What exactly is the Chinese for “ Minsky moment”? The chances are that we will soon need to know, after a startling moment of clarity from the outgoing chairman of the People’s Bank of China.
Speaking on the sidelines of the Communist party congress in Beijing, Zhou Xiaochuan, who is soon to stand down as governor of the PBoC, said: “If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky moment’. That’s what we should particularly defend against.”
This might sound unexceptional. But it is about as close as someone in Mr Zhou’s position can come to yelling “fire” in a crowded theatre. To quote Robert Hockett, an expert on China at Cornell Law School: “It’s calculated to inspire panic. It’s almost an incantation to panic — especially in China.”
Mr Zhou’s use of the term stunned investors and on Thursday prodded Hong Kong stocks to their worst daily fall of the year. The decline was swiftly reversed on Friday, but it would be unwise to assume that the incident is over. Mr Zhou had issued a clear warning of trouble and unpopular decisions ahead.
The term “Minsky moment” is named after the late Hyman Minsky, an academic economist, and was coined in 1998 by Paul McCulley when he was an economist at UBS. Minsky is best known for his insights that banking creates inherent instability at the heart of capitalism, and that periods of stability beget instability. Long periods of calm will generate over-confidence as banks engage in ever more speculative lending. It reaches the stage of Ponzi finance, to use Minsky’s term, and then it collapses.
The term moved from academic curiosity to the centre of the debate a decade ago, as the unfolding financial crisis showed that Minsky’s ideas had a lot to be said for them. Minsky’s framework fits the events leading up to the Lehman bankruptcy almost perfectly. The year 2008 even witnessed the discovery of history’s greatest ever literal Ponzi scheme, perpetrated by Bernard Madoff.
Thus a central banker should never use the term. Merely talking about such a moment could provoke one. Among investors and economists, however, the fear of a Chinese Minsky moment has been around for years, as China navigated the post-crisis era with the aid of ever more debt, the fear has been that it will suffer its own Minsky moment. According to the Institute of International Finance, China’s ratio of household debt to gross domestic product rose to 45 per cent in the first quarter of this year — far beyond the emerging market average of 35 per cent. Total debt, including for companies, is now more than three times GDP.
We also need to bear in mind the timing of Mr Zhou’s comments, at the congress which gives the regime another five years in power. Now that Mr Xi and colleagues are safely reinstalled, it is the optimum time to take the initially uncomfortable measures that may allow China to avoid a debt unravelling to match the Lehman crisis. Invoking Minsky at the congress itself was the earliest possible point to send the signal, and a sign of urgency.
Precedents for unwinding a huge burden of leverage without prompting a crash are not many. But China may have a better chance than others. The state has a degree of control over all the country’s lenders and many borrowers. This could give it a chance to peel away the layers of leverage without a Minsky moment or collapse in asset prices. Beijing’s attempt to achieve the feat will be arguably the most important factor moving the world economy for the next few years.
It would be unwise to take too much comfort from the market’s swift recovery from its Thursday panic. For another example of a central banker warning that the time had come to rein in a bout of speculation, look to Alan Greenspan’s speech about “irrational exuberance” from late 1996, which he followed up with a rate rise. That episode engineered a 10 per cent stock market correction, but then the Fed for some reason lost its zeal for countering the incipient bubble, with fateful consequences.
In hindsight, Mr Greenspan made that warning at the right time. There was still time to stop a strong bull market turning into a bubble. Mr Zhou probably thinks that much the same is true of China.
One final point is that it is worth returning to look at exactly what Minsky said. He developed his theory as part of a critique of John Maynard Keynes’s General Theory (Mr Hockett argues that maybe we should even be referring to a “Keynes moment”). Writing in the 1970s, as Keynesian economics had gone badly wrong, Minsky wanted to argue that Keynes had been misinterpreted, and that control over inherently unstable banking and investment was necessary if capitalism was to work.
Robert Barbera, a former Minsky pupil, argued in a 2009 book that “The Cost of Capitalism” (his title) was the need for occasional unpopular bailouts and rescues of the banking system. Minsky’s own preference appeared to be for socialising banking and investment, saying that “socialisation of the towering heights is fully compatible with a large, growing and prosperous private sector”.
Many will disagree with this, and Minsky’s post-Keynesian notions lost the 1970s battle of ideas. The world opted for the Thatcher-Reagan model of capitalism instead, and it worked well until the crisis.
It is not a coincidence that Minsky is back on the agenda (just as are critiques from libertarian “Austrian” economists who also decried the instability of finance). As the world looks for a new model amid inequality and persistent high levels of unemployment, the closing words on Minsky’s treatise on Keynes seem uncomfortably relevant: “with regard to both the stability of employment and distribution of income, capitalism is flawed.”
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