Book Review: Why Minsky Matters
A few decades ago, Paul Samuelson wrote a letter to Robert Shiller and John Campbell in which he discussed the notion that while the stock market was “micro efficient,” it was also “macro inefficient,” by which he meant that although profitable security choices were swiftly arbitraged away, the stock market as a whole irrationally swung between extremes of valuation.
Hyman Minsky would have made a similar point about the economy: While it is highly efficient, it is also unstable.
Minsky’s famous “instability hypothesis” encapsulates a simple, intuitive truth: A stable financial system encourages participants to leverage up and “invest down” to the point of instability, at which point the system eventually crumbles, thus making those same participants risk averse. In short, stability breeds instability and instability breeds stability — round and round we go.
Alas, just as John Maynard Keynes’s facile prose amplified his influence, Minsky’s turgidity served to diminish his. It was not until the Asian Contagion of 1998, when PIMCO’s Paul McCulley identified the point at which stability collapsed into instability as a “Minsky moment,” that Minsky’s name was ushered into the popular consciousness.
It was a shame this recognition took so long. If McCulley did us the favor of introducing us to Minsky’s signature paradigm, it took one of Minsky’s students, L. Randall Wray, to “translate” the rest of Minsky’s voluminous but nearly indigestible oeuvre into readable prose.
In Why Minsky Matters: An Introduction to the Work of a Maverick Economist, Wray observes how Minsky’s commercial banking experience gave him a unique and invaluable macroeconomic perspective. As with quantum mechanics, if banking seems intuitive to you, then you do not understand it. Just as a bank’s deposits are its liabilities, coins are the debt of the Treasury and paper currency is the liability of the US Federal Reserve. Taking this concept one step further, banks simply create loans — their assets — by creating money.
As of 15 September 2015, only $1.39 trillion of currency — almost all of it notes — was in circulation, compared with an order of magnitude more in outstanding loans. Wray observes that all the loans were created by banks, both formal and “shadow”; further, all the currency in circulation was dispensed, at some point, by the banks’ tellers and ATMs. Therefore, any economic analysis that ignores banks, as many largely do, is woefully incomplete. To complete the picture: When a bank’s customers demand cash, the Fed sends out armored vans to the bank, even if the bank is short of reserves. In other words, it is the Fed, not the depositors, that sends money to the banks. Wray writes that in the end, “money is always created out of ‘thin air.’ . . . The cash is really just a record of the liability that happens to be printed on metal or paper.”
As Minsky was fond of saying, “Anyone can create money; the problem lies in getting it accepted.” When you give your neighbor a $100 IOU, that IOU is money (which you likely do not otherwise have) of a sort: It can be given by your neighbor to a third party, who can eventually collect it from you or even, if the store clerk is in a good mood, buy groceries with it. When you write out that IOU, you have just created “money.”
As Wray explains, the key concept here is “moneyness,” with Federal Reserve notes and Treasury securities at the top of the hierarchy, followed, sequentially, by insured deposits, money market funds, corporate debt, mortgage-backed securities, and, finally, your $100 IOU. When times are good, moneyness extends far down this chain; when times are bad, not so much.
Once the Minskian nuances of money are grasped, instability comes into sharper focus. The central bank’s notes, a bank’s deposits, a corporation’s debentures, and your IOU are all liabilities, in decreasing order of moneyness. On the asset side, Minsky uses the analogous terminology. The assets with the highest moneyness are “hedging” assets, whose cash flows will easily repay interest and principal. Next come “speculative” assets, which can repay interest but not principal and thus need continuous refinancing; the shorter the financing terms, the riskier these speculative assets are. Last come “Ponzi” assets, which do not even have sufficient cash flow to pay interest and so require unsustainably increasing debt.
Your own success breeds confidence, the success of others breeds envy, and both engender a slow drift down the moneyness chain — from hedging assets to speculative assets to Ponzi assets to, inevitably, the Minsky moment.
Minsky did not dwell much on equity, but a similar and even more explosive calculus surely operates there as well. In a world where relative equity selection performance is almost entirely the result of luck, instability emanates from both sides of the mean: The lucky grow overconfident and so take ever-bigger risks, whereas the unlucky double down and thus do the same.
Minsky spent the later part of his career at the Levy Economics Institute, where he focused on policy issues. His primary conclusion was that an overreliance on monetary solutions inevitably leads to asset bubbles and thus to increasing inequality. He also did not much like social welfare and retraining programs; the former tended to exacerbate inflation, and the latter, since the payoff of educational investment is highest early in life, had proved ineffective. Rather, Minsky believed that just as the government should be the lender of last resort, so too should it be the employer of last resort. Government projects, he believed, were less inflationary than transfer programs, because the former yielded capital goods and the latter did not.
One of Minsky’s Levy Institute colleagues, Wynne Godley, recognized that the sum total of the three major components of the national debt balance — private, government, and foreign — must be zero. Accordingly, Minsky predicted, just before he died in 1996, that the budget surpluses of the Clinton years would necessarily result in a counterbalancing increase in private indebtedness, which he thought would prove highly destabilizing. For better or worse, he did not live to see this prediction come spectacularly true. But he also believed that the unprecedented stability and growth of the immediate postwar period was due to a stabilizing massive federal debt, with correspondingly little private debt and large public holdings of ultra-safe assets.
Perhaps the government, as the employer of last resort, will stabilize and grow the economy better than the current monetary regime, but Wray provides little empirical support for this notion, describing only the negative side of America’s national investment balance sheet — its crumbling bridges, antiquated passenger railroads, ancient water systems, and shabby airports. As much as we might sympathize with this view, a more evenhanded analysis that looked at the costs of, and private alternatives to, infrastructure rebuilding would have been in order. A strong case for a Minskian solution to infrastructure problems can be made — starting with the Interstate Highway System, National Weather Service, and Federal Aviation Administration (FAA) — but the author did not bother to make it.
Another weakness of the book is that Wray seems to aim at three separate audiences: the general public, policy specialists, and economists. If he wanted to engage the first two groups, and even the third, he should have laid on the narratives a bit thicker. After all, the history of market instability is filled with Sturm und Drang and colorful dramatis personae aplenty, and it is a shame that they were given short shrift. One small example from an earlier period will suffice: Wray mentions on multiple occasions the doctrines of Rudolf Hilferding, as if he were just one more musty Austrian-born economist. In fact, Hilferding served as the Weimar finance minister during both the climax of the great hyperinflation and the crash of 1929. He fled Germany after the Nazis came to power and finally washed up in Marseilles, France, where he was nearly saved by the storied American operative Varian Fry (who did succeed in spiriting to Spain the likes of Hannah Arendt and Marc Chagall), only to die in a Gestapo dungeon in Paris in 1941.
In the same vein, Wray hints at Minsky’s irascibility; appropriately placed personal anecdotes would have gone a long way toward improving the book’s readability. For example, I would have liked to learn more about how Minsky’s association with the Mark Twain Bank in St. Louis informed his command of the banking system, which served to distinguish him from other economists, past and present.
Finally, although the book’s bibliography is comprehensive enough to be the go-to compendium of Minsky’s output, the index is so thin as to be nearly useless.
But these are quibbles. Why Minsky Matters serves up a rich variety of concepts that will stimulate and inform anyone concerned about the fate of the economy. If you want to know where we are going, it helps to know where we have come from, and Why Minsky Matters provides an essential road map for that journey — past, present, and future.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.