A volte face — from scenes of apparent stability, marked by high growth of the gross domestic product and a booming financial sector, to a state of flux in the economy —can completely change the expectations of those who operate in the market, facing situations with an uncertain future. Possible transformations as those mentioned above were identified by Charles P. Kindleberger in 1978 as a passage from manias that generate positive expectations to panic that head to a crisis. While manias help continue a boom in the asset market, it is sustained by using finance to hedge and even speculate in the asset market, as Hyman Minsky pointed out in 1986. However, bubbles generated in the process in asset markets eventually turn out to be unstable, especially when the financial deals rely on short-run speculations rather than on the prospects of long-term investments in real terms. With asset price bubbles continuing for some time under the influence of what was described in 2000 as irrational exuberance by Robert Shiller, and also with access to liquidity in liberalized credit markets, unrealistic expectations of the future under uncertainty sow the seeds of an unstable order. This leads to Ponzi deals, as noted by Minsky, with the rising liabilities on outstanding debt no longer met, even with new borrowings since borrowers are nearing insolvency. Situations such as these trigger panic among private agents in the market who fear possible crisis situations. They are led by herd instincts or animal spirits in the market, as noted by John Maynard Keynes in 1936. In absence of actions to counter the market forces, a possible crisis finally pulls down what in hindsight looks like a house of cards. Indeed, when markets have the freedom to choose the path of reckless short-run financial investments with high risks and high returns, the individual’s profit calculus eventually proves wrong as a collective. This leads to a path of downturn, not just for the financial market but for the economy as a whole. This is how manias lead to panics and then to a crisis in the economy.
Posted on: Mon, 09 Sep 2013 05:42:37 +0000
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