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By rclosch
January 12, 2010


"Stability is unstable" was Hyman Minsky simple explanation for economic cycles. In a September story in the Boston Globe the author points out that Minsky's theory would have predicted the 2008 credit crash.

While this may not be exactly a news flash for most of us the author also points out that Minsky predicted that it will happen again and again. This may be newsworthy now in Boston, but in Nebraska we learned about business cycles in econ 101. Of course, now I am revealing my age by admitting that I went to school before all those wise men in Washington decided that it would be a good idea to eliminate the business cycle. It is true that I may have gone to college in the dark ages, but it turns out Minsky was right after all and the down part of the economic cycle is still with us. Capitalism is as Minsky said, inherently unstable.

But I have bone to pick with Stephen Mihn, the correspondent. The problem is he sees Minsky's instability as a structural flaw in our economic system that dooms capitalism to failure other why the title "Why Capitalism Fails". If I were writing a story about Minsky's theory my slant would be a little different, and the title of the essay would be "Why I Capitalism Works". For it is my contention that the business cycle and the hard lessons that trail in the wake of the economy that has gone off a cliff are what make capitalism work. A crash provides a nice ego haircut for those egos most in need of a trim, and also provides a reliable antidote to the terminal arrogance that is a part of the human condition at the top of the market. Witness the recent behavior of Corporate CEOs and masters of the universe on Wall Street. Nothing raises the risk of bad behavior in the market like a long period of good news.

This is part of the human condition and no amount of wringing of the hands or governmental regulation will change this. Benevolent government intervention and the invention of tricks such as a "Goldilocks Economy" or "soft landings" may prolong the good times, but sadly the prolonged stability feeds egos and inflates arrogance, and so makes the eventual crash more intense.

The reason that socialism did not work is that, in its attempts to smooth out the bumps, and remove pain it works to institutionalize stupidity. Forty plus years of exposure to the capital markets has convinced me that life's most important financial lessons are generally accompanied with pain. This pain seems to be the only remedy for the hubris that infects the majority of all human participants toward the end of a long bull market.

It is the things that we learn in the economic correction that propel the change that that makes our economy grow, not any ivy league preference for intervention of enlightened politicians (even if that term were not an oxymoron).

Current Events

James Grant of "Grants Interest Rate Observer" who has earned top tier credentials as a perma bear has recently turned (gasp) bullish. The reason being that for the entire period of the twentieth century corrections and the rallies that followed the corrections were without exception symmetrical. Sharp corrections have been followed by strong rallies. While this may seem a tenuous basis making investment decisions it is possible that there is a rational explanation for this pattern. The sharpness of the correction indicates the amount of pain. Since pain leads to wisdom it follows the sharper the correction the more we learn from it. While it is much too early to see what the lessons will come from our current learning experience, it is likely that the knowledge gained will be considerable.

So when Buffett says that America's best days are ahead of us I think it likely he is correct. It was certainly true after disaster struck in the 1930s and the 1970s. The market correction of the seventies laid the foundation of globalism, and changed the face of capitalism for the next thirty years.

There is of course no guarantee the current correction is over it is likely that we will have at least one more short term correction before our current long term bear is over. The bear market of the seventies lasted for seventeen years and in the thirties the economy did not fully recover until the nineteen forties. The current correction has been in progress for ten years now, and so we are probably closer to the end of the correction than the beginning. Indeed it may be fair to speculate that somewhere not too far down the road lies the reward for the pain that we are currently experiencing in the form of strong economic growth of a nature of that which we experienced in the Nineteen Forties and Fifties and the Nineteen Eighties an Nineties.