Current capitalism lives of asset bubbles


Are financial crises inherent to capitalism?

Yes, I am convinced that financial crises are inherent to capitalism. Capitalism is, as American economist Hyman Minsky would point out, a system that needs to finance capital goods over time. It’s exactly the financing of capital goods through credit over time that explains both the dynamism of capitalism – because it is at the core of the credit creation that fuels the system – but at the same time it is at the core of its fragility. Financing capital goods requires certain agents to take decisions in the present about an anticipated future and, in case this anticipated future sharply deviates from expectations, these agents committed to service those cash flows are brought into severe difficulties, hence the potential for financial crisis. Here we can draw again on Minsky’s financial instability hypothesis. He points to cyclical developments: as the system appears more stable, more and more capitalist agents move from stable sources of funding to the refinancing of their projects on financial markets, which makes the system more fragile. In case the refinancing of these projects is not available, a series of defaults occurs, amplifying the initial problems. In its most serious form, those cascades of default can lead to a balance sheet recession, a long and painstaking process in which balance sheets of lenders slowly return to a viable state.

The development of capitalism since the mid-1980s has been accompanied with more and more crises….

Capitalism basically lives of asset bubbles, what has been called financialization. In a sense, that works for a short period of time: these bubbles provide additional spending power to the people who hold these assets, and they can spend it. Capitalism then continues its process of accumulation for a while, when future expectations, which were feeding the boom, appear to be too optimistic, crisis ensues. This is aggravated by the current move towards market-based financing and the speculation it lives on. Keynes pointed out that financial professionals, by observing each other, might well know that some debt levels are unsustainable, but they remain active in the credit markets, hoping to be able to escape at the last moment before the house of cards falls, thus reaping a maximum profit. This is exactly what we witness: an ever growing accumulation of debt, as the IMF just pointed out and financial market frenzy. When the bubbles burst, it puts those agents (banks and lenders) that produce credit in society in a very precarious position. As witnessed in Japan, resolving the problems of these banks is very difficult politically, with the risk of never fully confronting the problem (just as the European Union now), since it can lead to decades of negative accumulation dynamics (balance sheet recession).

Which measures have been taken to avoid the birth of new crises?

We can say that the international regulatory community has agreed on the goal of increasing the resilience of the system, but it has also decided not to directly intervene in the cyclical evolution of credit booms and busts. Resilience is a term that stems from research on complex ecosystems. On the one hand, it refers to the capacity of a system to come back to life after a severe event or to react to a severe event without completely collapsing. On the other hand, it has been described as a stance by regulators that is taken when a direct and conclusive intervention can’t really solve the problem.

Increasing capital requirements falls in that category of regulatory intervention because more capital has been imposed to deal with unexpected events. Regulators have sought to reduce the complexity of the system by reducing interconnectedness of the different agents and they have sought to apply special requirements to those agents that they perceive to be too big to fail (systemically important financial institutions). But we can also observe that no radical measure has been taken, we have not observed the separation of commercial banking and investment banking, which happened in the 1930 in the US, and we have not observed the break-up of “too big to fail” banks.

More importantly, regulators have not actively pursued measures to limit the growth of credit in boom times. One idea that gained a lot of popularity after the last crisis was that we should limit the cycle of booms and busts of the system. However, today there are only few regulatory measures installed to seek to limit the financial cycle in the boom phase, e.g. in the time of housing price appreciation. Several measures that were initially contemplated in order to achieve such a taming of the financial cycle have not been realized - partially because of the political economy and the resistance of the banks because evidently, constraining the boom means for banks to constrain their business.

Secondly, there is a reliance of economies on the growth of the assets in financial markets to revive growth. This could all be expected from a political economy perspective, but what is really interesting is that inside the regulatory community there has been quite a lot of technocratic debates on that question, a closed expert discussion where skeptics have been saying “We do not have the metrics. We do not have the capacity yet to map the financial cycle. And as we do not map the financial cycle, how do we want to intervene?” So, as regulation has become more scientific, it has become a stumbling block for introducing new and good regulation: “we do not know what will be the impact, and therefore we do not… do anything.”

I think that if the development of these required measurements is impeded by a lack of experimentation, the problem we face is that of circularity. If actors (regulators and agents) do not know what the impact of such measures would be on the cycle and they do not act, they thus do not generate the data to know what the effects will be. Currently lots of data have been collected and are basically waiting for the next crisis in order to generate the data that will be needed then to make some kind of statement about the financial cycle. They are treating it as an external object, ignoring the fact that it is man-made regulation that very much influences it.

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