During the “good times” you can talk about it all you want, and yet, no one really listens.
It is interesting to hear the name of the economist Hyman Minsky mentioned again, but Martin Wolf of the Financial Times cites his name in the article “Coronavirus Crisis Lays Bare the Risks of Financial Leverage, Again.”
Mr. Wolf points out that Minsky taught us: debt causes fragility.
L. Randall Wray also introduces us to the Minsky phase “stability is destabilizing” in his 2016 book Why Minsky Matters published by Princeton University Press. The idea is that during the times when economic growth seems so present and stable, people take advantage of such times to build up a financial structure which makes a severe downturn just that much more probable.
And now the United States – and the world – has to face the consequences of the COVID-19 pandemic.
Mr. Wolf comments: “Among other things, coronavirus has revealed fragilities in the financial system. This is unsurprising. As before, reliance on high leverage as a magical route to elevated profits has led to private profits and public bailouts. The state, in the form of central banks and governments, has come to the rescue of finance on a gigantic scale. It had to do so.”
The Federal Reserve Takes On New Responsibilities
As never before, the Federal Reserve System is stepping up more than ever to finance private debt in addition to government debt.
During the Great Recession, the Federal Reserve took on the responsibility of purchasing mortgage-backed securities. Never had anything like this been done before.
Now, the Fed has $1.6 trillion of mortgage-backed securities on its balance sheet. The future holds out the prospect of the Fed having many other types of private debt on its balance sheet.
In this respect, many economists, and other pundits, raise issues about the changing role of the central bank in the US economy. There are big questions about the Fed losing its independence along with its mission.
Yet, the Federal Reserve also has its responsibility to keep the banking and finance system from collapsing. And at this point, the Federal Reserve seems to be doing this very well.
But the debt load goes deep.
Mr. Wolf provides us with these statistics: “Since the global financial crisis, indebtedness has continued to rise. In particular, the indebtedness of non-financial companies rose by 13 percentage points between September 2008 and December 2019, relative to global output. The indebtedness of governments, which assumed much of the post-financial crisis burden, rose by 30 percentage points. This shift on to the shoulders of governments will now happen again, on a huge scale.”
And the proliferation is not over. The US government has committed itself to massive deficits going forward as it has moved to provide a support for businesses and consumers during the coming period of economic distress.
The numbers are in the trillions of dollars. The government debt load will exceed that accumulated during the Second World War.
And the Federal Reserve’s balance sheet is also expected to explode into the trillions. Currently, the Fed carries more than $6.6 trillion in assets. Just before the Great Recession, the balance sheet was below $1.0 trillion.
These debts must be handled during the economic downturn. We have the first report on the growth of real GDP for the first quarter of 2020. The US economy declined by 4.8 percent going from the fourth quarter of 2019 to the first quarter of 2020. Year over year, real GDP rose by a 0.3 percent rate.
Furthermore, there is the collapse in the price of oil due to the COVID-19 virus spread and political issues. Commodity price declines, along with the possibility of a general price deflation, are not going to be helpful to those organization or to those individuals that have a lot of debt.
Mr. Wolf adds, “The crisis has revealed much fragility. It has also demonstrated yet again the uncomfortably symbiotic relationship between the financial sector and the state. In the short run, we must try to get through this crisis with as little damage as possible. But we must also learn from it for the future.”
As Minsky adds, the confidence in adding debt during the good times looks somewhat overly stated when one actually has to deal with the burden that the debt becomes during a crisis.
Will We Ever Learn?
This question is always there during the downturn. It was there during the Great Recession, and you see what has happened.
“The big question now,” Mr. Wolf asks, “is whether the essential systems that keep our societies running are adequately resilient,” and he follows this with, “The answer is no.”
“This is the sort of question the OECD’s New Approaches to Economic Challenges Unit has dared to address. Inevitably, it has created much controversy. Yet it is admirable that an international organization is daring to do so at all. The crisis has shown us why.”
The Changes Need To Go Deeper
As many of the people that read my articles know, I attribute the underlying problem in the United States to the federal government. The federal government in the United States, whether Republican or Democrat, has pursued a policy of what I call “credit inflation.”
Credit must be flowing, whether government or private, and for a very good cause… to keep unemployment as low as possible. Yet, a constant foot to the accelerator, keeping the credit flowing, creates expectations in the private sector that the government will continue to stimulate with deficits and will continue to underwrite these deficits with monetary ease, and will also produce programs that allow businesses and consumers to continue to pile on debt.
As Minsky says, this is all fine and good during the “good times” but it catches up with us during the “not-so-good” times. But we never seem to learn.
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