Minksy’s Five Steps to Contagion _ Prospect Magazine
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10/28/2015 Minksy’s five steps to contagion | Prospect Magazine http://www.prospectmagazine.co.uk/economicsandfinance/minksysfivestepstocontagion 1/8 HOME > ECONOMICS & FINANCE World leaders fear contagion, the final act in financial crises Minksy’s five steps to contagion by Tom Streithorst / November 18, 2011 / Leave a comment The fear of unsustainable debt levels has spread from Greece, first to Spain and Portugal, then to Italy and now to France, Austria, even Finland. Investors who had been pleased to put their money into dodgy assets now fear everything but the very safest. In the old days, they fled to gold. Today, the equivalent of gold is German bonds. Private investors are selling everything else. There are few buyers beside governments and the European Central Bank. The possibility of defaults, of bank closures, and of global recession grows by the day. How did we get here? Contagion is what the great Hyman Minsky and his populariser, Charles Kindleberger, call the final act in financial crises. According to Minsky there are five stages between bubble and bust. The first is displacement or innovation: something changes that makes a certain investment more profitable. In the 1990s, the promise of European unification and a single currency removed currency risk from the minds of European bond traders. One of the most profitable speculations towards the end of the last millennium was the convergence trade between German and southern European debt. Financiers were convinced that without the chance that the lira could depreciate against the Deutschmark, that Italian and German debt should have the same price. Now that proposition seems utterly daft, but back then, it made traders lots of money. Home About us Contact Us October 28 2015 10:48pm Login Subscribe Home
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Transcript of Minksy’s Five Steps to Contagion _ Prospect Magazine
10/28/2015 Minksy’s five steps to contagion | Prospect Magazine
http://www.prospectmagazine.co.uk/economicsandfinance/minksysfivestepstocontagion 1/8
HOME > ECONOMICS & FINANCE
World leaders fear contagion, the final act in financial
crises
Minksy’s five steps to contagionby Tom Streithorst / November 18, 2011 / Leave a comment
The fear ofunsustainable debtlevels has spread fromGreece, first to Spainand Portugal, then toItaly and now to France,Austria, even Finland.Investors who had beenpleased to put theirmoney into dodgy
assets now fear everything but the very safest. In the old days, theyfled to gold. Today, the equivalent of gold is German bonds. Privateinvestors are selling everything else. There are few buyers besidegovernments and the European Central Bank. The possibility ofdefaults, of bank closures, and of global recession grows by the day.How did we get here?
Contagion is what the great Hyman Minsky and his populariser,Charles Kindleberger, call the final act in financial crises. According toMinsky there are five stages between bubble and bust. The first isdisplacement or innovation: something changes that makes a certaininvestment more profitable. In the 1990s, the promise of Europeanunification and a single currency removed currency risk from theminds of European bond traders. One of the most profitablespeculations towards the end of the last millennium was theconvergence trade between German and southern European debt.Financiers were convinced that without the chance that the lira coulddepreciate against the Deutschmark, that Italian and German debtshould have the same price. Now that proposition seems utterly daft,but back then, it made traders lots of money.
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10/28/2015 Minksy’s five steps to contagion | Prospect Magazine
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The second stage is expansion. Minsky reminds us that no boom canoccur without fuel and that fuel is cash. Without easy money,bubbles don’t grow. The fuel was the German current accountsurplus. In the early years of this century, the German economyboomed, exporting far more to the peripheral European nations thanit imported. This current account surplus needed to be spent and soit flooded out of German banks into southern Europe, fundingcondominiums in Spain and government pensions in Greece. For awhile, everybody was happy.
The next stage, euphoria, peaked sometime around 2006. Thespreads between German and Greek debt became infinitesimal. Fora few extra basis points, optimistic traders were willing to ignore allsorts of dangers. Subprime mortgages, Indonesian corporate bonds,Greek government debt were priced as if they were almost risk free.The sad thing: traders made fat bonuses during those happy daysdespite the obvious idiocy of their speculations.
It turns ugly with the fourth stage, revulsion. The asset that had sorecently tempted investors now fills them with fear. After LehmanBrothers, the sense of placid optimism evaporated and traders fledto safe havens. The lust for higher yield was replaced with the needto preserve capital, and investors burned by subprime debtwondered where else they had been blinded.
The answer: Greece, with high wages and low productivity, withspectacular government debt levels and little prospect for growth.Before 2008, eager bankers rolled over Greek debt when it becamedue, making paper profits for themselves and allowing continuedGreek profligacy. By 2009 they were desperate to get their moneyout. To protect exposed banks the European Central Bank promisedmassive infusions of capital to buy maturing Greek debt, therebykeeping yields down to sustainable levels. The ECB had enoughmoney to bail out Greece (or more accurately to bail out the banksthat had lent to Greece) but nowhere near enough to bail out Spainor Italy.
And that is why we are in this mess today. Sometime over the pastyear, watching German politicians bloviate and Greek protestors riot,markets lost their faith in the ability of European elites to manage thecrisis. Contagion has turned a mess that could have beenmanageable to one that is out of control. Just as euphoria blindsinvestors to risk, revulsion blinds them to opportunity. Theassumption that Greek bonds are as solid as German bonds mutatedinto the fear that the Finnish or French economy is as fragile as theGreek. Neoclassical economics assumes investors are rational—butMinsky knew better.
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atimoshenko
So is there any point at which finical markets are workingproperly and creating value for the broader economy? Fromthe article it sounds as if financial markets have only twomodes – suffering from a current crisis or setting the stage for
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November 18, 2011 at 16:15
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modes – suffering from a current crisis or setting the stage forthe next one.
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Tom Streithorst
The efficient market theory says that security prices are alwaysright. That clearly doesn't fit the evidence. However I don'tthink that suggests that they are always wrong. What it doessuggest is that unregulated financial markets do not bestallocate societal savings, which is supposed to be their job.
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