The 2008 Global financial crash is now seen by economists such as Nobel Prize-winning economist Paul Krugman, as well as former central bankers Janet Yellan in the US and Mervyn King in the UK, as a Minsky Moment.
What is a Minsky moment?
In the 1970s Minsky outlined his economic theory, known as Stability is Destabilising, in stark contrast to the macro-economic theory that argues that the modern market economy is fundamentally stable.
In Minsky’s analysis banks, firms and other economic agents become complacent during periods of economic stability. As a result, they take greater risks in pursuit of profits.
A Minsky moment is a sudden, major collapse of asset values which generates a credit cycle or business cycle. The result is rapid instability as a consequence of long periods of steady prosperity and investment gains that built up risk through ever more leverage instead of improving the balance sheet.
Essentially it is an assumption of never ending growth funded by debt.
Arguably, this is exactly what happened in the run-up to the 2008 crash as banks and other lenders issued complex instruments such as Credit Default Swaps to conceal leverage and risky lending. The crisis crystallises when either interest rates rise or when replacement finance is so expensive that borrowers are unable to pay interest on their debts, never mind the debt itself or even some of the principal.
The Minsky Cycle
A Minsky cycle is a repetitive chain of Minsky moments, when a period of stability encourages risk taking, which leads to a period of instability when risks are realized as losses. The result is that participants move to risk-averse trading (aka de-leveraging), to restore stability, which eventually leads to complacency and so on so the whole cycle repeats.
So, is there a risk of an imminent Minsky moment?
Some investors have been warning of the likelihood of an imminent Minsky moment for the last couple of years.
Asset prices have been relatively high, stock markets have been buoyant and, crucially, central banks have kept interest rates artificially low for much longer than was anticipated after 2008 in order to prop up their economies and allow time for stability and growth.
It is worth noting that the US Federal Reserve late last year started to increase interest rates slightly and we should watch carefully what happens in other central banks.
The IMF, too, has been warning of the risks or another financial crisis as the global market has been slowing markedly.
While Minsky tended to concentrate his analysis on the economy of an individual state, another now-deceased contemporary of his, Susan Strange, who taught at the London School of Economics, supported his thinking but had a broader, global political perspective.
She argued that individual economies should not be seen in isolation but in fact are woven together across the world. This introduces the idea of contagion, where financial crises flow across borders. She also introduced the influences of a rise in populism and growing inequalities between rich and poor into the analysis.
Arguably, this is a more accurate analysis of the consequences of the Minsky Moment that began in 2008.
All this looks uncomfortably like what seems to be happening in economies now, but it is hard to say for certain yet whether a Minsky Moment is imminent. We only ever find out after the event.