The new economy

2 May 2009

Minsky’s moment has arrived

There is a big political prize dangling over the economic crisis. Whoever now devises a coherent economic programme will mould British society for a generation. Labour won the post-Great Depression prize in 1945 by creating the paternalistic welfare state and won again in 1966 — a short-lived victory — with Harold Wilson’s modernising ‘white heat of technology’. In 1979, Margaret Thatcher won the prize that arose from the failures of the preceding paternalism and technocratic modernism with her vision of free-market individualism. From then until Northern Rock was nationalised, all economic policy was recognisably some shade of Thatcherism.

Keynes dominated the thinking of 1945 and 1966; Hayek deﬁned the 1979 revolution. Who will deﬁne the next one? David Cameron needs an economics that is neither Hayek nor Keynes — and so do we all. There was a real failure of late Keynesianism after 1966 and we are now suffering the real failure of the Hayekian reaction.

Enter Hyman Minsky. A child of Depression-era Chicago, he sought a framework in which such a slump could never happen again, but unlike the economic mainstream, he recognised that ﬁnancial innovation always threatened a return to 1929. Though he died in 1996, his now-rediscovered ‘financial instability hypothesis’ describes the inescapable path of private ﬁnance towards ever-riskier practices. A better Cassandra than most, he offers a persuasive alternative.

The golden age of postwar stability was all about prudent lending. Banks lent to projects whose cash ﬂow would pay interest and repay principal. But prudence contains the seeds of its own destruction. A banker uses his good standing to ﬁnance long-dated, risky projects with rolled-over, short-term debts. The secret of all banking fortunes is to borrow short and cheap, lend long and dear. Prudent lending thus gives way to speculative lending. Boardrooms reward those who ﬁnd new and more lucrative ways to borrow short and lend long. We enter ‘money-manager capitalism’.

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