Harrison: This Bull Market Is Built On A Very Shaky Foundation

Your Real Vision Daily Briefing for August 31, 2020

How is it that the real economy can be so weak while the asset markets continue to fly? Ed and Ash discuss.

  • Hyman Minsky’s “two-price model” is a useful framework for understanding the dichotomy between Wall Street and Main Street.
  • Asset markets have responded differently to interest rate cuts than the markets for goods and services.
  • We are moving into a period of greater financial instability and the Fed’s inability to target inflation or unemployment may result in a “Minsky moment.”

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For insight into how to frame the real economy slowdown amid a gangbusters revival in the financial economy, Real Vision’s Ed Harrison recommended Hyman Minsky’s “two-price model” during today’s Daily Briefing.

The Minsky model essentially says there are two price systems in the world: one based on goods and services (price plus markup), and another based on prospective income streams (asset prices). Harrison pointed out that these are two totally different systems and they don’t have an interest rate that puts them in alignment at any one time.

What’s good for one system may not be good for the other, Harrison said. And we are currently seeing this play out with zero interest rates, which are great for asset price inflation but don’t allow for consumer price inflation.

With the Fed being the only game in town, we’re looking for them to keep economy going with inflation targeting and employment targeting. Harrison said the Fed tends to fall back on the interest rate lever, but now that it is zero, they’ve gone to the asset purchase lever, and asset prices are responding differently to the Fed’s mechanism than the real economy.

In the Minsky model there are three financial positions: hedge financing, in which income flows are expected to meet financial obligations; speculative financing, in which the firm must roll over debt because income flows are expected to only cover interest costs; and Ponzi financing, in which income flows won’t even cover interest cost.

The theory posits that as the business cycle lengthens, economies tend to move from a financial structure dominated by hedge financing to a structure with increasing speculative and Ponzi financing. Periods of stability naturally lead to optimism, to booms, and to increasing fragility.

Harrison said that when you lower interest rates in an unstable financial system where you’re much more fragile, any financial calamity will blow up the system. This is called a Minsky moment: a sudden, major collapse of asset values which marks the end of the growth phase of a cycle.

Harrison also said he believes that the Fed’s inflation targeting won’t change anything in a major way and it will take a very long time to trickle down into real economy. As a result, we are moving away from hedge financing and more and more toward Ponzi financing and greater instability.

“This bull market is built on the back of a shaky foundation and we have no idea what may cause it to continue or to unravel,” he said.

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