Banks, Lenders & Investors Cash Flow & Forecasting Finance

Are we nearing a Minsky moment foretelling the next economic crash?

Minsky moment fuse litHyman Minsky died in relative obscurity in 1996 but economists have adopted his name as a description of particular moments in an economy when asset prices collapse after months of seeming stability.
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.

Banks, Lenders & Investors Cash Flow & Forecasting Finance General Turnaround

Uncertainty after the Referendum is producing some wild predictions

keep calm and stay positiveIt is true that businesses dislike uncertainty when planning for medium and long term investment and that it will probably be at least two years before there is any clarity on the UK’s position over leaving the EU.
But how likely are the speculations of some economic commentators that the UK may be facing a period of stagflation, defined as a period of rapid interest rate rises coupled with a depression?
The last time the UK experienced stagflation was during the 1970s, when huge oil price rises precipitated an economic downturn in much of the Western world.  In the UK a combination of climbing interest rates and government borrowing, high unemployment and a miners’ strike culminated in Edward Heath’s government declaring a state of emergency in January 1974 and imposing a three-day week on industry amid fears of power shortages.

So what likelihood of a repeat of such a perfect storm?

Plainly much has changed since then including tighter regulations on strike action and diminishing trades union powers, less reliance on coal-fired energy supply, control of interest rates being moved to the Bank of England, and, at the moment, relatively high levels of employment.
While it is true that the IMF (International Monetary Fund) has downgraded global growth since the referendum, its predictions for the UK are still sturdier than they are for Germany and France.
Interest rates have been at unprecedentedly low levels since the 2008 financial crash and it would seem that the Bank of England may yet provide further stimulus by reducing them below the current 0.5% figure as well as introducing more quantitative easing. This is uncharted territory and lending markets may reassert their authority by demanding higher interest rates given the greater perception of risk caused by Brexit.
Another factor is the devaluation in £Sterling which followed the referendum results. At the moment this translates into cheaper exports from the UK and very soon will lead to price inflation for consumers due to the increase in cost of commodities bought by UK companies in $US or in Euros. 
In fact, commodity prices have been falling for some time thanks to lower demand from China and in the last week oil prices came down again by 20% after rising slightly for a short time. But when commodity prices rise, the impact will be felt by everyone.
Although uncertainty will lead to lower growth as some businesses hold off on investment there will need to be massive rises in commodity prices and interest rates, perhaps combined with a significant rise in Chinese consumption for the preconditions for stagflation to exist.
If, in addition future governments turn more protectionist by erecting barriers to trade and migration, while introducing measures to combat inequality by redistributing income (through taxation and regulation) then the situation could become more precarious.
While the referendum result has crystallised issues and opportunities in the UK and there will business winners and losers, in our view the more extreme predictions of imminent stagflation are decidedly premature, if not straying into the realms of fantasy.