Friday, November 19, 2010

Société Générale’s Dylan Grice on Bursting Bubbles

Alphaville never sleeps:
[you have to work on the time zone thing, 16:34 is not naptime -ed]
What better way to end the week than with a history lesson from Société Générale’s Dylan Grice:
Financial historians have shown that every single financial crisis since the 1870s has been preceded by rampant credit growth.
While you mull that over, like any historian worth their salt he’s asking some hard questions — specifically about a certain “emerging market narrative” du jour. Cut to China c.2010 (click to enlarge):

Now, I think we can see where this argument is going…but in his own words...MORE

Young Dylan speaks truth. According to the Kindleberger/Minsky model:
We start with the model of the late Hyman Minsky, a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster....

According to Minsky, events leading up to a crisis start with a "displacement," some exogenous, outside shock to the macroeconomic system. The nature of this displacement varies from one speculative boom to another. It may be the outbreak or end of a war, a bumper harvest or crop failure, the widespread adoption of an invention with pervasive effects---canals, railroads, the automobile---some political event or surprising financial success, or debt conversion that precipitously lowers interest rates. An unanticipated change of monetary policy might constitute such a displacement and some economists who think markets have it right and governments wrong blame "policy-switching" for some financial instability. But whatever the source of the displacement, if it is sufficiently large and pervasive, it will alter the economic outlook by changing profit opportunities in at least one important sector of the economy. Displacement brings opportunities for profit in some new or existing lines and closes out others. As a result, business firms and individuals with savings or credit seek to take advantage of the former and retreat from the latter. If the new opportunities dominate those that lose, investment and production pick up. A boom is under way.

In Minsky’s model, the boom is fed by an expansion of bank credit that enlarges the total money supply. Banks typically can expand money, whether by the issue of bank’s notes under earlier institutional arrangements or by lending in the form of addictions to bank deposits. Bank credit is, or at least has been, notoriously unstable, and the Minsky model rests squarely on that fact. This feature of the Minsky model is incorporated in what follows, but we go further.

Before banks had evolved, and afterward, additional means of payment to fuel a speculative mania were available in the virtually infinitely expansible nature of personal credit. For a given banking system at a given time, monetary means of payment may be expanded not only within the existing system of banks but also by the formation of new banks, the development of new credit instruments, and the expansion of personal credit outside of banks. Crucial questions of policy turn on how to control all these avenues of monetary expansion. But even if the instability of old and potential new banks were corrected, instability of personal credit would remain to provide means of payment to finance the boom, given a sufficiently throughgoing stimulus....
Manias, Panics and Crashes
Ch.2 Anatomy of a Typical Crisis
Charles P. Kindleberger