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March 30, 2001

Hyman Minsky on John Maynard Keynes
by Doug Noland

Instability abounds for financial markets in the U.S. and globally. For the week, the Dow gained 4% and the S&P500 added 2%. The Utilities surged 10%, while the Transports added 5%. The Morgan Stanley Consumer index increased 4% and the Morgan Stanley Cyclical index gained 2%. The small cap Russell 2000 added 2%, while the S&P400 Mid-Cap index gained less than 1%. Financial stocks were mixed, with the S&P Bank index adding 6%, while the Securities Broker/Dealer index declined about 2%. After last weeks sharp rally, technology stocks found themselves again under heavy selling pressure. For the week, the NASDAQ100 and Morgan Stanley Technology indices dropped 8%, the Semiconductors 15%, and the NASDAQ Telecommunications index 4%. Gold stocks generally declined about 2%.

The credit market was quite unsettled as well, with 2-year interest rates swinging wildly before ending the week with yields about 3 basis points lower. The yield curve steepened noticeably, with long-bond yields rising 14 basis points. Five-year yields rose 5 basis points and the key 10-year T-note, despite today's market rally, saw its yield jump 10 basis points. Benchmark Fannie Mae mortgage-back yields rose 5 basis points, while agency yields rose as much as 10 basis points in noteworthy underperformance. Most spreads widened slightly over the week. With global currency markets in disarray, the dollar index gained about 1% this week.

It appears the first quarter experienced one of the strongest periods of debt issuance in history, with a staggering $223 billion of new debt coming to market in the U.S. $198 billion of investment grade bonds were issued, almost double the fourth quarter's $102 billion and a 77% increase from last year's first quarter. The junk bond market came to life, with $25 billion issued (compared to about $4 billion during the fourth quarter). Municipal bond issuance surged to $57 billion during the quarter, a 41% increase from last year's first quarter. And from Bloomberg's tally, $41 billion of asset-backed securities were issued during the month of March, more than double February. March saw $11.5 billion of home equity loan securitizations compared to about $2 billion during February. After three months, we are on record pace with $84 billion of asset-backs issued. This is compared to $290 billion issued for all of year-2000. European bond issuance jumped 12% to a record $246 billion during the first quarter. From the Wall Street Journal: "Some online investors are even abandoning stocks for bonds." Today from Reuters: "Corporate credit quality fell for the 12th straight quarter, the longest losing streak in a decade, because the U.S. economy is slowing, corporate profits are eroding and companies are taking on too much debt, Moody's Investors Service said this week. Not since 1988 through 1993, which encompassed the last recession and included 19 consecutive down quarters, has corporate credit quality headed south for so long."

Broad money supply (M3) expanded by $10 billion last week, continuing the historic monetary expansion that has seen broad money expand at a 14% rate over the past three months. Importantly, we are witnessing a significant divergence between money expansion and the pace of activity in the real economy. Broad money has surged an alarming $680 billion during the past twelve months, a rate of 10%. By category, currency outstanding has increased $22 billion during the past year, a 4% increase. Demand and other checkable deposits have actually declined about $20 billion, as narrow money/M1 has suffered a minor contraction over the past twelve months. M2 components (excluding M1) have increased by about $370 billion, with savings deposits increasing $198 billion (11%), small time deposits $76 billion (8%), and retail money market fund assets by $98 billion (11%). M3 components (excluding M2) have jumped about $320 billion, with institutional money fund assets surging $234 billion (37%), large time deposits $68 billion (9%), "Repurchase Agreements" $6 billion (2%), and "Eurodollar deposits" $11 billion (6%). There is nothing typical about this monetary expansion.

There has been considerable recent discussion regarding the monetary aggregates. The extreme divergences between the M's and individual component growth rates certainly provide "something for everyone." In clearly flawed analysis, some fixate on the narrowest definition of money and make silly statements professing Federal Reserve stringency and "monetary deflation." This is a massive monetary inflation and the Fed could hardly be more accommodative of financial excess. And then there are those analysts keenly focused on the struggling manufacturing sector that have made comments regarding the abrupt deceleration of commercial paper borrowings. Clearly, the commercial paper market came under heightened stress, with liquidity all but disappearing for lower-tier issuers. Even major companies such as Xerox and Lucent have lost access to CP borrowings, while the California utility debacle has seen these companies abruptly go from major CP borrowers to major defaulters. There is also the issue of homeowners replacing variable-rate mortgages with fixed, apparently leading to a pay down in related commercial paper instruments. And, importantly, there has been a surge in corporate bond issuance that has taken funding pressure off of the commercial paper marketplace. Anyway, there are several factors that explain the sudden stagnation of CP, but its slowdown should not be used as a gauge of general financial system liquidity.

Since commercial paper is a major holding of money market funds (and since money market funds are a component of M3, adding CP back to M3 in calculating a measure of "money" or "liquidity" would be double-counting CP), the fact that money market fund assets continue their historic expansion in the face of stagnating CP issuance provides clear evidence of acceleration in the issuance of other money market instruments. Money fund assets jumped an amazing $40 billion last week to $2.08 trillion, and have now exploded for an increase of $210 billion over just that past 11 weeks (annualized growth rate of 53%). Money fund assets have surged $414 billion, or at a rate of 34%, since mid-year 2000 (38 weeks). This stunning surge in money fund assets is clearly associated with the ballooning of GSE balance sheets. Not only are the GSEs borrowing in the money market to fund their mortgage purchases, it is quite likely that a significant increase in money market borrowings is being used by the financial sector to finance speculative positions in agency debt (and other) securities. The manufacturing sector may be, voluntarily and otherwise, tempering commercial paper borrowings, but the real estate finance superstructure continues to lend with absolute reckless abandon and this process is leaving footprints all over the monetary aggregates (and real estate prices, consumer spending, and system fragility).

This week saw news of record home prices in the San Francisco Bay Area and strong sales and price gains in Florida. For the first two months of the year, existing home sales are running at a rate of 5.2 million units, right at 1999's record pace. New homes have sold at a rate of 922,000 units through February, compared to 903,000 units sold last year. The crucial issue, however, is the financing of extracted equity. Yesterday from BusinessWire: "Standard & Poor's is projecting 20%-25% growth in home equity line of credit (HELOC) securitization volume in 2001-a dramatic increase from the relatively stable levels in 1999 and 2000, according to a new report titled 'The Changing Landscape of the HELOC Market.'" Wednesday the Mortgage Bankers Association reported a surge in refinance activity, with applications jumping to the highest level since the historic refinancing boom of October 1998. Refinancings are currently running at about 6 times year ago levels. And with 59% of mortgage applications associated with refinancings, total applications are more than double last year. Purchase applications have been running near last year's very strong pace.

Yesterday from Dow Jones News: "Angelo Mozilo, chief executive of Countrywide Credit Industries Inc., believes 2001 will be a record-setting year for the number of home refinancings. In a CNBC interview Thursday, Mozilo said loan application numbers are exceeding those of 1998, which set a record for home refinancings. While mortgage bankers have predicted 2001 will ring up $1.5 trillion in refinancings, Mozilo believes the figure could reach $1.6 trillion to $1.7 trillion." With mortgage originations of about $1 trillion last year, Countrywide's prediction of potentially a 70% increase should be an "eye-opener." And with 1998's "off the charts" record mortgage refinancings of $1.5 trillion looking increasingly in jeopardy, the amount of extracted equity will almost certainly prove unprecedented. One cannot overstate the importance of this development. This refinancing boom is stimulating consumer spending, while also the main factor driving the surge in broad money supply and general financial system liquidity in the face of the historic NASDAQ decline. Yes, the great technology bubble has burst but the even greater real estate finance bubble thrives, for now…

During the past four years (1997-2000), total credit market debt outstanding surged $7.7 trillion, or almost 40%. Financial sector borrowings increased $3.6 trillion, or 70%, to $8.4 trillion. Total mortgage debt jumped $2.1 trillion, or 43%, to almost $7 trillion, with total outstanding agency securities increasing $1.7 trillion, or 65%. The "heart and soul" of The Great Credit Bubble is the expansion of financial credit (financial sector borrowings/liability creation to fund the holdings of financial assets) and, specifically, the expansion of mortgage credit. Interestingly, over the past four years the Federal Reserve has increased its assets (expanded credit) by about $140 billion (28%). During this same period, the government-sponsored enterprises increased borrowings $981 billion (99%), "Federally-Related Mortgage Pools" $781 billion (46%), "Asset-Backed Security Issuers" $977 billion (114%), finance companies $386 billion (54%), Securities Broker/Dealers $576 billion (91%), and "Funding Corps" $628 billion (126%). The numbers are simply unbelievable.

There is good reason why predicaments like this are called bubbles; once commenced, credit excess breeds only additional excess; speculative excess begets only greater speculation. Dangerous monetary processes are unleashed, and the path of economic activity is permanently distorted. Powerful financial institutions only become more powerful, with consequences including a breakdown in the market pricing mechanism, a serious misallocation of resources, and a major redistribution of wealth. For almost a decade now, Federal Reserve policy has nurtured a leveraged speculating community that has grown to unimaginable size and power. This massive edifice knows only one thing: speculation. It is not an issue of whether "The Community" will place leveraged bets, but only where and to what degree. And speculative bubbles, as have been witnessed repeatedly throughout history and certainly recently with the Internet/technology bubble, have great proclivity of going to wild extremes only to end with a final crescendo of unimaginable excess - "the terminal phase". We are seeing this same fascinating and acutely dangerous phenomenon presently in mortgage finance, and it is simply shocking (but, at the same time, sadly not surprising) that the Federal Reserve plays right along. And just as the Internet bubble made its final crazy speculative run during last year's first quarter in spite of the fact that it was patently clear the "The Game" was coming to an imminent conclusion, the Great Real Estate Bubble today goes for one final spectacular "last hurrah." This, even as the dire prospects for the U.S. financial sector and economy are becoming increasingly conspicuous. But then again, The Great Credit Bubble is very much The Great Bubble of Leveraged Speculation, and "The Game" still works in agencies, mortgage-backs and asset-backed securities. Yes, it's very much on "borrowed time," but it does work, especially relative to the other "bets" no longer in vogue. Whereas enormous leverage was a key facet in the 1920's stock market bubble, significant equity market leverage today pales in comparison to the unprecedented leverage that has become endemic to the entire U.S. (global) financial system during this, the greatest of all financial and economic bubbles.

I have been fascinated with my recent readings of the work of Hyman Minsky. Interestingly, his writings (generally the 1960's through the early 1980's) make little reference to borrowings to finance the holdings of financial assets. He does briefly mention the problematic stock margin borrowing boom of the late 1920's, but it seemed like it was almost in passing - as if he thought that such a crazy thing could never happen again in an era of greater knowledge, information, and financial sophistication. Little did he know… But Minsky clearly stated that borrowings for the speculative positioning of securities is destabilizing and clearly "Ponzi Finance." Why not a more complete discussion including the issue of leveraged speculations in credit market instruments? Well, I must assume that this can be best explained by the fact that such borrowings were not a significant factor for the fifty years after the 1929 crash. At the same time, Minsky goes to great length to explain why, despite the problems of increasingly endemic inflation and unemployment (stagflation); the system was successfully avoiding another Great Depression. He does not, however, address some key fundamental differences between the financial and economic circumstances that preceded the Great Depression and 70's/early 80's stagflation.

I would argue that his analysis may somewhat lack an appreciation that, even with the financial excesses of his era, there was nothing comparable to the highly-leveraged speculative bubble that came to overwhelm the financial markets in the late 1920s or the resulting historic "Roaring '20s" bubble economy. Indeed, the heightened inflationary pressures of the late 60's, 1970s and early 80s and the resulting guarded policies of the Federal Reserve were specifically counter-productive for the creation of speculative financial bubbles and bubble economies. Inarguably, high and/or generally rising interest rates and taut credit conditions are not conducive to speculative leveraging in financial asset markets. Instead, financial and economic bubbles are fostered during periods of tranquil consumer prices and central bank accommodation. My analysis would view the present financial and economic bubble unlike anything since the 1920s and, unfortunately, today's bubble is of much grander proportions. The degree of both financial leverage and security speculation today is simply unprecedented. Surreptitiously, history's greatest speculative bubble runs unabated in the U.S. credit system to this day.

"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done." John Maynard Keynes, The General Theory of Employment, Interest, and Money, 1936. p. 159

I have included the oft-quoted (by bears, of course!) line this week. Today, more than ever before, the key enterprise of our country has become a "bubble on a whirlpool of speculation." And with the word "speculation" seemingly not even in the vocabulary of contemporary economics, the previous passage underscores Keynes's great appreciation for market processes and their potentially deleterious impact on the real economy. Unfortunately, over time some of the most brilliant analyses of the "processes of a capitalist economy" by the Great John Maynard Keynes have been lost or diluted along the way.

From Minsky: "Thus the integrated Keynesian classical economic theory - what is labeled the neoclassical synthesis - does violence to both the spirit and the substance of Keynes's work. The substance of what was neglected in the development of the synthesis can be grouped under three headings: decision-making under uncertainty, the cyclical character of the capitalist process, and financial relations of an advanced capitalism economy." Certainly, after reading through Hyman P. Minsky's 1975 book John Maynard Keynes, I appreciate the valuable insights afforded the "revolutionary" thinking of Keynes. His work provides not only powerful analyses but also particularly pertinent insight to the current environment. My interest is not in economics as viewed from the "left" or the "right" (that's not my "game"), and it certainly has nothing to do with "Keynesian" fiscal policy tools. My interest today lies with the fact that Keynes's seminal work provides much that is keenly relevant to our focus on monetary processes and financial fragility.

"In 1936, when The General Theory appeared, the world was in the seventh year of the Great Depression. Although a considerable recovery from the low point of 1933 had taken place, and the series of financial traumas and crises that marked the years between 1929 and 1933 were now apparently past, unemployment rates remained high. In the United States the peak national incomes of the late 1920s had not yet been regained. The world economy was sluggish and stagnant, the spirit of enterprise, though alive, was not vigorous.

The standard economic theory of the time - what Keynes called the 'classical' school - had failed to predict the coming of the depression, to understand why it took place, to explain its depth and duration, or to offer useful guidance to policy. From the point of view of the standard economic theory of 1930s, the events in the United States in the period 1929-33 were unexplainable. Keynes took these current events as his point of departure: his new view was going to make the anomaly the ordinary." Hyman P. Minsky, John Maynard Keynes, 1975 p. 59

Alarmingly, it appears that the "standard economic theory of the time" is even more inadequate today than it was in the 1930's. How obviously precarious debt levels throughout the household and business sector are downplayed, while unprecedented financial sector leveraging and gross speculation go virtually unrecognized by the economic community is simply unbelievable. Somehow, there has developed this ridiculous dogma that as long as the government's calculation of consumer prices is stable, "productivity" is increasing, GDP is expanding, and unemployment is low, one need not even be bothered with developments in the financial realm. As long as the economy looks sound on the surface, gross credit excess, major financial imbalances, and wild speculative excess can be ignored. This has been a momentous analytical and policy blunder.

"So far we have had chiefly in mind the state of confidence of the speculator or speculative investor himself and may have seemed to be tacitly assuming that if he himself is satisfied with the prospects, he has unlimited command over money at the market rate of interest. That is, of course, not the case. Thus we must also take account of the other facet of the state of confidence, namely, the confidence of the lending institutions towards those who seek to borrow from them, sometimes described as the state of credit. A collapse in the price of equities, which has had disastrous reactions on the marginal efficiency of capital, may have been due to the weakening either of speculative confidence or of the state of credit. But whereas a weakening of either is enough to assure a collapse, a recovery requires the revival of both. For whilst the weakening of credit is sufficient to bring about collapse, its strengthening, though a necessary condition of recovery, is not a sufficient condition." J.M. Keynes, The General Theory 1936 p. 158

"The state of credit reflects bankers' views toward borrowers, and bankers finance the positions of both real-asset holders and equity-share holders. A revision by bankers of their views about the appropriate leverage to use in financing positions in capital assets will not necessarily cause an immediate revision in the market value of these assets- especially if the prospective yields and the capitalization ratio are unaffected. But such a revision of bankers' views can have a strong impact upon equity prices…" Hyman P. Minsky, John Maynard Keynes, 1975 p. 119

I would argue strongly that the bursting of the technology bubble and the increasingly generalized weakness in U.S. and global equity markets has everything to do with the deteriorating "state of credit." I would also argue that this deterioration was the unavoidable consequence of excessive and ill advised lending and speculation. And while it is generally recognized that stock markets discount approaching economic downturns, what is not appreciated is that faltering stock prices - "discounting" - is specifically a function of deteriorating liquidity conditions ("state of credit") within the credit system. Clearly, the bursting of the technology bubble has exposed the perilous financial position of scores of individual "Ponzi Finance" units, as well as virtually the entire Internet/telecom sector that runs on huge negative cash flows. This bust encompasses the impairment of borrowers and lender alike. And while there is great effort to sustain the Confidence Game, it is clear that we are now in the early stage of what will prove an arduous and protracted retrenchment and workout.

"A key contribution of Keynes to the study of disequilibrium processes is the explicit introduction of the perspective that changes induced by disequilibrium in a particular market may have their major effect upon the initially affected market by first affecting conditions in other markets; that is, the reaction to a disequilibrium in one market may induce disequilibria in other markets. The question arises whether these intermarket feedbacks lead to a new equilibrium or whether the feedback process exacerbates the initial disequilibrium." Hyman P. Minsky, John Maynard Keynes, 1975 p.49

My analysis argues strongly that, particularly with the bursting of the U.S. led worldwide technology bubble, the increasingly impaired global financial system is in the midst of severe "disequilibrium process." Moreover, "intermarket feedbacks" are playing a significant role in fostering general system instability and these feedbacks are self-reinforcing, clearly exacerbating "initial disequilibrium."

With collapsing technology shares and disintegrating manufacturing profits in an environment of general corporate over borrowing, there is now the clear specter of large-scale debt defaults. Not only are alarmed investors responding to this process by turning increasingly risk-averse, financial institutions and players are increasingly recognizing the true impairment of their underlying financial position. This immediately places an already fragile global financial system in a truly precarious position. The immediate "feedback" is a flight away from "high risk" periphery markets globally, with currencies in disarray and the dollar benefiting from general market dislocation. Derivatives, which generally work to augment market movement in either direction (foster boom/bust dynamics), are likely a key factor in exacerbating currency market dislocation in the face of investor and speculator/"Hot Money" flight.

Furthermore, general risk aversion is engendering a flight to the "safety" of highly rated securities, only exacerbating a speculative bubble and fostering huge flows into these very same instruments. As the world's unmatched "producer" of triple-A rated securities, this provides further support for the U.S. dollar in spite of the U.S. being at the heart of the global technology collapse and acutely vulnerable debt bubble. And as the absolute leaders in top-rated securities issuance, the U.S. GSEs have and continue to take full advantage their current unlimited access to money and capital markets both at home and abroad. Importantly, this abuse not only provides a very powerful recycling mechanism for the perpetual "flood" of dollars globally, it also creates the fuel that sustains both inflated real estate prices and the U.S. bubble economy. As discussed in previous commentaries, "Liquidity Loves Inflation" and the U.S. still possesses the mechanisms, ability and willingness to inflate. Yes, this is perverse, but more importantly this is critical evidence supporting our contention of the disequilibriating character of current dysfunctional U.S and global financial systems. Fed policy only stokes this historic, fateful and expanding divergence away from anything remotely resembling financial or economic equilibrium.

"How do units get into a position where their cash outflow due to commitments is greater than their cash inflow due to operations? One way is deliberate, when a unit is engaged in an investment program that requires external financing. Another way is by error, such as overestimating the net cash inflow, or by being unduly optimistic about sales or costs. A further way is by having debtors on owned contracts default - which in a closely articulated set of layered financial relations can have a domino effect. Firms may also deliberately and actively speculate by taking a chance that refinancing will be available at a reasonable rate. This will be done if more favorable refinancing terms are available on short-term liabilities than are available on long-term liabilities, or if terms on long-term liabilities are viewed as being unduly high, so that they are expected to be lower in the relevant future." Hyman P. Minsky, John Maynard Keynes, 1975 p. 88

Ironically, as many corporate borrowers in the "real economy" face potentially disastrous cash flow deficits - both through mindless over borrowing and, particularly in the technology sector, by "unduly optimistic" boom-time extrapolations - this at the same time only emboldens the "animal spirits" of the speculators operating in the "financial realm." The bet by the speculators is that Greenspan will provide "more favorable refinancing terms" on their short-term liabilities as well as creating capital gains - that Greenspan will inflate the value of financial assets. This is a very dangerous game of layer after layer of financial leverage. After the Mexican collapse in 1995, SE Asia in '97, and Russia/LTCM in 1998, one would hope that there would be a keener appreciation for the significant risks associated with the heavy reliance on "Hot Money" finance. How did the leveraged speculators expect to get their money back after the flood of "Hot Money" into Russia went to buy Mercedes and properties in the Mediterranean? Where will buyers be found in the U.S. credit and currency market when the speculators head for the exits? Contemporary "Hot Money" flows are a problem by definition and a critical issue when allowed to dominate market pricing mechanisms and the capital allocation process; they lead to destabilizing "domino effects" (as are now in process); and they have become endemic to the acutely unstable U.S. financial system. Even worse, manipulating speculative "Hot Money" flows has become the main tool of Federal Reserve policy.

"A capitalist economy is characterized by private ownership of the means of production and private investment. In a sophisticated capitalist economy, monetary and financial institutions determine the way in which the funds required for both the ownership of items in the stock of capital assets and for the production of new capital assets are obtained. In a capitalist economy of the kind that Keynes postulated, there are private portfolios, real-capital assets are in essential details equivalent to speculative financial assets, and banks, generically defined, as institutions specializing in finance, are important. In Keynes's theory the proximate cause of the transitory nature of each cyclical state is the instability of investment; but the deeper cause of business cycles in an economy with the financial institutions of capitalism is the instability of portfolios and of financial interrelations." Hyman P. Minsky, John Maynard Keynes, 1975 p. 57

It was an historic money and credit expansion (clearly going at least as far back as the speculative bubble that developed in the U.S. credit system with 3% short-term interest rates during 1992/1993) that provided the fuel for the manifestation of the historic technology and general economic bubble ("instability of investment"). It was a classic "Austrian" case of massive malinvestment and resource misallocation. This instability forged through an unprecedented expansion of "financial credit" fueled massive and fateful over-investment (including technology and "communications" but certainly not excluding cinemas, retail outlets, hotels, casinos, homes, restaurants, etc.) that is today behind the unfolding profits collapse and debt impairment. But the story of instability continues: it is collapsing profits collapse and spectacular technology industry bust that is creating only more extreme "instability of portfolios and of financial interrelations." The bottom line is that we are in the midst of an historic period of credit excess-induced financial instability and fragility, with the continuation of reckless monetary expansion fueled by a bubble expansion of U.S. financial credit and mortgage finance. A system that for years has run terribly amok today rises to a sprint.

"In the part of The General Theory that was lost to standard economics as it evolved into the neoclassical synthesis, Keynes put forth an investment theory of fluctuations in real demand and a financial theory of fluctuations in real investment. Desired portfolio composition and thus financial relations in general are most clearly the areas of decision where changing views about the future can most quickly affect current behavior. This responsiveness is true not only for ultimate units like business firms and households but also for specifically financial institutions like commercial banks, investment banks, etc. But the future is uncertain. To understand Keynes it is necessary to understand his sophisticated view about uncertainly, and the importance of uncertainly in his vision of the economic process. Keynes without uncertainly is something like Hamlet without the Prince." Hyman P. Minsky, John Maynard Keynes, 1975 p. 57

Amazingly, heightened uncertainty in this "mixed up world" is only leading to more reckless GSE expansion and more belligerent use of derivatives and financial engineering, as the Great Credit Bubble comes to prey ever more intently on "money" to finance the perpetuation of bubble excess. As I have written previously, we are witnessing the unfolding of the absolute worst case scenario with the poisoning of "money." Keynes had interesting views on money.

"Money, it is well known, serves two principal purposes. By acting as a money of account it facilitates exchange without it being necessary that it should ever itself come into the picture as a substantive object. In this respect it is a convenience which is devoid of significant or real influence. In the second place, it is a store of wealth. So we are told, without a smile on the face. But in a world of the classical economy, what an insane use to which to put it! For it is recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit. Why should anyone outside a lunatic asylum wish to use money as store of wealth? J.M. Keynes, The General Theory 1936

"The answer to Keynes's leading question is that the world we live in is not the world of 'the classical economy'; the world is an uncertain world because there are yesterdays, todays, and tomorrows. Furthermore, this is a capitalist world in which units have portfolios - assets and liabilities which embody yesterday's views and both earn and commit today's and tomorrows' receipts. In a world with uncertainty, portfolios are of necessity speculative. The demand for money as a store of value exists because in a world where speculation cannot be avoided - where to decide is to place a bet - money is not barren. As has been pointed out earlier, money in our world has attributes of an insurance policy, in that possession of money protects against the repercussions of particular undesirable contingencies. Thus money is held because 'The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude" Hyman P. Minsky, John Maynard Keynes, 1975 p. 77

"There is a multitude of real assets in the world which constitute our capital wealth - buildings, stocks of commodities, goods in course of manufacture and of transport and so forth. The nominal owners of these assets, however have not infrequently borrowed money in order to become possessed of them. To a corresponding extent the actual owners of wealth have claims, not on real assets, but on money. A considerable part of this 'financing' takes place through the banking system, which imposes its guarantee between it depositors who lend it money and its borrowing customers to whom it loans money with which to finance the purchase of real assets. The interposition of this veil of money between the real asset and the wealth owner is a specially marked characteristic of the modern world." Hyman P. Minsky, John Maynard Keynes, 1975 p. 117

"Although Keynes did not go into the details of how finance affected system behavior, he emphasized that in an economy with borrowing and lending, finance took on a special importance:

'Two types of risk affect the volume of investment which have not commonly been distinguished, but which it is important to distinguish. The first is the entrepreneur's or borrower's risk and arises out of doubts in his own mind as to the probability of his actually earning the prospective yield for which he hopes. If a man is venturing his own money, this is the only risk which is relevant. But where a system of borrowing and lending exists, by which I mean the granting of loans with a margin of real or personal security, a second type of risk is relevant which we may call the lender's risk. This may be due to either a moral hazard i.e. voluntary default or other means of escape, possibly lawful, from the fulfillment of the obligation, or the possible insufficiency of the margin of security i.e. involuntary default due to the disappointment of expectation.'" J.M. Keynes, The General Theory 1936 p. 144

"Keynes wrote that in dealing with uncertainty, 'In practice we have tacitly agreed, as a rule to fall back on what is, in truth, a convention'. But in a capitalist economy the aspect which is least bound by technology or by fundamental psychological properties, which is most clearly a convention or even a fashion, subject to moods of optimism and pessimism and responsive to the visions of soothsayers, is the liability structure of both operating and financial organizations. In economies where borrowing and lending exists, ingenuity goes into developing and introducing financial innovations, just as into production and marketing innovations. Financing is often based upon an assumption 'that the existing state of affairs will continue indefinitely' but of course this assumption proves false. During a boom the existing state is the boom with its accompanying capital gains and asset revaluations. During both a debt-deflation and a stagnant recession the same convention assumption of the present always ruling is made; the guiding wisdom is that debts are to be avoided, for debts lead to disaster. As a recovery approaches full employment the current generation of economic soothsayers will proclaim that the business cycle has been banished from the land and a new era of permanent prosperity has been inaugurated. Debts can be taken on because the new policy instruments - be it the Federal Reserve System or fiscal policy - together with the greater sophistication of the economic scientists advising on policy assure that crises and debt-deflations are now things of the past. But in truth neither the boom, nor the debt deflation, nor the stagnation, and certainly not a recovery or full-employment growth can continue indefinitely. Each state nurtures forces that lead to its own destruction. Of all the markets in the economy, the markets for investments and the debt instruments used to acquire shares and control over capital asset are most clearly based upon tenuous conventions. It is therefore "not surprising that a convention, in an absolute view of things so arbitrary, should have it weak points…" Hyman P. Minsky, John Maynard Keynes, 1975 p. 128

We'll let this wisdom from Minsky and Keynes speak for itself.

Doug Noland
The Credit Bubble Bulletin
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