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The Unknown Hyman Minsky

by Martijn Konings on September 18, 2018

If there is one theme that unites the various critiques of contemporary finance, it is the emphasis on its speculative character. Financial growth is said to be driven not by the logic of efficient markets, but rather by irrational sentiment, “animal spirits” that do not respect fundamental values.

However, predictions regarding the collapse of neoliberal finance have not enjoyed a good track record. Over and over, the contemporary financial system has proven capable of sustaining higher levels of speculative activity than anticipated. This has certainly been true of the past decade. Capital and Time: For a New Critique of Neoliberal Reason is my attempt to make sense of this – that is, to understand what might be wrong or missing in the existing heterodox critique of speculation, and to advance a more accurate understanding of the role of uncertainty, risk and speculation in contemporary capitalism.

At the heart of the critique of speculation we find a distinction between real and fictitious forms of value. Although “essentialist” (or “foundationalist”) modes of explanation have been under fire across the social sciences for several decades now, when it comes to the critique of finance they have had considerable staying-power: without a notion of real value, it often seems, we lose any objective standard against which to assess the speculative gyrations of capitalist markets.

Capital and Time asks what kind of critical theory we might develop if we bracket the anxious attachment to a notion of fundamental value. To that end, it turns to the work of Hyman Minsky. Although Minsky has been popularized precisely as a critic of speculation, he in fact insisted that almost all value judgments and investments were to some degree speculative – their success or failure would be determined in an unknown future. For him, the key economic question is how order emerges in a world that offers no guarantees, how more or less stable standards and norms arise amidst uncertainty.

Of course, the “endogenous” origin of financial standards is a well-rehearsed theme in heterodox economics – indeed, it is a staple of the “post-Keynesian” literature that claims Minsky’s legacy. But such perspectives have never been able to break with the idea that financial stability is at its core dependent on external interventions that suppress speculative impulses. For Minsky, however, this is to miss the point about endogeneity. To his mind, there was no clear dividing line between financial practices and their governance: central banks and other public authorities are no more able to see into the future and to transcend uncertainty than private investors are.

Minsky was therefore highly skeptical about official claims of discretionary precision management: financial governance is always embroiled in the very risk logic that it is charged with managing. That also means that financial policy can appear quite ordinary, even banal: at the heart of capitalist financial management is a logic of backstopping and bailout that responds to the possibility that the failure of an institution may take down wider financial structures.

The stability of the post-New Deal financial system is often attributed to the Glass-Steagall separation of the stock market and commercial banking. But Minsky tended to view Glass-Steagall as one of several measures to direct bank credit away from the stock market towards other, no less speculative ends, notably consumer and mortgage financing. To his mind, the stability of the post-war period derived rather from the creation of an extensive financial safety net (which included, for instance, deposit insurance, which removed the rationale behind bank runs) that served to socialize risk.

This institutional arrangement turned out to have a significant drawback: a pattern of chronic inflation emerged that, by the late 1970s, was widely perceived as a major problem. Minsky’s lack of faith in the possibility of cleanly staged external interventions led him to feel that that there was no real way out of this predicament. Monetarist doctrines, ascendant during the 1970s under the influence of Milton Friedman, relied on exactly the belief in an arbitrarily defined monetary standard that Minsky rejected as naïve. Muddling through, it seemed, was the price of avoiding another financial crash and depression.

The Volcker shock of 1979 changed this dynamic in a way that Minsky had not foreseen but that is comprehensible when seen through the lens he provided us with. Paul Volcker looked to monetarism not as a means to enforce an external limit or standard on the financial system, but as a politically expedient way to break with accommodating policies and to proactively engage the endogenous dynamics of finance. The consequences of the Volcker shock were predictable (which is exactly why the Federal Reserve had been reluctant to pursue similar policies in previous years): inflation gave way to instability and crisis. Inflation was conquered as jobs were lost and wages stagnated. And, far from money being returned to its neutral exchange function, opportunities for financial speculation multiplied.

The American state was never going to sit idly by as the financial system returned to dynamics of boom and bust: when instability took the form of systemic threats, authorities would bail out the institutions that had overextended themselves. Of course, Volcker would not have been able to predict the specific features of the too-big-to-fail regime as it emerged during the 1980s and evolved subsequently; but the very point of the neoliberal turn in financial management that he had overseen was to create a context where risk could be socialized in ways that were more selective and therefore did not entail generalized inflation.

The inflation of asset values that has been such a marked feature of the past four decades has always been premised centrally on the willingness of authorities to view the “moral hazard” of the too-big-to-fail logic as a policy instrument – even if they may have decried it officially as a regrettable corruption of market principles. Spectacular bailouts, mundane policies to protect the key nodes of the payment systems, the “Greenspan put”, the different iterations of quantitative easing – these are all variations on that basic too-important-to-fail logic.

Existing critical perspectives tend to view crisis and the need for bank bailouts as manifesting the essential incoherence of neoliberal finance, its lack of solid foundations and the irrationality of speculation. Capital and Time breaks with such moralistic assessments. The way deepening inequality and the growth of asset values continue to feed off each other is troubling for any number of reasons, but there is nothing inherently “unsustainable” about it – the process does not have a natural or objective limit.

At this point in time, the critique of speculation does little more than lend credibility to official discourses that present crises as preventable and bailouts as one-off, never-to-be-repeated interventions. In that way, it prevents us from critically relating to a neoliberal reality that has been shaped to its core by the speculative exploitation of risk and uncertainty, and in which regressive risk socialization serves as the everyday logic of financial governance.

Martijn Konings
Martijn Konings works in the Department of Political Economy at the University of Sydney. He is the author of The Development of American Finance (Cambridge University Press, 2011), The Emotional Logic of Capitalism: What Progressives Have Missed (Stanford University Press, 2015), Neoliberalism (with Damien Cahill, Polity, 2017) and Capital and Time: For a New Critique of Neoliberal Reason (Stanford University Press, 2018). With Melinda Cooper, he edits the new Stanford University Press series Currencies: New Thinking for Financial Times.
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  • Neale
    September 18, 2018 at 4:16 pm
    Two questions are raised by the aggregate demand structure above. First, what motivates and enables the private sector to run deficits over extended periods? Second, how long can this process continue?

    Minsky’s Financial Fragility hypothesis provided insight into the motivations and enablers of private sector deficits and the viability of sustained private deficits.

    The type of economic system envisaged by Minsky is a modern capitalist system consisting of long-lived, expensive, and privately owned capital assets with sophisticated financial arrangements (debt contracts) designed to fund the acquisition of such assets.

    For Minsky, it is the processes and consequences of the investment in such capital assets in a modern capitalist system that forms the theoretical crux of the Financial Fragility hypothesis.

    I discussed that hypothesis in detail in this blog (2010) – Counter-cyclical capital buffers.

    By way of summary, the Financial Fragility hypothesis has two fundamental propositions:

    First, the economy has financing regimes under which it is stable and financing regimes under which it is unstable.
    Second, expansions driven by private spending are typified by agents taking increasingly fragile investment positions.

    The articulation between expected income cash flows and contractual obligations are what Minsky terms ‘financial relations’ with three categories being identified:

    An investor is hedge financing if realised and expected income cash flows are sufficient to meet all their payment commitments.
    An investor is engaged in speculative financing if their balance sheet cash flows exceed expected income receipts and they roll-over existing debt.
    An investor becomes a Ponzi financial unit if they increase debt to meet the gap between their balance sheet cash flows and expected income receipts. So unlike hedge units, speculative and Ponzi financing units must engage in portfolio transactions to fulfill their payment commitments.

    It is the relative weight of income, balance sheet, and portfolio payments in an economy that determines the vulnerability of the financial system to disruption. An economy in which income cash flows are dominant in meeting payment commitments is relatively immune to financial crises whereas an economy is potentially financially fragile and crisis-prone if portfolio transactions are relied on for meeting payments.

    Over a period of prolonged prosperity, the economy endogenously transits from stable financial relations (an aggregate liability structure dominated by hedge finance) to unstable financial relations (an aggregate liability structure dominated by speculative and Ponzi finance).”

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