Date: Sun, 30 Apr 1995 21:04:55 +1000 From: Steve.Keen-AT-unsw.edu.au Subject: Re: Stock Ownership 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 --- from list marxism-AT-lists.village.virginia.edu --- ------------------
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