there is no mechanism to
assure consistency and coordination aside from convoluted markets that are
likely to be unstable.
In the half century since the end of World War II, the business cycle
performance of the rich capitalist economies has been strikingly better than
their performance during the half century prior to World War II. Recessions
have been short and shallow and the ratio of the time spent in expansion to
that spent in contraction has been greater.
The deep and long Great Depression, which ran for a decade beginning in 1929,
is one reason the earlier experience was poorer, but it does not explain the
entire difference. Cyclical performance in the half century before 1929, which
excludes the Great Depression, also was poorer than in the past half century.
It should be noted, however, that the post-World War II period is not
homogeneous. The first half or so of the period, from 1946 to about 1970, was a
truly epochal period in which sustained economic growth was interrupted only by
mild recessions. It was devoid of economic crises. During the second half-which
I date from the Penn Central commercial paper debacle of 1969/70-cycles have
been frequent, associated with financial problems, and often have required
special interventions to contain potential debacles.
In the past half century, government deficits, which sustained aggregate
profits, and central bank and Treasury interventions, which sustained the
liquidity and solvency of financial institutions, were the mechanisms that
contained financial crises and constrained the path of the economy so that a
deep depression did not happen. The institutional developments of the recent
past-in part induced by the belief that "they" will not allow a serious
depression to happen-may well have undermined the ability of the mechanisms
that prevented serious recessions and depressions over the past half century to
do so in the future.
The weight of government in the economy is the main difference between
post-World War II capitalism and the prewar version. The weight of government
as a creator of demand and as a refinancing agency can be measured by the ratio
of government spending to gross domestic product, by the extent of government
regulation of labor, industrial, and financial markets, and by the willingness
of central banks and Treasuries to intervene to contain financial crises and
refinance failing banks and firms.
Every policy-ori-ented analysis is a reflection of an economic theory. It
behooves an economist who takes policy positions to make the underlying theory
explicit, especially if the theory is not the orthodox theory of the day. The
theory underlying my views is based upon a reading of Keynes and an integration
of Keynes' theory with strands derived from Henry Simons, Joseph Schumpeter,
and modern critics of general equilibrium theory.
Keynes described the writing of The General Theory of Employment, Interest, and
Money as a process of "escaping from the confusions of the Quantity Theory of
Money which once entangled me." The essential proposition of the Quantity
Theory of Money is that money is neutral, i.e., money has no nontransitory
effects upon the outcomes of the economy. Keynes' great work was to construct a
theory of the capitalist economy in which money, because it is a part of the
financing mechanism for a capitalist economy, is not neutral. One reason this
is so is that the key operators in a capitalist economy-investing
businesspersons, households holding capital assets, and bankers-pursue
endeavors expecting to come away with more money than they put into the
endeavor.
There are two distinct price levels in a capitalist economy. One is the price
level of current output, and the other is the price level of capital and
financial assets; i.e., capitalist economies have both a consumer price index
(CPI) and a Dow Jones index. As we know, these two price levels can and do vary
relative to one another. This is so because their proximate determinants are
quite different. In capitalist economies the prices of current output recapture
producers' costs and carry profits: They measure unit labor costs and a
realized markup. The price level of assets is determined by views about future
expected incomes, the current capitalization rates of such incomes, and the
value placed upon the ability to transform assets into cash. Because the ways
that money enters into the determination of these two price levels differ,
money is not neutral.
There are two sources of liquidity in a capitalist economy. One is the flow of
wages, gross profit income, and taxes accruing as a result of the production of
the national output. The second source of liquidity is from selling or pledging
assets. The current capitalization rate of assets includes a discount for the
risk that the markets in which the selling and pledging of assets takes place
will be thin when such actions are necessary.
A decline in investment in a simple model without government or foreign trade
leads to a decline in profits. This lowers the prices of the assets and
financial instruments that are losers in the competition for profits. The flow
of liquidity from the income stream decreases for the losers, which means that
they are likely to need to negotiate asset sales to meet commitments. But their
ability to buy cash with their own assets is reduced by the lower values of
those assets. They are forced to sell or mortgage what third party assets they
own. This forces down the price of these assets even as those firms and
financial institutions that hold the liabilities of the firm under pressure
find their net worth on a mark-to-market basis and their liquidity decreased. A
cumulative fall in investment and the prices of financial assets can result. If
the overall indebtedness of the economy is high, these processes can lead to a
financial crisis in an economy with a small government. In an economy with a
large government, the decrease in the aggregate flow of liquidity will be
halted and even reversed as the government deficit increases.
Perhaps the most dramatic price movements of the century took place between
1929 and 1933, the great contraction phase of the Great Depression. Over that
period the CPI fell by some 33 percent and the Dow Jones fell by some 85
percent. The CPI is a measure of the offer price for current output, including
investment outputs. Thus the offer price for investment output (new machinery
and buildings) fell by one-third even as the price on the market of existing
capital assets as collected in firms fell by some 85 percent. If the ratio of
investment prices to capital asset prices was 1:1 in 1929, by 1933 the ratio
was 4:1. Neither developers nor bankers would finance new firms when existing
firms could be purchased for about a quarter of the cost of producing their
capital.
A key issue in understanding a market economy is: "What determines the cash
flows earned by capital, and thus by the aggregate of profit seeking firms?" M.
Kalecki (and Jerome Levy) replied to this question by first making heroic
assumptions to the effect that wage earners do not save and profit earners do
not consume. In a simple model with no government and no foreign trade, these
assumptions lead to the result that as the total demand for consumer goods
equals total wages in the production of consumption and investment goods,
profits in the production of consumer goods equal the wage bill in the
production of investment goods. As profits in investment-goods production equal
whatever is set in the negotiations between producers and buyers of investment
goods, total profits equal total investment spending.
If there is a government sector, then the net consumption financed by
government spending, after allowing for the impact of taxes, needs to be added
to the demand for consumer goods. The result is that gross profits equal
investment plus the government deficit.
As the economy started into the Great Depression, federal government spending
was about 3 percent of GNP, while investment spending was about 16 percent of
GNP. In this economy with small government, the government deficit could not
offset the impact upon aggregate profits of a decline in investment. In our
modern world, government spending is usually well over 20 percent of GNP. This
means that when private demand is too small to sustain a balanced budget, the
resulting government deficit can easily be 6 percent or more of GNP. As a
result, when private investment falls in a recession, government deficits rise
rapidly and sustain the aggregate flow of profits. Furthermore, if the
government engages in countercyclical fiscal policy, then the aggregate flow of
business profits can turn up even before private investment recovers.
During a strong business cycle expansion, households and corporations increase
the ratio of debt payment commitments to incomes. This increases the danger
that a liquidity crisis yielding a solvency crisis will emerge.
Experience in the 1930s and in the recent solvency crisis of nonperforming
assets of thrifts and banks shows that the Federal Reserve is not able to
handle solvency crises. In both cases the solvency crises were handled by other
government agencies. In the 1930s the Reconstruction Finance Corporation (RFC)
refinanced one-half of the banks that reopened when the bank holiday ended. In
the 1980s and 1990s the Treasury had to supply the funds that financed the
payoff of deposits and the mergers of failed banks. In the 1930s the RFC took
an equity position in the institutions it refinanced. As the economy recovered
these turned out to be "good investments." In the recent experience no such
equity position was taken. As a result, the costs of the refinancing added to
the dead weight debt of the federal government.
Conclusion
The declining weight of institutions chartered as banks implies that money as
usually defined is a smaller part of the nation's financial totals than
previously believed. This has implications for the ability of the Federal
Reserve to contain financial crises and thus prevent deeper depressions. As
part of the nonbank financial mix is truly international in scope, this means
that disturbances in other economies can have a quick impact upon the viability
of domestic institutions. There is a need to rethink the relation between
government institutions and financial markets. The changes that have occurred
have increased the relative importance of the Securities and Exchange
Commission and decreased that of the Federal Reserve. However, the SEC commands
no funds with which it can refinance organizations whose inability to fulfill
contractual obligations can lead to systemwide disturbances.
The RFC of the depression and recovery years was a government investment bank
that can serve as a model for a government refinance institution. The
corruption in Italy and other countries that have used similar organizations
may make it difficult to suggest such an institution. However, the doctrine of
transparency that guides American policy toward firms and markets could be
applied to a modern RFC. This would bound the potential for corruption.
In the late 1980s and 1990s the United States escaped a major financial crisis
by the proverbial skin of our teeth. The indications are that a new wave of
business indebtedness is in the wings waiting to take center stage. Our
weakened financial institutions and the poor understanding of the nature of
American capitalism that is evident in our public discourse imply that our
economy will not come through another solvency crisis that centers around the
financial system with as little damage to the economy as we have experienced up
to now in the half century since World War II.
Hyman P. Minsky is a Distinguished Scholar at the
Jerome Levy Economics Institute of Bard College.

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Copyright 1994; Milken Institute for Job & Capital Formation, Santa Monica,
California
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