Every Stability Prepares Its Own Collapse

Isn't stability one of the main goals of economic policies? Isn't sustainability of stability also a goal? Is sustainability of stability possible under market conditions?

According to Hyman P. Minsky (1919-1996), stability in market conditionsprepares its own collapse. The confidence created by stability causes investors, banks, and firms to become more courageous in taking risks and to increase their tendency to make speculative decisions.

If the stability of the market prepares its own destruction, can theses that defend the efficiency of the market be justified? Can it be thought that the market can be the place to solve economic problems?

Did it go unnoticed at the time that the deregulation, financialization and market-oriented views that have become widespread around the world since the 1980s would lead to today's inequalities? Or are the economic models flawed?

The necessity for a change of understanding in economic management on a global scale is being expressed with increasing intensity and prevalence.

The increasing prominence of central banks along with the financialization process has led to the search for alternative policies. Will these searches ensure that future economic policies will serve to eliminate the problem of inequality?

Let's summarize Minsky's theses from the perspectives set out above. I stated that I would return to Minsky in my article dated March 30, 2023, where I addressed the problem of financial instability.

In the 1970s and later, the efficient market hypothesis, led by Eugene Fama and Robert Lucas, attracted academic interest. The hypothesis was widely accepted to be correct. Minsky, who had begun working on the financial instability hypothesis in the 1950s, opposed the efficient market hypothesis.

According to Minsky, the efficient market hypothesis did not focus sufficiently on the concepts of money and finance. Within the complex structure of a modern capitalist economy, money and finance had a greater importance than the efficient market hypothesis considered. Money, which is treated neutrally in many schools of economics, was not neutral in Minsky's financial instability hypothesis.

Minsky was an academic with a background in mathematics. However, he did his work in the field of economics. He lived during the Great Depression of 1929 and was influenced by J. M. Keynes. He did not use mathematical formulas as intensively during the period when economics was developed with intensive mathematical approaches.

Minsky explains the financial instability hypothesis with the concept of investment. There can be two sources of investment. One is the firm's own cash source, the other is the cash source provided by debt. The point at which the balance between these two sources can be optimal is an important topic of discussion.

Minsky analyzed the financial resources that can be provided for an investment under three different classifications:

1. Financing a company's investment with its own resources (hedge financing). In other words, a company's payment of its debts with cash resources that it will obtain in the future through its own activities. This is the safest financing method and will keep a company's debt level low.

2. Speculative financing. It is the use of future cash resources from a firm's operations for interest payments while paying back the financial resources provided today. The financial resource must be reused to repay the principal. This is riskier than the first method mentioned above. An economy in recession or depression may not be able to reuse the principal.

3. Ponzi financing. A situation where a company does not use the future cash resources it will obtain from its activities for either interest or principal while paying back the financial resources it provides today. It is a financing based on the assumption that the asset that is the collateral for the financial resource can be of a value that can make both interest and principal payments until the maturity of the debt. There is a risk that the asset will have a value that will not make both interest and principal payments at the maturity of the debt.

The market can tend towards the Ponzi financing type over time with the environment of trust that is created in stability. Thus, stability prepares the ground for instability over time. When instability occurs, trust collapses. Risks that are aware of but not taken precautions or are not aware of can turn into a systemic risk.

Source: https://www.edgarepeters.com/blog-2-2/the-financial-instability-minsky-regime

The emergence of systemic risks and therefore the spread of risks related to debt repayment will lead to a fall in asset prices. Irving Fisher called the process debt deflation. The Great Depression that emerged in 1929 occurred under debt deflation conditions.

As mentioned above, financing investments with the first method defined by Minsky is a risk reducing element in terms of macroeconomic balance. Financing investments with the use of the other two methods and especially Ponzi financing will expose economies to high risks.

The fall in asset prices will initiate a process in which firms, especially those in poor financial conditions, will begin to sell their assets. Such a development will bring about a new wave of decline in asset prices. Crises have repeatedly confirmed Minsk's theses.

Financialization and the types of debts have also become determinants of financial crises. As long as debt is directed towards investments in the production of goods and services, it serves macroeconomic stability and can provide an environment that will not create inflationary pressure. When debt is given for consumption, demand inflation can be created and stability can be disrupted. When debt is given for asset purchase and sale transactions, it inflates asset prices and encourages speculative decisions.

Systemic risks are growing as the demand for debt that matches Minsky's definition of Ponzi financing is combined with the increasing shift of lenders from lending for the production of goods and services to lending for consumption and the purchase and sale of assets.

The view that a change of perspective on the economy is needed is increasingly gaining support. For the right economic policy design, the models that explain economic developments must be correct. For the right policy design, correct regulation is needed. Can all economists understand and explain economies correctly? Also, what is correct according to which ideology?

Which variables economic models consider and which policies they recommend based on these models vary according to current practices in countries.