The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.We certainly wouldn't call this a period of "prolonged prosperity" or "good times," but Bernanke's policy of 0% interest and massive money-printing has had much the same effect on asset markets, dampening volatility and encouraging leveraged speculation in asset markets. Which works... until it doesn't.
In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.
Mr. Market, meet Mr. Minsky
Ben Bernanke would have done well to study Hyman Minsky's financial instability hypothesis before he set about trying to centrally plan the markets.
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