By FERNANDO NOGUEIRA DA COSTA*
The financial stances of economic agents, the instability process and the role of monetary policy and fiscal policy
The monetary economy of production is unstable due to capitalist finance. If, for some time, a mix of speculative and covered financing with internal and external investment financing prevails, there will be incentives to change this mix that will emerge within the economic-financial evolution itself.
Any temporary lull soon becomes a boom by increasing both speculative financing of positions and external financing of investments. Further on, a tree of investments.
It sucks liquidity from the units and increases the debt ratios of financial institutions. So, the safety margins are eroded, despite the success of the boom, and lead us to believe that the previous (or even current) margins are above what is necessary.
O tree passes to crash always when short- and long-term interest rates increase enough for reversals in present value relationships to occur. This typically occurs after a surge in demand, financed by speculative finance, has raised interest rates, worker wages and raw material prices. In this way, profit margins, and therefore the ability to validate the past, are eroded.
If the interruption or rupture of the tree Whether or not it will lead to a financial crisis, debt deflation and deep depression or not-so-traumatic recession will depend on the overall liquidity of the economy, the relative size of the public sector and the magnitude of actions taken by the Central Bank in terms of last resort lending. Thus, the outcome of a contraction is basically determined by structural and political characteristics.
Trends toward speculative financing in investment debt are the result of institutional structures and political expectations. Faced with the difficulties, the thought arises: “perhaps with other institutions and other policies, the economy's susceptibility to financial crises would be lower instead of what is happening now”.
Empirical evidence indicates, with the deregulation of financial institutions, there was a progression in the severity of financial crises. To be effective, policies must counter this neoliberal trend.
In the study whose link is available for download found at the end of this review article, after presenting the key concept of portfolio decision, in the work of Hyman Minsky, I analyzed the financial stances of economic agents, the process of instability and the role of monetary policy and fiscal policy .
Hyman Minsky
The portfolio decision refers to which assets to choose and hold (capital market economics) and how to finance the retention or ownership of the assets (debt economics). It involves making cash inflows (revenue and/or credit) compatible with resource outflows to fulfill contractual commitments.
Maintaining a defensive financial posture depends on the normality of the market for goods and production factors. The speculative stance is conditioned by the normality of the financial market. When taking a Ponzi stance dependent on refinancing, you need support from the financial market. In abnormal conditions of financial instability, economic agents are led, involuntarily, to adopt speculative positions or even Ponzi.
The lending decision refers to the borrower's risk regarding expected profitability and the lender's risk regarding insufficient collateral margin in case the borrower fails to pay. It involves reconciling different points of view regarding investment financing, according to the creditor's and debtor's degrees of risk aversion, each taking into account their external funds/internal funds ratio.
The degree of financial fragility refers to the level of prudence in debt, given by the ability to pay debt services with revenues obtained in the product market, that is, goods and services. Otherwise, refinancing is used, obtained in the credit market. Ultimately, resources resulting from asset settlement with asset sales in the capital market are appealed.
The recipe for monetary policy, given by Minsky, is the adoption of an accommodating attitude regarding the endogeneity of the monetary supply simultaneously with rigid institutional control and/or permanent administrative supervision over the banks' actions.
In practice, there are two complications capable of suggesting inconsistencies in the analysis.
The first is the issue of financing in the capital market through debentures or capitalization, the latter through subsequent launches of shares. In Minsky's view, it is a classic form of financing “hedge” or protected. Financial commitments depend on adequate operating profits to pay dividends.
A second complication is the existence of multiplied deposits as counterpart to loans to continue financing the investment. These deposits must appear in the banking network. They appear as deposits of companies' high profits and workers' salaries.
Debt-financed investing can therefore provide its own “hedge”. But not necessarily for companies in debt and in need of financial protection.
While speculators borrow money to buy some property, those protected, instead of keeping demand deposits, invest to earn interest, for example, in time deposits. These are liabilities capable of allowing banks to back their loans.
The banking system multiplies currency based on loans. But the easy granting of credit ends when property investors become immobilized and in need of more working capital to pay their employees or their creditors.
If more and more debtors fall behind in their payments and nothing is done for the government to intervene in the systemic problem, both banks and debtors could fail – and the economy will contract. These cycles of expansion and contraction occur, repeatedly, until a Great Debt Crisis emerges, analyzed by Ray Dalio.
Ray Dalio
In general, resolution is achieved with a slow and gradual process of financial deleveraging. It can last for years!
Lending naturally creates self-reinforcing upward movements in asset prices. Loans are based on the expectation of following an uptrend indefinitely.
But those suspicious of this possibility are growing until a general reversal of expectations prevails. It occurs when income or capital gains fall below the cost of borrowing.
The cycle ends up reversing into downward movements with feedback. We went from the euphoria of easy gains to the panic of all debtors selling quickly, at the same time, to meet contractual commitments. The herd bursts – and there is only one gate for the salvation of whoever leaves first!
In summary, according to Ray Dalio, an upward trend in productivity allows for an increase in wealth and leads to higher standards of living. Favorable cycles are then detected in times of prosperity, when the country is strong, debt is low, people work together effectively, gaps in wealth or political values are small, education and infrastructure are good , leadership is strong and capable, and the world order is peaceful and guided by one or more dominant powers. These are periods of well-being and happiness.
But when imbalances accumulate, sooner or later these excesses lead to periods of depression, destruction and restructuring. The country's fundamental weaknesses are such that high levels of debt and widening gaps between assets and political values can be observed.
The increasingly pronounced differences between people lead them to work less and less together and cohesively. There are changes for the worse in education and infrastructure and increasing complexity associated with the challenge of maintaining a very large Empire. It is also threatened by a growing number of emerging rival powers.
All of this induces a painful process of struggle, destruction and restructuring. It establishes a new order by inaugurating a new period of advancement.
*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Brazil of banks (EDUSP). https://amzn.to/3r9xVNh
Reduced version of the digital book available at Fernando Nogueira da Costa. Compared financiers Hyman Minsky and Ray Dalio.
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