Why Minsky Matters (part 4)

October 31, 2021

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Minsky’s interpretation of the history of capitalism rested heavily on his understanding of capitalist finance. He associated each stage of capitalism with a distinctive financial structure.

From commercial to finance capitalism

This distinction corresponds to the distinction between commercial and investment banking described previously. During the nineteenth century, commercial banking was the dominant source of financing. Banks made mainly short-term loans to businesses so that they could hire labor and purchase raw materials for production. Banks relied on interest-earning deposits for their cash flow.

The growth of big business in the late nineteenth century required financing for more expensive, long-term investments. Investment banks developed for that purpose, and by the early twentieth century they came to dominate the financial system. That, in turn, helped the big companies grow even bigger and dominate their industries, as Wray explains:

The investment banks played an important role in helping the “trusts” to consolidate power and oligopolize markets. Indeed, to obtain long-term external finance through the investment banks, the borrower really needed market power—for otherwise the lending was too risky. Borrowing firms needed to demonstrate that they had sufficient price-setting power to ensure that they could survive the long-term debt issued to finance positions in complex and long-lived plant and equipment.

Finance capitalism was still riskier than commercial capitalism for a couple of reasons. The financiers themselves were at risk because they had to bet on the long-term success of the businesses they financed. And the investment banks—not yet constrained by modern financial regulations—could offer their own shares in dubious financial enterprises to the public. Many of these were essentially Ponzi schemes, named for the famous swindler of the 1920s.

Unregulated finance capitalism proved to be unsustainable. “This phase of capitalism collapsed into the Great Depression—which Minsky saw as the failure of finance capitalism.”

Managerial welfare-state capitalism

The New Deal ushered in a new phase of capitalism, characterized by a larger role for the federal government. Regulations like the Glass-Steagall Banking Act and the Securities Exchange Act reined in some of the riskiest financial behavior.

The government’s fiscal policies also had important financial implications, which Minsky saw as largely positive. Government spent much more, first on economic relief projects and then on World War II, which had the effect of stimulating production and employment by increasing aggregate demand. To the extent that it financed this spending by selling government bonds, it provided lenders a secure, high-quality form of savings. As long as the government ran deficits and accumulated debt, it followed that the private sector could run surpluses and accumulate more financial assets than liabilities. (In the system as a whole, financial assets and liabilities must balance, while real assets like homes and factories can keep growing.) Large companies engaged in less risky borrowing, and financed their operations more from retained earnings.

Compared to the periods before and since, the period from the 1940s to the 1970s stands out as an era of relative financial stability, high economic growth, and broadly shared benefits of prosperity. [The benefits flowed mainly to white, male breadwinners, but by no means just the wealthy ones.]

Money manager capitalism

The last two decades of the twentieth century saw the rise of a new kind of capitalism that Minsky regarded as less stable. Here is where Minsky’s saying that “stability is destabilizing” most applies. While the Depression had discouraged risk-taking and produced a longing for stability, the postwar prosperity had the opposite effect. As incomes rose and a sense of economic security spread, people regained some of their tolerance for risk. Households that could now afford to save more were less content to keep their savings in federally insured but low-interest bank deposits, or in safe but boring government bonds.

Enter the money managers. Money manager capitalism was driven by “huge pools of funds under management by professionals—pension funds, sovereign wealth funds, hedge funds, university endowments, corporate treasuries, and so on.” Foreign money also contributed to a “global glut of managed funds,” as foreigners took the dollars they earned by selling goods to American consumers and reinvested them.

Leading the way were the “shadow banks,” which provided financial services but did not have federally insured deposits and were not regulated as banks. They were free to attract money by offering higher interest rates, and they were willing to take on the risks necessary to achieve higher returns. More traditional financial institutions, such as savings & loans, also sought and received more regulatory freedom so that they could remain competitive. As a result, they were no longer as safe as they used to be either, as the S & L crisis of the 1980s revealed.

Wray describes the growth of the financial services industry:

From the 1980s, the financial sector grew relative to the non-financial sectors (manufacturing, agriculture, and nonfinancial services, including government)—by the time of the GFC [global financial crisis], the financial sector accounted for 20 percent of U.S. national value added and 40 percent of corporate profits. By itself, it was an autonomous source of growth and also of rising inequality because of high compensation in the sector. Up to half of the college graduates from the elite colleges went into the financial sector because rewards there could be far higher than in other sectors. Compensation at the very top quite simply exploded.

Money manager capitalism increased the incentives for risky behavior. The financial reforms of the New Deal had prohibited bankers from offering very high returns on deposits. That eliminated any need to pursue high-risk, high-return investments, and encouraged only the most prudent of loans. For the new money managers, touting high returns was the way to get more assets under management. Given the normal fluctuations and uncertainties of markets, high returns were an elusive long-term goal, but short-term success could be very profitable. The managers could rake in management fees while making their investments with their clients’ money, so that they did not suffer the long-run losses from any bad bets they did make. On the average, mutual funds with high fees are more likely to underperform than outperform the market, but their clients either failed to grasp those odds or thought that they could beat them. Another implication was that corporate executives who could boost their company’s stock price with short-term profits attracted more capital from the financial managers. Executive compensation soared along with that of the financial managers, and both were increasingly tied to short-term performance.

Financial assets are always somebody else’s obligations. The economy becomes more fragile as the underlying obligations become harder to fulfill. If money flows into “hot” funds investing in “hot” companies whose long-term outlook is poor, then assets are overvalued and some collapse of values is likely.

The growth of the financial sector was largely driving the economy, but it was increasingly disconnected from the creation of real wealth.

The problem was that the sheer volume of financial wealth under management outstripped socially useful investments. To keep returns high, money managers and bankers had to turn to increasingly esoteric financial speculation—in areas that not only did not serve the public purpose but actively subverted it.
An example would be the rise of index speculation in commodities markets that drives up global prices of energy and food, leading to hunger and even starvation around the world.

Money manager capitalism distributed its economic benefits more unequally, compared to the postwar era. The largest benefits went to the financial management firms themselves and the wealthiest households. Income from executive compensation and capital gains far outstripped general economic growth or wage growth. Little increase in spending was possible for the less affluent without taking on more debt, which was readily available at high interest. Wray describes a “self-reinforcing” cycle, in which increasingly powerful financial institutions used their political clout to perpetuate and expand their freedom from regulation. Caps on interest rates charged on consumer loans were one of the restrictions that disappeared.

The “esoteric financial speculation” Wray refers to includes innovative but risky ways that financial managers made money. In the leveraged buyout, they would buy companies using other people’s money, then run them mainly for short-term profit, selling off useful assets and alienating workers with cuts in wages and benefits. If the companies failed, it was mainly someone else’s loss.

Minsky was especially critical of securitization, as exemplified by mortgage-backed securities. It begins as something benign, an attempt to reduce risk by buying a package of mortgage loans instead of owning just one. One mortgage might fail, but a package of loans should mostly be repaid. The trouble is that traditional underwriting may go out the window. Unlike a traditional banker making a loan, a money manager packaging and reselling loans may not know or care as much about the original borrower’s ability to make the payments, especially if the loan itself is a riskier adjustable-rate loan instead of a traditional fixed-rate mortgage. Some financial companies routinely made risky loans intended for resale. Securitization—an ironic name if it results in less secure obligations—resulted in multiple layers of debt, such as mortgage-backed securities further packaged into collateralized loan obligations and insured by credit default swaps. Financial firms that created and sold such securities participated in a network of obligations to one another, each making new speculative bets on the basis of dubious assumptions.

In the late 1990s, as economists and policymakers applauded the elimination of the federal deficit by the Clinton administration, few grasped the implications for the private sector. With the public sector moving into surplus, and the trade deficit worsening (which means a surplus of dollars in the hands of foreign countries), the private sector had to be in deficit, spending more than its income and going more deeply into debt. The wealthy were accumulating more financial assets than liabilities, but more of the private sector was doing the opposite. And while Americans were obsessing over federal debt, private-sector debt was actually less secure. That’s because the federal government has never defaulted on an obligation, and never really has to. (Congress can make it default by refusing the raise the debt ceiling, as Republicans are threatening to do solely to score political points.) Private and increasingly risky debt was what was really putting the economy at risk. The housing boom of 2003-2006 depended heavily on it.

Although he didn’t live to see the system crash in 2007, Minsky saw the weaknesses of money manager capitalism early on. The crash was the worst since 1929, but rapid responses from the federal government mitigated the damages and avoided another Great Depression. Minsky’s policy proposals remain relevant to the challenge of creating a less fragile and more productive form of capitalism for the twenty-first century. That will be the topic for the final post.


Why Minsky Matters (part 3)

October 27, 2021

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As a self-described “financial Keynesian,” Minsky incorporated an analysis of the banking system into his theory of investment cycles. The result was a more creative and dynamic conception of capitalism than more orthodox theories had achieved.

In Minsky’s macroeconomics, spending is what drives income, a reversal of the way most people think about their personal finances. In particular, investment spending is an autonomous decision not determined by a firm’s existing revenue. Instead, investment creates revenue and profits, as well as income for households.

Minsky’s macroeconomics requires us to think differently about banks as well. Here the key capitalist decision is the decision to lend. From an individualistic point of view, a household deposits income into a bank, and then the bank lends money to borrowers from such deposits. The process seems income-driven. But that does not fully capture the banking system’s creative role in the capitalist economy. Minsky looks at the process the other way around, saying that “a bank first lends or invests and then ‘finds’ the cash to cover whatever cash drains arise.”

How banks create money

What does a bank do when it agrees to make a business loan? It issues a promissory note, which is a promise by the firm to repay the loan. It also gives permission for the business to make cash withdrawals by creating a balance in the business’s bank account. Presto! Money is created.

The business’s balance sheet shows the debt as a liability and the cash account as an asset. The bank’s balance sheet shows the loan as an asset and the cash account as a liability. All the money in the economy is somebody’s liability as well as someone else’s asset. Economic institutions create financial assets by simultaneously creating financial obligations. Even the dollar bills in your wallet represent the obligation of the government to accept them as payment for taxes, giving them an established national value.

Of course, the bank has to worry about its cash flow as well as its balance sheet. As Minsky says, it has to find the cash to cover whatever cash drains arise. The bank maintains a positive cash flow by receiving at least as much in deposits as it pays out in withdrawals. It attracts deposits by offering to pay interest on them, which it can do because it charges (even higher) interest to its borrowers. It must always have a reserve on deposit with the central bank to cover likely withdrawals.

If a bank should need additional reserves, it can obtain them by borrowing from another bank on the federal funds market. If banks need more reserves than other banks want to lend, they can get them from the Federal Reserve itself. This is even more obviously a creation of money, since the Fed simply credits a bank’s reserves in an amount corresponding to the obligation the bank is assuming. Presto again!

One implication is that the Federal Reserve does not control the money supply completely and directly. It does influence it through its power over the interest rate that banks charge each other and the rate it charges the banks. The Fed can encourage or discourage the creation of money by making it more or less expensive for banks to borrow. But the decisions of bankers themselves also expand and contract the money supply. Modern monetary theorists say that the money supply is not controlled exogenously by the Federal Reserve, but endogenously from within the capitalist system. It responds to fluctuations in business’s willingness to invest and banks’ willingness to lend. While the exogenous view has been the orthodox neoclassical view, and is still found in many textbooks, Wray says that Minsky’s view is now becoming the dominant one among economists and policymakers.

Types of banks

A commercial bank makes short-term loans to finance a firm’s production and distribution of goods. When the goods are sold, the loan can be repaid. The bank relies on depositors for its cash flow.

An investment bank provides long-term financing of more expensive capital assets. It may act as an intermediary, marketing a company’s stocks or bonds to investors and charging a fee for that service. It may also act as an investor itself, assembling its own portfolio of stocks and bonds. Investment banks are generally riskier operations than commercial banks. While commercial bank depositors can place their savings in federally insured cash accounts, purchasers of stocks and bonds are vulnerable to market fluctuations and loan defaults. And whenever an investment bank is holding securities itself, it can get stuck with devalued assets or try to stick its customers with them.

New Deal banking reforms tried to protect consumers from being taken advantage of by investment banks. The Glass-Steagall Banking Act of 1933 required a clear separation between commercial and investment banking. Minsky did not live to see its repeal in 1999, but he probably would not have approved.

The massive expansion of the financial sector in recent years has created many institutions that provide financing without being regulated as banks. These so-called “shadow banks” include hedge funds, money market funds, mortgage lenders, payday lenders and private equity funds. Many of them played a role in the global financial crisis.

Financial cycles

The ability of the financial system to create money enables it to expand and contract the money supply. These fluctuations then amplify the business cycles created by variations in investment.

Minsky’s theory can be summarized as “an investment theory of the cycle and a financial theory of investment.” The first is the usual Keynesian view, which sees fluctuations of investment spending as driving the business cycle. When firms are optimistic, investment in plant and equipment grows, creating jobs and income. When expectations turn around, spending and employment fall.

 Minsky’s extension was to add the financial theory of investment, stressing that modern investment is expensive and must be financed—and it is the financing that generates structural fragility. During an upswing, profit-seeking firms and banks become more optimistic, taking on riskier financial structures. Firms commit larger portions of expected revenues to debt service. Lenders accept smaller down payments and lower quality collateral.

Minsky classified the financial positions of firms according to risk. A “hedge” position is one in which a firm can make both principle and interest payments on any debts. A “speculative” position is one in which the firm pays only interest, but must periodically rollover the principle to a new loan in order to remain solvent. A “Ponzi” position is one in which a firm cannot even pay the interest due without taking on new loans or other obligations. As firms take on more debt and banks approve more questionable loans, the safer financial positions evolve into riskier ones, and an economic boom ends in financial crisis.

Minsky believed that capitalist institutions were especially vulnerable to instability in the most recent phase of capitalism. He had already reached that conclusion before the global financial crisis. I turn next to Minsky’s interpretation of economic history.


Why Minsky Matters (part 2)

October 25, 2021

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Here I summarize L. Randall Wray’s description of Hyman Minsky’s theory of the investment cycle, which is the part of his economics most based on Keynes. Keynes and Minsky viewed the investment cycle as an endogenous phenomenon generated from within the economy, not an exogenous phenomenon triggered by external events. As Wray puts it, “it is in the nature of capitalism to cycle due to ‘whirlwinds’ of optimism and pessimism.”

Think macro

Making a shift from microeconomic thinking to macroeconomic thinking is essential for understanding Minsky. This is mainly a matter of avoiding the fallacy of composition, which is the logical error of assuming that whatever is true on the individual level is also true at the aggregate level.

When most people think about building wealth at the individual level, they think about the importance of thrift. People who spend their entire income on current consumption cannot build wealth, but people who save and invest can. But in the aggregate, thrift can work against economic growth, a phenomenon Keynes called the “paradox of thrift.” If all the households in the economy were to become more thrifty at once, businesses would respond to the lack of aggregate demand for their products by running at less than full capacity and employing fewer workers. That would reduce national income and the capacity to build national wealth.

Macroeconomic thinking also has implications for what really drives the economy. In the national accounting, the income side of the economy must balance the spending side, if all forms of spending are included. Everybody’s income is tied to somebody’s spending—if not consumer spending then business investment, government spending, or foreign purchases of our exports. But when income and spending both grow or shrink, which is driving which?

At the personal level, income seems to drive spending, since you don’t usually spend what you don’t have. You can buy things on credit, but how much credit a bank will extend to you also depends on your income. But macroeconomists like Keynes and Minsky argue that spending is what drives income. If businesses don’t spend on the means of production like land, labor and factories, they don’t create income for individual households. Notice also that capitalist enterprises do not just invest from their existing profits. They often borrow to build their businesses, even before they have turned a profit. And they are not necessarily just borrowing from someone else’s income either, since borrowing often involves the creation of money. Capitalist firms, in cooperation with the banking system (and, as we’ll see, with government), function as creators of income and wealth, not just spenders of income. This creative function is not automatic—automatic creativity would be a contradiction in terms—but is subject to endogenous fluctuations, the boom and bust cycles that are endemic to capitalism.

Not surprisingly then, a macroeconomic theory of capitalism must focus on the investment decisions of capitalists!

Investment decisions

Wray’s economics text, coauthored with William Mitchell and Martin Watts, defines investment as the “flow of spending which is devoted to increasing or maintaining the stock of productive capital.” Suppose a firm is considering an investment in new equipment. Minsky argued that the decision to invest depends on a comparison of two prices:

  • The demand price is how much the firm would be willing to pay for the equipment, given the firm’s expectations about how much the equipment would add to future revenues;
  • The supply price is the price the firm would have to pay for the equipment, including the cost of financing the purchase if it is to be made with borrowed money.

If the demand price exceeds the supply price, the firm will normally make the investment. However, the calculation of a demand price depends on expectations of future revenue, which the firm cannot know with certainty. Optimism—a positive business outlook—plays an important role. One firm’s optimism helps create income for others because its spending puts money in the hands of other firms and their workers. In the aggregate, investment is one factor in the determination of overall business profit. Minsky incorporated Michal Kalecki’s macroeconomic theory of profit that derived this result mathematically. In the aggregate, it is investment that drives profits, not profits that necessarily fund or limit investment.

Once an economic expansion begins, what Minsky called the “peculiar circularity of a capitalist economy” can accelerate it. Optimism feeds investment; aggregate investment creates income; income enables consumer spending; spending creates profit; and profit helps maintain optimism. Profit does not automatically lead to more investment, but it does invite firms to infer that they are doing something right, and that more of the same kind of investment may lead to more profit.

Macroeconomics also includes the role of government, and the analysis of profits by Kalecki and Minsky takes that into account. In Kalecki’s profit equation, G – T (government spending minus taxes) is a positive determinant of profit along with I (investment). Think about it. If government spends more than it taxes, that creates more income for the private sector, some of which ends up as profits in the hands of capitalists. What winds up as wages for workers gets subtracted from the profit equation. This is, of course, relevant to Kelton’s The Deficit Myth, which pleads for a macroeconomic understanding of deficit spending. It can have more positive effects than a deficit in your household budget!

From boom to bust

What could possibly go wrong with an economic expansion driven by investment spending and fueled by optimism?

As optimism is validated by increasing profits, firms are tempted to engage in riskier behavior. They continue to invest, even if that means going more deeply into debt. They may reduce their margins of safety, such as the collateral they provide to qualify for financing, the positive net worth they can show on their balance sheet, and the liquid assets they can fall back on if revenues fall short of expectations. As the economy booms, some overoptimistic firms run into trouble and default on their obligations.

Once an economic boom has raised expectations sky high, “…anything that lowers expected future profitability can push today’s demand price of capital below the supply price, reducing investment and today’s profits below the level necessary to validate past expectations on which demand prices were based when previous capital projects were begun.” The price that firms are willing to pay for new capital goods declines because firms aren’t so sure they want to take on more debt for the sake of dubious future returns. At the same time, the supply price of capital rises if lenders charge higher interest rates to firms with more existing debt.

What would lower expected future profitability? Maybe markets for many goods have become saturated because consumers have already bought as much as they want or can afford. That suggests a lesson for firms: Creative investment requires imagination, not just producing more and more of the same thing.

Another factor that helps turn boom to bust is a reduction in fiscal stimulus by government. As an economic expansion proceeds, government collects more tax revenue from rising incomes and spends less on things like unemployment compensation and public assistance. It may also adopt a more restrictive monetary policy to prevent inflation, with higher interest rates that raise the cost of borrowing.

As confidence in future profits erodes, businesses shift their priorities from investing at all cost to improving their margins of safety to avoid financial problems. The decline in investment then reduces aggregate income and consumer spending. Not only does optimism turn to pessimism, but pessimism feeds on itself by producing poor aggregate results that validate the pessimism. Acceleration turns into deceleration, until expansion turns into contraction.

The role of the financial system in amplifying such boom and bust cycles will be the topic of the next post.


Why Minsky Matters

October 20, 2021

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L. Randall Wray. Why Minsky Matters: An Introduction to the Work of a Maverick Economist. Princeton: Princeton University Press, 2016.

This book is an introduction to one of the most important critics of mainstream economics in the twentieth century. Although he did not live to see the 2007 global financial crisis, Minsky’s understanding of the economy led him to anticipate how it would unfold. His work is getting a lot of attention now that the crisis has generated some reassessment of economic theory, as crises usually do. Minsky’s ideas are part of the foundation for the emerging Modern Monetary Theory, now well represented not only by the author of this book, but also by Stephanie Kelton, whose The Deficit Myth I reviewed recently.

Hyman Minsky (1919-1996) studied mathematics at the University of Chicago and economics at Harvard. He taught at Berkeley from 1957 to 1965 and at Washington University in St. Louis from 1965 to 1990. After retiring from teaching, he was associated with the Levy Economics Institute at Bard College, a nonprofit research and policy organization specializing in alternatives to mainstream economics. Wray, who was once Minsky’s teaching assistant, calls Minsky “the smartest guy in the room, in every room.”

L. Randall Wray is a Professor of Economics at Bard College and Senior Scholar at the Levy Economics Institute.

The nature of the economy

Minsky’s disagreements with mainstream neoclassical economics were fundamental. He objected to its portrayal of a free-market economy as a self-stabilizing machine seeking equilibrium. Market forces supposedly move the economy toward a state in which supply equals demand, everything that is produced can be sold, and resources are allocated most efficiently. Deviations from equilibrium come from exogenous (externally caused) shocks, such as a global shortage of some commodity or excess spending by government. The economy is something like a climate-control system regulated by a thermostat. During the so-called “Great Moderation,” the 25 years preceding the financial crisis, many economists came to think of the central bank as the thermostat, raising or lowering the interest rate if the economy was either too hot (high inflation) or too cold (high unemployment). Some economists even proposed making such decisions more automatic by devising a rigid rule to govern them.

By the way, I have been noticing how scientists in a variety of disciplines have been challenging mechanistic models lately: biologists who say that an organism is more than a molecular copying machine, or neuroscientists who say that a brain is more than a computing machine. Sociologists have long questioned whether the machine metaphor is very useful for understanding societies and their institutions, which are creators of new culture and organized behavior. Minsky’s work is in the tradition of institutional economists like Thorstein Veblen, who was a sociologist as well as an economist. Minsky praised the University of Chicago for teaching economics as “part of the study of society…vastly superior to the usual practice of teaching economics in isolation in a specialized course.” That was before the ideas of Austrian economists and Milton Friedman came to dominate the Economics Department.

Minsky rejected the assumption that the economy is naturally stabilizing. He argued that market forces generate instability endogenously (internally). In fact, he said that “stability is destabilizing,” since a period of stable growth tends to alter expectations, policies and behaviors in ways that undermine stability itself. For example, confidence in continued profits can breed overconfidence and riskier behavior. Minsky saw this happening in a big way in the 1980s and 90s.

Society needs a variety of institutions to constrain instability and keep the economy working in the service of societal goals. That means especially the whole government, not just the central bank. Minsky said that “the institutions established through public policy play a vital role in determining what form capitalism takes; and…laissez faire is a prescription for economic disaster.”

Although he held an undergraduate degree in mathematics as well as a doctorate in economics, Minsky was skeptical of formal mathematical models that were devoid of historical and institutional context. He said “to be useful, analytical tools have to be embedded in an understanding of the institutions, traditions and legalities of the market.” Wray makes a similar criticism in his own macroeconomics textbook (coauthored with William Mitchell and Martin Watts):

Over the past half century mainstream macroeconomics has become increasingly devoid of relevance to our understanding of how modern monetary economies operate. In part this is due [to] an increased emphasis on mathematical models underpinned by simplistic assumptions that reduce human behaviour to that of a ‘rational agent’ who maximizes simple goals in at worst a ‘risky’ economic environment.

A revolutionary Keynesian

Minsky considered himself a follower of John Maynard Keynes, having been a teaching assistant to Keynesian Alvin Hansen at Harvard. However, he was disappointed in how Hansen, Paul Samuelson and others had integrated Keynesian ideas into the mainstream “neoclassical synthesis.” Minsky regarded Keynes as a revolutionary thinker whose revolution had been aborted. Mainstream economists acknowledged that government fiscal policy could be useful in combating recessions, but they did not take seriously enough his analysis of why recessions kept happening. Rather than moving toward an equilibrium where resources are optimally allocated, an economy could get stuck at a low level of utilization where producers lack the confidence to spend on production, and workers lack the income to spend on consumption. Minsky took chronically high unemployment as a sign that capitalism wasn’t working very well.

After the stagflation of the 1970s, the monetary school led by Milton Friedman discredited Keynesian fiscal policy as it was then practiced and minimized the role of government in the economy. At a time when Keynes was largely out of fashion, Minsky preserved and elaborated on Keynes’s analysis of investment cycles. Calling himself a “financial Keynesian,” he added the idea that the financial system amplifies those cycles, endogenously producing dangerous swings between financial booms and busts.

The following posts will start with Minsky’s theory of investment cycles and financial cycles, and then go on to discuss his take on the history of capitalism and his proposals for making it work better.


Why Isn’t Democracy Working?

October 12, 2021

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I woke up this morning to more headlines announcing disagreement among Democrats regarding President Biden’s $3.5 trillion spending bill. Ah, if only Democrats could get their act together, the country could move forward. But is that the real story?

Once upon a time, the United States had a two-party system with a range of opinion within both parties. The Democrats were more liberal, but contained some moderates and conservatives, at least on some issues. The Republicans were more conservative, but contained some moderates and liberals on some issues. Neither party could stray too far from the center without risking popular support, and both had to reach across the aisle from time to time to get things done. In order to pass liberal bills like the Voting Rights Act, Democrats needed moderate Republicans to offset the opposition of Southern Democrats.

Today, bipartisan cooperation is conspicuously missing. About the only one of President Biden’s proposals that both parties can support is improvements in physical infrastructure. Republicans have an explanation for the larger legislative impasse: that Biden has a radical socialist, fiscally irresponsible agenda that the American people do not want and his own party cannot agree on. I want to play down the last part of that narrative, since it is nothing new. The Democratic Party has been a loose coalition of various interest groups for a long time. “Democrats disagree” is about as newsworthy as “Republicans don’t like taxes.” What is more unusual and troubling is Republican lockstep opposition to just about everything Democrats want to do.

How radical?

Most of the president’s domestic agenda is in the same spirit as the Affordable Care Act, which has become more popular as Americans have come to understand what it really does. Biden’s main objective is to help working families afford services they need in order to be productive. Making child care more affordable so that parents can take jobs without child-care costs devouring their paychecks. Making college more affordable so that students can prepare for today’s jobs without starting their careers deeply in debt. Providing paid family leaves for new parents and other family caregivers. Extending the child tax credit so that people can afford to raise children at all. Letting Medicare negotiate prescription drug prices with pharmaceutical companies so that people can afford their medications. These are the kinds of things that many other countries are already doing, and they poll well with a majority of the American people.

Biden’s plan calls for spending $3.5 trillion over ten years, and he proposes to pay for it by rolling back some of the Trump tax cuts of 2017, mainly the parts affecting corporations and the wealthiest 2% of taxpayers. The top personal income tax bracket would go back up from 37% to 39.6%, where it was before 2017 and where it is scheduled to return in 2025 anyway if Congress takes no action. (And remember that the actual rate that rich taxpayers pay is far lower than that because of tax deductions and loopholes, and because the top rate only applies to income that exceeds a high threshold.) The corporate tax, which was lowered from 35% to 21% in 2017, would go up to 28%.

Some economists argue that certain forms of spending help make people more productive and employable, and therefore can reduce unemployment without increasing inflation, even if the spending is not paid for with tax increases. (See The Deficit Myth.) But even economists who do not make that argument often expect more economic stimulus from spending on useful services than on tax cuts for the wealthy. Either way, the important point is that the Biden plan is neither especially radical nor fiscally irresponsible.

The real problem

Then why is it so hard to get it done? The most obvious answer cites two Democratic senators who just don’t accept the rationale for the proposals But while I don’t share the conservative views of Joe Manchin or Kyrsten Sinema, I don’t really expect unanimous consent from the Democrats in Congress. The real problem is unified opposition from a Republican Party that has been purging moderate voices from its side of the aisle for years. Moderate Republican politicians are now an endangered species, thanks to campaigns by rich donors with anti-government views and vested interests in the status quo, like the Koch brothers (see Kochland), propaganda from right-wing media like Fox News, and most recently the Trump movement. Every elected Republican is now expected to support all tax cuts, oppose initiatives like Obamacare, block action on climate change, and propagate the Big Lie that Trump won the 2020 election.

The Senate filibuster allows a 41-vote minority to stop senators from debating and voting on any bill. Filibustering used to mean extending debate, but now it means avoiding debate altogether in what once was known as the “world’s greatest deliberative body.” The filibuster is not in the Constitution, but is only a Senate rule that a majority can change at any time. When they were in charge, Republicans abolished it for approving Supreme Court nominations, so that Democrats would be unable to block President Trump’s nominees. (That’s how we got the most conservative court in almost a century.) Today, a new voting rights bill—needed because conservative justices threw out the old one—seems unlikely to overcome a Republican filibuster. Another way around the filibuster is the “reconciliation” process, but that applies only to certain budget bills, and it requires the Democrats to be as united in their support as the Republicans are in their opposition. That’s not bipartisanship.

Republican Senators even used the filibuster to block a vote on raising the debt ceiling, which has to be done to finance the deficit increased by the Republicans themselves during the Trump administration. (They relented, temporarily, but are threatening to block it again in December.) Why oppose something that almost everyone agrees has to be done? The aim is to force the Democrats to raise the debt ceiling all by themselves, through reconciliation, so that Republicans can dishonestly attribute the change to Democratic spending plans. (If you ever have the opportunity to go out to dinner with Mitch McConnell, don’t do it. He will probably order an expensive meal, stick you with the bill, and then if you pay it tell everybody what a wasteful spender you are!)

The greatest danger here is that Republicans will make good on their threat to block the debt ceiling increase. That would be an act of financial terrorism, since a democratic government cannot function without the confidence of its citizens. People will not buy and hold government bonds at reasonable rates without the “full faith and credit” of the U.S. Treasury, which has never defaulted on an obligation. Republicans seem more interested in making the Biden administration fail than making government work. Mike Pence has even said that the purpose of the Congressional investigation into the January 6 assault on the Capitol is to distract attention from Biden’s “failed agenda.” He did not mention that Senate Republicans are refusing to allow that agenda even to be debated.

While blocking Senate debate on voting rights, Republicans are working at the state level to keep Republicans overrepresented in state legislatures and Congressional delegations. They are accomplishing this through redistricting, gerrymandering, and restrictive voting laws that disproportionately impact Democratic voters. Worse still, they are trying to make it easier for state legislators and administrators to overturn election results if Democrats win. And of course, they continue to rally around Donald Trump despite strong evidence that he encouraged foreign interference with the 2020 election and tried have its results thrown out. I cannot think of a greater threat to our democracy in my lifetime.

One more form of obstruction deserves dishonorable mention. Opposition to vaccination and masking is strongly associated with Republican Party affiliation, Trump support and watching Fox News. It has prolonged the pandemic, delayed the economic recovery, and cost thousands of lives.

Restoring bipartisanship

Few Americans want a system in which one party has unrivaled power. That is too susceptible to corruption. But those of us who believe in the two-party system have to do more than encourage both parties to reach across the aisle and compromise. We must first demand that each party play by the rules of democracy, like engaging in honest debate, encouraging every citizen to vote, and respecting the outcomes of fair elections. Supporters of a democratic society have an obligation to stand up and vote down a party that is willing to lie and cheat in order to win. We must be willing to send a strong message that an increasingly authoritarian party must either change its ways or suffer massive defeat at the polls. Only then can two or more major parties thrive and hopefully cooperate to move the country forward. I only hope that it is not already too late.