Stock Ownership

Steve.Keen at unsw.edu.au Steve.Keen at unsw.edu.au
Sun Apr 30 05:04:55 MDT 1995


What a question! My nomination for the best theory of stock and
asset speculation is Minsky's Financial Instability Hypothesis,
the gist of which is summarised in the following outline which
will be published in a journal called "The Chaos Network: later
this year:
The Economics of Chaos: Minsky's ''Financial Instability
Hypothesis''

Introduction

Few areas of study would appear more amenable to chaos theory
than economics. Yet, with few exceptions, economists model the
economy as a linear, highly stable process, with cycles caused
by exogenous shocks. One exception to the rule is Hyman Minsky,
who has developed what he calls the ''Financial Instability
Hypothesis''.

Minsky's model considers an economy which has only just
recovered from a severe economic breakdown; consequently, both
borrowers and lenders are very conservative. Firms include a
large margin for risk in their project assessments, and try to
get by with internally generated funds, while banks lend only to
lowly geared companies. Given this general conservatism, the
vast majority of investment projects succeed--confounding the
generally pessimistic expectations. Firms therfore revise their
previous margins for risk, leading to higher estimates of
investment returns, while banks become more willing to finance
highly geared entrepreneurs.

 Asset valuations begin to rise, encouraging the emergence of
speculators, who make money on the back of increasing asset
values. As this process spirals, the economy enters what Minsky
terms its ''euphoric'' stage: economic actors come to expect
that good times are here to stay, asset prices rise higher
still, further encouraging speculation, while companies finance
more and more of their investment by borrowing, leading to
rising gearing levels. In this environment, while there is
plenty of money, there are also plenty of people clamouring for
it, and interest rates rise as more and more risky projects are
undertaken.

Eventually, the level of returns being anticipated exceeds the
physical capacity of the system to generate a profit. The most
highly geared projects start to fail, and asset prices taper off
or even fall, pushing speculators into distress. Suddenly, both
firms and bankers become pessimistic about the prospects for
successful investment. The most highly geared firms go bankrupt,
while the remainder focus solely on reducing their gearing,
leading to a collapse in both investment and speculative
activities. Banks try to rein in their credit exposure, leading
to a collapse in the growth of money--and a new crisis.

What happens after the crisis depends on the rate of inflation,
and the behaviour of government. Low inflation (and no
government intervention) can mean that debts can never be
repaid: firms go bankrupt, eventually so do the banks, and the
economy enters a Depression. High inflation can enable debts to
be repaid, thus avoiding a depression, but leading to what in
the 70s was called Stagflation. Prompt government intervention
(lowering taxes or increasing spending) can generate sufficient
cash flow for firms to repay their debt, and thus let the system
limp out of the crisis---into yet another cycle.

-------------
(The remainder of the paper was an outline of a simple nonlinear
model of the above)

What is implicit in the above is the belief that the money
supply is endogenous--and thus it can expand when capitalists
and bankers are optimistic (the euphoric economy), and contract
when pessimistic (the collapse), regardless of government
attempts to manipulate the money supply. So the money that
speculators make comes from the process of speculation itself--
but it will ultimately collapse, and in the end the sole source
of profits is dividend flow, which itself comes from surplus.

A neat illustration of this occurred in Australia, when one year
the money supply rose by 30%. A pair of conservative economists
stuck their necks out with a newpaper article predicting a
rate of inflation the next year of 27%, on the basis of a
conservative theory of economics known as rational expectations.
I had great fun mocking their prediction with my students, since
it was based on the notion that the money supply was exogenous--
determined by government action--and such a rate of growth of
the money supply would "rationally" lead people to expect a
rate of inflation of 27% the next year, thus causing such
a rate.

In fact, the rate of inflation the following year was 2% (the lowest
rate in 25 years), and the money supply shrunk by 2%--the boom
had collapsed.

Hope this is helpful,
Cheers,
Steve Keen


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