Wednesday, November 28, 2007

The Subprime Crises: A Mises or a Minsky Moment? (amv)

In a recent post my fellow co-blogger fg has suggested the paper of Prof. Calomiris who approaches the current financial market tensions by means of Minsky's 'Financial Instability Hypothesis,' which claims that instability is inherent to capitalism and that the innovating power of financial producers destabilzes the system in boosting the leverage. In contrast, the Austrian Business Cycle Theory emphasizes that general boom-bust cycles on financial markets as well as on good markets are due to the destabilizing impact of monetary policy, that is, while the market is seen as inherently stable the crises in capitalism are assigned to government manipulation.

Who is right? Do we face a 'Minsky moment' or a 'Mises moment'? Here you can find Frank Shostak's post on, supporting my one point of view: We have clearly no Minsky moment. The problem with Minsky, as with all Post-Keynesian theory, is that it is not founded on the allocation problem. It fails to perceive that the economic problem, the problem of how to allocate scarce means to a multiplicity of ends over time, is an universal aspect of human action, that choice is a burden which we can never escape. The Minsky system is not based on scarcity, however, but is a theory based on affluence - here we face a rather quirky kind of Nirvana where the universality of the burden of choice is superseded. The economy is seen mostly in nominal terms and there is no real economy which checks the nominal expansion of the system. The Minsky approach blinds out the fact that the economy can only generate booms and bubbles by means of credit expansion!

From the neoclassical/Austrian point of view it is simply superficial to assume that the sheer innovative power of financial entrepreneurs in producing new kinds of financial products is sufficient to explain the ballooning of the nominal system. Why is a demand for one asset not accompanied by a decrease in the demand for annother asset (or even good)? Because money is pumped into the system! The way from Hedge to Ponzi finance is indeed a good description of what really happens, yet it is triggered solely by the monetery authority which increases the money supply, therewith shifting the nominal constraints of the system, suggesting a relaxation from the burden of scarcity. But this is merely fake, since the increase on nominal terms is left unaccompanied by any increase of the actual means available to satisfy our ends.

It comes to no surprise that Minsky is unable to give any positive role to the price system, because only if individuals are not checked by the price vector and the price vector is not bounded by the fact of scarcity, the economy is left as a system without purpose, just stumbling blindly and by itself from crises to crises, repeating the same errors with new financial innovations, while learning is reagrded either as to complicated because unguided by relative prices or as to conservative given the short-run greed presumed for financial actors. Thus, Shostak rightly concludes:
"So while Minsky's story accurately describes the present financial-market turmoil, it does not provide any satisfactory explanation based on previously established and identified phenomena. It arbitrarily puts the blame for instability on the capitalistic economy without even making the slightest attempt to establish a logical verification for this claim. We have seen, however, that it is the existence of the central bank that lays the foundation for financial instability. This means that, contrary to Minsky and the other post-Keynesians, the source for current financial turmoil is likely to be the central bank, i.e., the Federal Reserve's monetary policies. [...] Contrary to Minsky, there is nothing wrong with capitalism. To avoid the menace of boom-bust cycles what is needed is to close all the loopholes for the creation of money "out of thin air."