Why Capitalism Fails: Hyman Minsky- Economist of Instability

by Roy C | September 21, 2009 at 08:42 am

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Hyman Minsky was a rather obscure economist who had the contrarian position that capitalism was inherently unstable. Until recent events proved him to be a Wise Man, he remained overlooked. His successful prediction of the present world economic meltdown came about by focusing on his belief that capitalism was inherently unstable and that no arrangement of government and big banks would necessarily prevent the next Great Depression.

Unfortunately, he is no longer here to enjoy the celebrity that that would have been his due being the Cassandra of today's global economy.

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 macro-economist 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.”

Is it capitalism itself or is it our stewardship of the system that is the problem?

The characteristic of capitalism that leads it to instability and quasi-self-destruction is not something "out there", but rather is a derivative of what is inside us, our own incomplete being and the resultant one-sidedness that favors one aspect of life over another to the detriment of the whole. (Minsky does talk about attitude.)

When people suffering from what Jung called "one-sidedness" theorize about the world, their interpretations inevitably serve to camouflage that one-sidedness, that tendency to overlook the flaws of whatever they support and to overestimate the evil of things that they oppose.

We are characteristically invested in these "wars", usually of words, because of our intense identification, our position, our self-esteem, and, with financiers and economists, our very material means of existence.

This all makes retreat from our errors painful and more difficult.

When there is opportunity to avoid catastrophe, we don't. Attitudes change as conditions appear to allow and even encourage indulgence. Sobriety is lost. A thorough dose of Stoicism would do it, but doesn't look like any fun.

Besides, if you are so smart, Mr. Critic, why aren't you rich?

That line has killed the credibility of a lot of potential healers and redeemers who are then cast aside. I mean, who are you going to listen to, Minsky, or someone with a billion dollars on Wall Street?

Because of that, Minsky spent his life in professional isolation. That does say something about what is needed to get at the truth, however.

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.

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The_Cynic

at 09:50 on September 21st, 2009

As we look at "capitalism" we are missing the point - as with socialism and Marxism - I would even bring into that equation that conservatism has taken a back foot.

Capitalism as should be seen, is not used, neither has Socialism nor Marxism nor - the great evil, communism.

What we do see is controlled, to a point, consumerism.

Capitalism is feared by governments - they try to regulate it. And fail miserably. What governments want people to do is buy things - things that can be taxed.

Again - if people took the time to read The wealth of Nations they would see that Smith was looking for a more equal society out of the utilisation of capitalism - that didn't happen. It cannot happen because you would then have a very different world than we do now.

Capitalism is an economic view - socialism/Marxism is a social view - and again, we see that these things have NOT happened because of the over burdening aspect which is consumerism.

a211423

at 10:07 on September 21st, 2009

From what I read about Minsky, he advanced the theory of cyclical, dynamic economics in capitalism that needed to be counter balanced by governmental regulation. He was against the deregulation of the 1980s, and rightly so predicted the recession we find ourselves in now.

Roy C

at 10:13 on September 21st, 2009

The deregulation brought about by the Clinton-Reuben-Gingrich "triumvirate". I was against that too.

hidflect

at 10:45 on September 21st, 2009

Capitalism is just an iron rule of nature, like gravity. It is not any kind of a philosophy or ideology. Some people (mostly rich glibertarians) like to loudly proclaim themselves strong adherents of capitalism - capitalists in short. They might as well call themselves gravitationalists. Harmless as an idea, it's only when they start insisting that putting up safety barriers to falling as being some sort of an impediment to natural forces of gravity that they become a danger. Many of these people on the Right see no evil in throwing weaker members of society into the void stating only that they are obeying nature's law of gravity and will not see it denied. They themselves, of course, sit safely on the highest, flattest plateaus safe from any such calamity.

Rory Cripps

at 14:57 on September 21st, 2009

Excellent post Roy! I'm champing at the bit to comment but you've put out so much economic food for thought here that I have to sit back for a bit and reflect. Later . . . .

Roy C

at 19:12 on September 21st, 2009

I have not read Smith but seen quite a few quotes that have convinced me that his intention was for the best, and not a rationale for interest groups to look after their own to the detriment of the rest of society.

I don't agree about consumerism being at the base of the problem, but I do agree that consumerism is designed to make us malleable for the market, undermine spiritual values, make "herd" animals of us, and think that consumption is a kind of ultimate pleasure, a sign of the good life and of being blessed.

What was good about traditional religion is the baby thrown out with the bath water as we have secularized.

Science and economics can help us make moral decisions but science and economics cannot substitute for morality. Agreed.

Socialism's flaws are lack of accountability based on an over-concentration of power and a logos, an operating philosophy, that made its opponents and dissidents into traitors.

Capitalism is more likely to regard you as a fool and effectively isolate you without violence. You can still teach your unorthodoxy somewhere and right a book about it. The government-media-business complex is still sufficiently heterodox in its attitudes to accommodate heresy.

That is why we are here discussing capitalism's flaws while living in a mixed, but still capitalist system, while the socialist systems have died.

rng

at 09:21 on September 22nd, 2009

That is why we are here discussing capitalism's flaws while living in a mixed, but still capitalist system, while the socialist systems have died.

I think that neither system exists in its purest form. What we have that is stable are mixed systems that are a combo - it is just the relative elements vary in strength or dilution. Norway, as an example, is strong and stable but has more socialism mixed in than the US. It is just the amount of one v the other that is under debate. In addition, you cannot govern a modern state by capitalism alone, it is purely an economic platform not a system of government. Regs, rules and law are required for a civil society.

Yellow Guitar

at 09:23 on September 22nd, 2009

Excellent post Roy. Minsky presents a more realistic perspective than most, although I agree with your critique of his basic premises. In my view, capitalism is marginally better than the alternatives. Like money, capitalism makes an excellent servant but a terrible master.

I'm not educated enough to know whether the 'boom and bust' cycle is inherent in capitalism or whether it's due to human greed and irrational behaviour like purchasing products that are harmful and/or unecessar (either of which must have Adam Smith rolling over.) Suffice to say there are flaws in the system, or flaws in human nature, which render capitalism only slightly less terrible than socialism in the long run.

Capitalism gets really ugly when it's integrated with science and technology and used as a way of making sense of the world. As such, it's a seductive and powerful little god ... an unholy trinity of sorts ... and here I'm thinking of Christ's prophetic warning about trying to serve two masters.

cwucnspt (not verified)

at 07:28 on September 23rd, 2009

Once you prove that change in savings is a function of growth then Keynes and other economists make sense. See my result at: knol.google.com/k/cheng-wu/savings-and-growth/3mfkvo9c0qndy/2#