UBS strategist George Magnus helped popularize economist Hyman Minsky’s thinking in the runup to the financial crisis by warning of the likelihood of a “Minsky moment.” For those not familiar with Minsky’s work, a short overview from ECONNED:
Hyman Minsky, an economist at Washington University, observed [that] periods of stability actually produce instability. Economic growth and low defaults lead to greater confidence and, with it, lax lending.
In early stages of the economic cycle, thanks to fresh memories of tough times and defaults, lenders are stringent. Most borrowers can pay interest and repay the loan balance (principal) when it comes due. But even in those times, some debtors are what Minsky calls “speculative units” who cannot repay principal. They need to borrow again when their current loan matures, which makes
them hostage to market conditions when they need to roll their obligation. Minsky created a third category, “Ponzi units,” which can’t even cover the interest, but keep things going by selling assets and/or borrowing more and using the proceeds to pay the initial lender. Minsky’s observation:
Over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight of units engaged in speculative and Ponzi finance.
What happens? As growth continues, central banks become more concerned about inflation and start to tighten monetary policy, meaning that
. . . speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently units with cash flow shortfalls will be forced to try to make positions by selling out positions. That is likely to lead to a collapse of asset values.
From that, Magnus coined “Minsky moment” in early 2007, which occurs when
…lenders become increasingly cautious or restrictive, and when it isn’t only over-leveraged structures that encounter financing difficulties . . The risks of systemic economic contraction and asset depreciation become all too vivid.
Given that Magnus was one of the few prior to the financial meltdown (and not too long before either) to see the possibility of a generalized credit contraction, as opposed to, say, a “contained” subprime crisis, his warning on China is worth considering. He highlights, as other commentators have, that China’s dependence on investments, now 47% of GDP, is unprecedented, particularly in a large economy. In addition, half that total is in property investments, which is not necessarily productive.
But what troubles Magnus most about Chinese investment is the degree to which it depends on lending. From the Financial Times:
But a more immediate worry is the growing credit intensity of China’s economy. What China calls “total social financing” – conventional bank loans and most other external sources of finance – was still 38 per cent of GDP in the first quarter of 2011, almost as high as in 2009 when China implemented a credit-centric stimulus programme. The credit intensity of growth, or the amount of new credit generated for each unit of GDP growth, has risen from 1-1.3 before 2009 to 4.3 in 2011.
Despite a 500 basis points rise in bank reserve requirement ratios since January 2010, and four 25bp increases in interest rates since October, credit demand and supply seem barely affected. In real terms, interest rate levels are the lowest for 13 years: the three-month deposit rate stands at -3 per cent, and the one-year lending rate at 1 per cent. Companies are borrowing more as cash-flows weaken, with energy, utility and wage bills rising.
Although formal bank loan volumes are subject to restraint, they only comprise about half of TSF. Companies can also access plentiful liquidity in Hong Kong, where the renminbi deposit market has increased eightfold since mid-2010 to more than RMB400bn and where offshore renminbi financing is rising fast….
But financial instability, arising from excessive credit, increasing inflation and weak investment returns, is always an important catalyst…..In this, the leadership changeover in 2012, a reluctance to compromise growth or alienate workers, and political interests in rising property prices could lead to a premature call of victory over inflation. This might boost asset price and growth in the short term, but increase the likelihood the new leadership will have to deal with a credit-fuelled Minsky moment.
Magnus does depict another set of choices which would steer clear of that result, that of increasing interest rates both to stanch inflation and shift the economic model away from lending-stoked investment towards more consumption. But putting on the brakes will slow growth short term. This is a tricky bit of economic management, and as the experience in the US and other major economies in the 1970s and 1980s showed, politicians are reluctant to induce a recession (which is what it might take in China to shift gears) until the alternative is painful. And even then, the temptation is to abandon the course. Carter pressured Volcker to abandon his squeeze on financial firms and the economy generally; can you imagine either Greenspan or Bernanke showing Tall Paul’s resolve? Today’s nominally independent Fed chairmen have been pre-screened for their bankster friendliness.
Given that preventing labor unrest is a major priority in the Chinese officialdom, it seems they have a non-win situation: either see worker real incomes squeezed further by rising prices, or deprive some, perhaps many, of jobs by putting the brakes on growth. As much as the entire world has every reason to hope for a happy outcome, soft landings are notoriously hard to engineer even in a command economy like China’s.
Insightful piece from Magnus, but I disagree with his comments that “Despite a 500 basis points rise in bank reserve requirement ratios since January 2010, and four 25bp increases in interest rates since October, credit demand and supply seem barely affected.” Credit supply (bank loans n M2) came down sharply from its peak in late 09. And credit supply got especially tight since Feb this year (note that informal banking sector interest rate shot up and many SMEs have to pay record high rates in informal mkts). Level of official interest rate does not offer a good gauge on the monetary policy tightness in China. Chinese govt is more reliant on credit control (via loan quota) rather than adjusting lvls of interest rates.
China’s economy is currently showing signs of slowing down due to this sharp slowdown in money supply – as Magnus pointed out that China’s economy is growingly credit-intensive…
The usual and classic solution is to eliminate debt by direct transfers from creditors to debtors, which also has the advantage of redistributing wealth.
Creditors don’t like to talk about this option. However, *Communist China* might just plain do it. The simple method is through taxes and direct payments, but there are others.
I thought Paul McCully (sp?) at Pimco coined ‘minsky moment’?
You are probably right, I’ll be sure to cite that in the future. Magnus took to regularly discussing “Minsky moment” in his research, and often in FT comment pieces, so I think of him as being important in popularizing that expression.
I would suggest this long-expected slowdown in China may not have the characteristics of a recession in the West. A period of bankruptcy and unemployment will no doubt create serious strains, and China’s political system may well react as ours did with policies that serve to protect the entrenched interests. Or, as I think could be the case because I think the top priority of the Chinese Communist Party is to remain the sole party in control of China, the government may make several moves to shore up the social contract. As I understand it, the government has some flexibility with regards to taxes, which they could use to redistribute income/wealth and fund their almost non-existent social net. Additionally, as basic security for the mass of Chinese is promised and established as well as having the renminbi continue to rise, so too does the purchasing power of the consumer and China advances its move to consumer rather than exporting economy. Problems such as the environment and other quality-of-life issues could be a source of “make work” employment. These moves are not new, but would be accelerated: recessions are good times to become more populist. Finally, and this would affect how we see China, these squabbles and disputes would not be played out in public.
Are Chinese banks required to report on the performance
of the loans on their books? For example,
secured/unsecured loans that are 30, 60, 90, 120+ days
“past due”? Is there published data either by bank or
in aggregate for all banks? And I was wondering
hat happens when loans go bad?
Indeed, I have argued that many people have perhaps overestimated the ability of the Chinese government in engineering a soft-landing.
Many people who are optimistic about often cite the fact that it is in the interest of the government to ensure that the economy doesn’t crash. The problem is while the government has strong willingness in doing so, it may not have the ability of doing so.
“This Time is different” syndrome in China
ISTM that a real question is: “How does a banking system held in thrall by political considerations as is the case in China behave differently from a political system held in thrall by financial industry as is the case in the US.” I just don’t know enough about Chinese politics to guess. But I would bet that they will take an increasing bellicrose attitude as Nationalist ferver is used to try and distract the masses from a declining economy.
Exactly! As if the US government and our Federal Reserve doesn’t have a strong will, well, at least desire, to help ensure the economy doesn’t crash.
..reading “Wall Street-A History” by Geisst, I find Minsky overshadowed by Pecora-FDR..towit, it was regulation, and deregulation of, by inside government banksters who caused
economic devastation-not Minsky’s tome…
I think soft landings are reasonably easy to engineer, and would be easiest in a place like China. As with the U.S., the main impediment is corrupt ties to wealthy elites. However, when the continued power of the elites is in jeopardy…
This Minsky moment
So different and so new
unlike all the others
until it all blew
And when it happened
It took you by surprise
I knew you would try to sue
By the look in your eyes
But now it’s mine (Now it’s mine)
and you got no legal right (no legal right)
Everything you had I have (everything, everything)
And I’ll be holding it tight
This Minsky moment (this Minsky moment)
It should prob-lee be a crime
But I’ll just be playin’ golf
Forever till the eh-end of ti-yi-yime
-John E. Cash, CDO, AA, CCC-, BYOB
“Over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight of units engaged in speculative and Ponzi finance.”
It would be very interesting to see the growth rate compared to the rate of these speculative/ponzi borrowing practices. At what rate is economic growth comprised of such “toxic” assets? To what degree is growth encouraged by these bad loans, rather than the inverse as implied in this quote?
Hyman Minsky, an economist at Washington University, observed [that] periods of stability actually produce instability. Economic growth and low defaults lead to greater confidence and, with it, lax lending. Yves Smith from Econned [bold added]
What lending? Banks create money, so-called “credit”, as they lend it out. Furthermore, because we have a government enforced monopoly money supply for ALL debts, that “credit” is not for the bank’s goods and services but for other people’s goods and services. It is thus counterfeit credit.
The fact that the practice is hundreds of years old is irrelevant. It has caused boom-busts, depressions and wars for hundreds of years too.
It’s time for fundamental reform based on sound ethical principles.
Or not. The world must end someday.
Given that preventing labor unrest is a major priority in the Chinese officialdom, it seems they have a non-win situation: either see worker real incomes squeezed further by rising prices, or deprive some, perhaps many, of jobs by putting the brakes on growth. Yves Smith
Let’s dream for a moment and imagine that Chinese workers were paid in the common stock of the corporation they worked for. They would thus work for themselves since they would be part-owners of that corporation.
Now imagine that some of the management or workers think it is wise to expand. They put that motion to the other stock-holders. The motion passes and new stock is created and spent on the expansion.
1) Do the share owners suffer some price inflation (share dilution) as the new stock is created and spent? Yes, probably.
2) Does anyone else suffer? No.
3) Will the share dilution pay for itself in time? Yes, if the new shares are invested wisely.
The question then remains “Why aren’t Chinese workers paid in common stock?” The answer is that corporations do not need to dilute their stock as long as they have the government enforced counterfeiting cartel, the banking system, to borrow from.
It all goes back to the unethical money system. Fix that and MANY problems will disappear over time.
Stock has the potential to grow in value and also shrink in value. Any worker paid in stock takes on risk that likely doesn’t work well with supporting a family.
I also think that those that distribute stock have a much better understanding of its present and future value than those who would receive it, creating situations ripe for exploitation.
Stock has the potential to grow in value and also shrink in value. CE
So does conventional money but the long term trend for common stock is up while the long term trend for conventional money is almost always down.
Any worker paid in stock takes on risk that likely doesn’t work well with supporting a family.m CE
Then the worker could sell his wages for another currency if he desired. The government’s fiat should be stable if only there were private alternatives to it since competition would normally keep it honest.
I also think that those that distribute stock have a much better understanding of its present and future value than those who would receive it, creating situations ripe for exploitation. CE
Our current system IS exploitation. Liberty in private money creation should easily lead to less exploitation not more.
Our current system contains exploitation, no doubt. But small or large employers (other than GS and the like) don’t have the ability to manipulate currency as they do with their own stock. That doesn’t stop people from investing but investing takes work and time that most people don’t have. I think in general that workers chinese or not would benefit from more compensation, not different forms.
Not that option to buy programs aren’t a good thing, aligning incentives with your employer can be a good thing.
But small or large employers (other than GS and the like) don’t have the ability to manipulate currency as they do with their own stock. CE
They don’t have to. The Fed manipulates it for them and for the banks. Private currency alternatives would tend to keep everyone honest.
The one missing ingredient from our so-called “free market capitalism” is genuine competition in money creation.
Someone asked me for a summary of Minsky the other day, so I have these links lying around:
A short one: http://bit.ly/2uD80
Aaaaaand, a long one (PDF): http://bit.ly/mdG9N1
As far as the above goes…
“Magnus does depict another set of choices which would steer clear of that result, that of increasing interest rates both to stanch inflation and shift the economic model away from lending-stoked investment towards more consumption. But putting on the brakes will slow growth short term.”
I know Yves has already highlighted, but I think it’s justified getting a liiitle bit more hysterical about this one. The Chinese economy is sustaining itself almost wholly on production growth — the consumption base is so small that you see those infamous ghost malls forming.
This is like nothing the world has ever seen before. And should the Chinese put the brakes on the train will crash a lot harder than the US did after the Volcker shocks — mark my words.
The Chinese economy is not only relying a lot more heavily on pure investment growth than the US economy was in the 1970s — it also doesn’t have comparable ‘automatic stabalisers’ (dole checks, essentially) as the US economy had when it went into recession because of the Volcker shocks.
Minksy himself discusses this in ‘Stabalizing an Unstable Economy’. In the second chapter — entitled ‘Big Government’ — Minsky shows how necessary the deficits are that open up due to the automatic stabalisers when recession hits. He’s quite clear in saying that, were these not in place ‘It would happen again’ (meaning, that another Great Depression would occur).
China has pathology on both sides. Investment is FAR too large — and government stopgaps are FAR too small. The worst of both worlds, you could say. When they hit the brakes — or when the brakes lock themselves — there’s gonna be a MAJOR crash.
Following this is going to be serious social unrest — perhaps even the likes of which the world hasn’t seen in decades. Poor Chinese will revolt and the CCCP will be forced to respond with force. What’s more, the Party know this is coming — and they’re terrified.
I’m usually the first to call ‘end of the world’ economic hysteria for the nonsense it is — but in this case, I put my bets in: the Four Horsemen are going to ride.
In a depression, it is the fast growers and exporting countries which tend to get hit the hardest. China, like the US in the 1920s, is both. It isn’t just the credit overshoot but the one in productive capacity that are the killers.
The completely different culture that is Chinese, for thousands of years with no influence from Western Civilization makes critical analysis of the imposition of our finance system problematic. The 2 estates of China are the CCP and the People’s Army. Most of the wealthy are not in a position yet to capture their political superiors. However, we do have a world wide capitalist economy with rules that have been established independent of the nation states within which they operate.
I recall the super tanker America thesis by Abby Joseph Cohen. She was the big cheerleader from Goldman who described the US economy as analogous to a giant supertanker, cruising the typhoons of market storms, and staying afloat by sheer scale and mass. This time it is really different she frequently advocated through the booming 1990’s. China’s size, mass, and control by The Party will not absolve it from the internal logic of the financial system that they have willingly entered into.
In China’s case, Minsky’s use of idiographic analysis as opposed to a search for some general laws, mathematically grounded, may prove more valuable in forecasting what can go on in non Western, and hence non familiar cultures. Capitalism has a logic of its own, and the CCP has been dominated by the victors who have chosen the Capitalist Road. The Party is politically in charge of letting the market flourish, not allowing political power to be transferred from them to financial oligarchs.
The Party will inherent the problems of capitalism no matter how well they can politically manage the fallout, or not. Once a market system has been introduced as a social organizing process, it will behave consistent with the other similarly structured markets. The interaction between the other institutions of the Chinese social order will differ from our responses, but I see no reason why a valid Minsky Moment is not in the near term future of the Chinese economy. The Capitalist Road once taken, has a direction all its own, only to be avoided by choosing another road altogether.
“Most of the wealthy are not in a position yet to capture their political superiors.”
That would be incorrect. Many of the wealthy are the offspring of the party leaders, and the others are allowed to become wealthy only with the blessing of the party leaders. Naturally, these blessings are for sale, and a take of the profits is expected. On the local level, everything is as it is in the U.S. viz. total political capture by the wealthy.
Your point does not make logical sense, as I said, the the CCP does not let markets operate to transfer power from them to a wealthy class, the wealthy class is well populated by the party membership and the People’s Army, not a new, previously disenfranchised set of actors. Yr point that it is just like the US is ridiculous, there is no comparison of our 2 cultures that makes them just like us in this regard. All power resides in the Party and the wealth concentrates with Party members, making the Party even stronger, not weaker. Your point implies the decoupling of wealthy party members upon achieving wealth. They are not stratifying, or segmenting apart from the Party, but further consolidating WITHIN the Party and concentrating power with political capital augmented by economic capital.
…except for the fact that a lot of them leave China to live elsewhere. But yeah, it’s a political nepotism based arrangement. In the U.S., nepotism certainly exists but doesn’t account for 90% of all rich people.
Still, it’s hard to read the wikipedia article on corruption in the PRC and not notice the parallels.
One last thing I should mention about political power is that the offspring for political reasons can’t become politicians themselves. The politicians settle for the next best thing: making their offspring immensely wealthy in order that they influence the next generation of politicians with their wealth. Thus, in roughly a generation, you will have the situation where the wealthy control the government.
This is why the People’s Bank of China is so worried about another surge in non-performing loans. If the household sector is forced once again to clean up a banking mess, this will make China even more reliant for growth on the trade surplus and on investment, and that is something many in Beijing, including the PBoC, do not want to see.
Pettis: Chinese NPLs
Remember that there is no such thing as a painless banking crisis and anyone who suggests otherwise should not be taken very seriously. There is always a significant cost, and the cost is almost always borne one way or the other by the household sector. In China, with its already too-low household consumption, it will be very risky to force households to clean up yet another surge in non-performing loans. It would only make it more difficult than ever for China to achieve the rebalancing its economy so urgently needs.
Remember that there is no such thing as a painless banking crisis pezhead9000
The solution to a banking crisis could be relatively painless if some debt-free fiat was distributed to the population along with some fundamental reform.
and anyone who suggests otherwise should not be taken very seriously. pezhead9000
So far, no one has been able to refute my reform suggestions.
There won’t be a Minsky moment(outright default). They’ll keep printing money to sustain high real estate prices, so there won’t be many defaults.
Yes it’s a credit fueled growth, but credit can be paid for by printed money these days.
Check out the balance sheet of China’s banking system. There was an unexplained increase of some 2.7 trillion yuan in deposits in the first quarter of this year. This amount can not be attributed to trade surplus, foreign investment or “hot money”. The good thing about a totalitarian regime is, they don’t have to explain anything to anyone.
There’s your Minsky moment, which happened quietly behind the scenes.