Can It Happen Again? (1982) is a work by Hyman Minsky which focuses on the instabilities of finance in the capitalist system. It is therefore a super relevant book to deepen your knowledge of the second chapter of the second year of ESH, entitled “The dynamics of financial globalization”.
Introduction
About Minsky
Anecdote: Minsky completed his doctorate in economics under the supervision of Schumpeter. We will therefore see that this proximity to the theorist of “creative destruction” will profoundly influence him in his understanding of the financial system.
Minsky is strongly influenced by John Maynard Keynes, and his economic theories can be seen as an extension of Keynesian ideas. The author of the General theory of employment, interest and money (1936) had already proposed a vision in which markets, left to themselves, did not necessarily guarantee full employment or economic stability. Minsky took this idea further by developing a comprehensive theory of financial instability.
Hyman Minsky is considered a heterodox economist because his ideas and theories diverge widely from mainstream economics, including the neoclassical and monetarist approaches that dominated economic thought during his time.
About the work
Now that you have a clearer picture of the author, let’s get down to business. The name of the work is quite transparent about Minsky’s questions by referring to the crisis of 1929. In this work, the question is whether a crisis resembling that of 1929 could occur again in the future. Can It Happen Again? (can this happen again?).
In his work, Minsky develops several different notions, which we will detail in several parts. First, it goes without saying that the latter develops a theory of financial instability, thereby leading a critique of the classical vision of the economy (he is, let us remember, a heterodox thinker). Finally, we will study the recent perspectives of the Minsky model, answering the following question: is the Minsky model still relevant for explaining and predicting financial crises?
A theory of financial instability
Dynamics of instability and financing phases
Minsky describes a three-phase economic cycle, which inevitably leads to the financial crisis.
Conservative financing phase (Hedge Finance)
At the start of the cycle, economic agents borrow conservatively. They use loan amounts that they can repay with their income. During this phase, the financial system is relatively stable and investments are made prudently and risks are low.
Speculative financing phase (Speculative Finance)
As the economy grows and confidence builds, economic agents begin to take more risks. They no longer borrow to directly finance their productive activities, but to speculate. Borrowers no longer repay the principal of their debts, but only the interest, betting that future income growth will allow them to honor their commitments.
In the same perspective, banks are becoming more lax in granting credit, because they anticipate that economic growth will continue. He thus states in his work: « Stability, even in a period of expansion, is destabilizing to the extent that more adventurous financing of investment pays off for the first movers, and the others follow. »
Ponzi financing phase (Ponzi Finance)
Economic agents are no longer able to repay their debts. They must borrow even more to repay their existing commitments, falling into a debt spiral. This corresponds to a form of speculative bubble, where solvency depends entirely on the possibility of contracting new loans.
This phase is unsustainable in the long term, and the slightest disruption (rising interest rates, falling asset prices) can lead to a collapse of the financial system
An endogenous cycle
Furthermore, one of Minsky’s central ideas is that this cycle is endogenous. That is to say, it is integrated into the very functioning of financial markets and not caused by external factors. As we saw previously, according to him, financial instability is a cumulative process that arises in periods of economic prosperity.
During periods of stability, investor confidence grows and encourages them to take more and more risks. The Minsky cycle is therefore a cyclical process of growth, over-indebtedness, then crisis, and not a tendency towards a stable equilibrium.
The paradox of stability (or paradox of tranquility)
In times of growth and apparent stability, economic actors are inclined to underestimate risks. Economic stability leads to a form of collective blindness, where investors and even regulators believe that crises are a thing of the past. This feeling encourages you to take more and more financial risks. Minsky develops here a psychological argument which will give rise to the emergence of a branch of finance: behavioral finance.
During this stability phase, invisible vulnerabilities accumulate. Debt levels are rising, lending standards are becoming more lax, and investments are increasingly speculative. But this increased risk-taking only becomes visible once the bubble bursts and economic actors realize that they can no longer honor their debts.
It is precisely this paradox that makes capitalist systems fragile. Excessive confidence in economic stability generates behaviors that make the appearance of crises inevitable.
Hence the role of banks and credit in instability
Credit plays a central role in Minsky’s theory of financial instability. Unlike traditional theories which see credit as a simple intermediary between savings and investment. Minsky grants the banking and financial system a creative role in the economy, thus extending Keynesian analysis.
Banks, according to Minsky, are not just passive intermediaries, they have creative power in the economy. In good times, banks have an incentive to relax their lending standards and take more risks to maximize profits. They thus contribute directly to the accumulation of debt in the economic system. By granting increasingly risky loans, they fuel speculation and the formation of financial bubbles.
Credit expansion is not inherently bad, but it can quickly become a source of systemic risk. When debts become too large and assets begin to lose value, banks find themselves exposed to heavy losses. If they can no longer recover their debts, this can trigger a banking crisis and a contraction of credit throughout the economy, as was the case during the crisis of 1929. It is also this mechanism which was observed during the 2008 financial crisis, where the collapse of loans subprime led to a global banking crisis, as banks had lent heavily to insolvent borrowers.
Here is a quote to summarize his thoughts
“A capitalist economy is fundamentally flawed because the financial system necessary for capitalist vitality and vigor—transforming entrepreneurial visions into effective demand for investment—contains the potential for uncontrolled expansion, fueled by a corporate boom. investment. »
A critique of the classical view of economics
As you will surely have already understood, Minsky stands very far apart from his contemporaries (Friedman, Fama, etc.), but also from neoclassical economists.
This theory postulates that markets are rational and naturally tend towards equilibrium. According to the classical view, economic crises are often attributed to external factors (wars, natural disasters) or excessive state interventions, rather than to inherent weaknesses of capitalism.
Minsky rejects the idea of a natural equilibrium of markets. For him, markets are always in motion, influenced by human behavior, uncertainty and above all the psychology of investors. Financial crises, according to Minsky, are not exceptional accidents, but regular manifestations of the instability of capitalism.
Minsky also shows that instability is an endogenous characteristic of capitalism. Unlike neoclassical theories, which seek to demonstrate that financial markets are efficient, Minsky demonstrates that crises are a natural product of the system. The role of credit, speculation and human behavior make the formation of bubbles and busts inevitable.
It challenges the idea that public interventions (such as monetary or fiscal policy) can eliminate the risk of crisis. Although such interventions can delay or alleviate seizures, they can never prevent them entirely (notably because of the psychological dimension at the origin of seizures).
Recent Insights
So, let’s answer the question: Can It Happen Again? Minsky’s conclusion in his book is clear: yes, it can happen again. As long as market economies continue to rely on credit expansion and speculation, major financial crises will recur.
Minsky warns us against the illusion that we have learned enough from the past to prevent future crises (history repeats itself, according to him). Still according to Minsky, instability is an intrinsic characteristic of capitalism and no reform will completely eliminate this risk (cf. the analysis of psychology as the origin of crises).
However, it is possible to limit the severity of crises by adopting more prudent economic policies and more strictly regulating financial markets. It calls for greater vigilance from regulators and policy makers to ensure that banks and investors do not take excessive risks that could destabilize the entire system (cf. phases 1 and 2 of instability) .
Minsky’s ideas remain as relevant as ever. Recent financial crises, such as that of 2008, and the volatility of financial markets remind us that apparent stability can often mask deep instabilities. Moreover, we spoke of the “Minsky moment” in 2008 to describe the origin of the crisis of subprimethus attesting to the relevance of the author to analyze such a crisis.
Be careful, however, not to analyze everything under Minsky’s sieve. Typically, it is more difficult to argue about the relevance of Minsky’s analyzes to explain the crisis due to Covid, or even with the war in Ukraine, the latter being much more caused by exogenous shocks.
Conclusion
Can It Happen Again? thus remains a key work for understanding the mechanisms of financial crises in market economies. His theory of financial instability, based on the central role of credit, speculation and human behavior, provides a clear explanation of the cyclical dynamics that lead to crises. More than a simple diagnosis of the past, Minsky’s theories offer a still relevant reading grid (even if we have qualified this) to understand the future of finance in the economy.
It is therefore an ideal work to cite on subjects on financial globalization, a chapter often covered in the second year of ECG preparation. You can therefore perfectly use such a work on subjects like: ESCP 2023 “The primary objective of the Central Bank is to ensure price stability”, “Treaty on the Functioning of the European Union (TFEU)”, or even Ecricome 2023 (2) “What is a good SMI?” “. It is therefore not necessary to go back for a long time in the subjects to find where to mobilize Minsky!
Now all we have to do is cross our fingers that a topic on finance comes up in the next writings!
Click here for more articles from ESH.
Related News :