Are China and US Reaching Their Minsky Moment?

An investor views stock prices on monitors at a securities company in Changchun of Jilin Province, China, on May 28, 2007. China Photos/Getty Images

Commentary

As China’s economy continues to implode, there are important lessons to be learned. One, in particular, is the negative impact and calamitous long-term effect of an artificial economy based on low-cost money policies and deferred risk. Another is that no nation is immune from either one.

The Minsky Moment

A brilliant concept by economist Hyman Minsky explains how extended periods of low-risk capital reduce the perception of risk, which can eventually lead to a crisis as investors take on too much risk. Minsky theorized that an overextended bullish economic growth cycle could spur excessive speculation, eventually resulting in market instability or even economic collapse. Furthermore, the longer the period of bullish speculation lasts, the more severe the crisis will likely be.

The Great Recession of 2008–09 is a great example of such an outcome. Essentially, a Minsky moment is a tipping point when high-risk, economically unsupported behavior becomes unsustainable, which can result in the rapid decline of price and unstoppable market deterioration.

Rising Risk Factor Applies Everywhere

Minsky’s theory has usually been applied to the stock market. It focuses on bullish periods that are no longer supported by fundamental or economic factors but rather by illusory ones, such as external capital, unreasonably optimistic market sentiment (also known as “irrational exuberance”), or buying momentum, which triggers new entries into the market driven by the fear of missing out. Meanwhile, the risk and severity of a market collapse continue to rise.

However, the Minsky analysis is also widely applicable in other economic spheres.

Is This China’s Minsky Moment?

In China’s case, it can be reasonably argued that after decades of the People’s Bank of China (PBC) repeatedly funding massive and unnecessary growth via real estate development, Minsky’s risk theory has finally come into effect.

For years, the risk to investment capital in China was minimized by circular debt, whereby loans on projects were often never paid off but simply refinanced in ever larger amounts by the PBC. This overreliance on property development for so-called economic growth funded by seemingly unlimited amounts of public and private investment capital is a classic example of artificially lowering capital risk and, therefore, raising risk tolerances—and risky behavior—for investors.

At some point, the risks are too great because the debt in the system is no longer sustainable by investment returns or the bank. The riskless capital runs out, and the investments aren’t yielding enough to service the debt.

What’s more, foreign investment from the West, such as that from the European Union, China’s largest trading partner, is declining and likely won’t return to prior levels.

The bankruptcies now happening among China’s largest development firms, comprising about 30 percent of the gross domestic product (GDP), may mean that China’s Minsky moment is finally here.

One potential mitigating factor is the possibility of China extracting more wealth and high-yielding investments from the debt-captive nations of its Belt and Road Initiative. The fact that China is adding trading partners and gaining wealth and GDP from them may somewhat offset the collapse of its domestic economy.

Is the US Nearing Its Minsky Moment?

But what about the United States? Are we finally reaching our Minsky moment?

Perhaps so.

Keep in mind that deficit spending in the United States has been the norm for decades. Part of that is a result of the dollar being the world’s reserve currency. Given that 60 percent of all international transactions are done in dollars, the global need for dollars far exceeds the amount needed for just the United States. But, as history has shown, the spending level rises as the income level rises (even if the “income” is trillions of foreign dollars flooding into the U.S. bond market decade after decade).

As other nations’ economies have grown, their need for dollars has also increased, driving more printing and borrowing. In that scenario, deficit spending is almost impossible to avoid, much less resist.

But there comes a point when that mechanism no longer works.

For example, the national debt is more than $30 trillion and growing. Furthermore, oil is no longer exclusively sold in dollars, meaning less demand for U.S. dollars worldwide. Adding salt to the wound, the U.S. bond market is weaker than ever. That means that foreign countries that used to buy U.S. bonds as a sure and safe investment and a secure way to park billions of dollars in cash are less interested in buying U.S. bonds.

The reason for that is simple. Fewer nations believe in the American promise to repay all the money it owes in those bonds.

Why should they, especially in light of the high interest rates that make debt service much more expensive than it was just a couple of years ago? Additional headwinds include the fact that dollar-denominated transactions are decreasing around the world, the petrodollar is dead, and more nations are aligning themselves economically with China.

In short, the United States may be running short of “riskless” capital in the form of the global bond market and the petrodollar it has relied upon for decades to fund its overly optimistic financial, military, economic, and foreign policy commitments worldwide.

As China seems to be experiencing right now, Minsky’s calamitous outcome for the U.S. economy may be closer than we care to admit.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.