The mere mention of a "Minsky moment" -- a sudden crash of markets and economies that are hooked on debt -- is enough to send shudders through policy makers. The theory stems from the work of Hyman Minsky, a U.S. economist who specialized in how excessive borrowing fuels financial instability. Record debt levels around the world, coupled with sky-high financial market valuations, have kept Minsky’s theory prominent, drawing warnings from the International Monetary Fund and others. Before taking over the U.S. Federal Reserve, Janet Yellen described his work as "required reading."
1. What makes a Minsky moment?
The term refers to the end stage of a prolonged period of economic prosperity that has encouraged investors to take on excessive risk, to the point where lending exceeds what borrowers can pay off. At that point, Minsky wrote, there’s an increase in "speculative and Ponzi finance." When a destabilizing event as simple as an increase in interest rates occurs, investors are forced to sell assets to raise money to repay loans. That in turn sends markets into a spiral amid a demand for cash. There have been attempts to distinguish between a Minsky moment and a Minsky process that leads up to it.
2. Have there been Minsky moments before?
Yes. In 1998, following the bursting of asset bubbles in Asia, Russia defaulted on its domestic debt and devalued the ruble. (It was during that crisis that Paul McCulley, then an economist at Pacific Investment Management Co., coined "Minsky moment.") The global financial crisis of 2007-2008 is considered another Minsky moment, since it was caused by the implosion of the U.S. subprime mortgage market.
3. How does the idea apply today?
Record borrowing around the world has some warning of another Minsky moment. The IMF, in October 2016, reported that the debt of governments, households and nonfinancial firms "is currently at an all-time high," at 225 percent of global gross domestic product. A year later, the IMF warned about "a continued search for yield where there is too much money chasing too few yielding assets, pushing investors beyond their traditional habitats." If a Minsky moment is on the cards, it could be triggered when central banks rein in ultra-easy money supply and raise interest rates. The risk of a Minsky moment these days is often linked to China, the world’s second-largest economy.
4. What explains the focus on China?
Zhou Xiaochuan, the governor of the People’s Bank of China, cited Minsky by name in warning against excessive optimism that could spur a sudden collapse in asset prices. "When there are too many pro-cyclical factors in an economy, cyclical fluctuations will be amplified," Zhou said on Oct. 19, in response to a question at an event on the sidelines of the 19th Communist Party Congress in Beijing. "If we’re 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."
5. How widespread are Minsky fears about China?
For a while now, some economists and analysts have warned that China is due for a Minsky-level reckoning. The argument is that China’s government has overseen an unsustainable pace of credit creation that is bound to end in tears. State-owned banks are said to be covering up bad loans and propping up zombie companies that are dragging on the wider economy. But others argue that China’s government assets outstrip its liabilities, and as long as the economy continues to grow, doomsayers will be proven wrong.
6. Who was Minsky?
Minsky studied at the University of Chicago and at Harvard University, where he was a teaching assistant to Alvin Hansen, who coined the term secular stagnation. From 1957 to 1965, Minsky was an associate professor of economics at the University of California, Berkeley, where he developed his major theories. He died in 1996, before his ideas gained wide prominence.
The Reference Shelf
- Minsky’s biography at the Levy Economics Institute of Bard College.
- The guardians of the world economy aren’t worried about soaring asset prices.
- The IMF’s October 2016 report on global debt.
- A QuickTake explainer on secular stagnation.
- QuickTake Q&As on financial risks in China, and why China is scrutinizing its biggest dealmakers.
- Mohamed A. El-Erian says China won’t have a typical Minsky moment.