People are fundamentally the same throughout space, time, skin colour and background. A glance at the pages of history provides the chance for the quirks of our behaviour to reveal their consequences. Since Tulip Mania in 1637, we have recorded the boundless optimism of human spirit as it tangles with greed in predictable booms and busts; but for some reason we refuse to learn from the mistakes of the past and build a financial system that allows for our human imperfections.
As the calendar ticked over to the dreaded month of October it seemed fitting to reflect on our collective folly and fortune in finance. Taking account of the news reports, tweets and sentiment it had that eerie sense of deja vu. We’ve been here before. Populist governments imposing irrational tariffs, exponential growth in technology with sky high valuations for businesses that generate no profits, government induced asset speculation and mania, as well as the conditions ripe for a collapse of confidence.
As Reinhart and Rogoff have demonstrated, this time certainly is not different. But, we need to make it so.
This time, we need to ask who is responsible for our actions?
This time, we need to ask who is holding our politicians to account?
As we look headed for a crash we need to address our animal spirits, our moral sentiments, our heuristics and emotions and greed. This time our economic policy must address the things that make us fundamentally human. Or else, what good is it?
In this article we’ll explore facets of today’s political and economic environment that have reared their heads in the past. Government policy and its effect on driving asset speculation, impoverishment, inequality, financial stability, Tesla and technology speculation, and we will conclude with similarities of 2018 populism and that of 1893.
The Game of Government
It’s scary how much influence the government has on our daily lives and how little we seem to understand it. Most of our ancestors fought for the right to vote but many of us today, fail to turn up to a voting booth come election day. The game of government has long been regarded for the already rich and powerful who then rig policy in their favour. In 1790 Alexander Hamilton set a precedent that would control government behaviour for the next 200 years or more. In order to limit the damage to the overall economy and the everyday person, Hamilton chose to bail out the banks.
Looking at the world today it seems that Australian politicians in particular have been busy rigging the game in their favour. The revolving door of prime ministers masks the policy to provide rebates to the rich who speculate in property, and storm clouds gather over the markets, a carefully constructed Royal Commission into banking has put any blame of a possible market crash squarely at the feet of financial institutions.
Australian policy is such that if you purchase an investment property that is making a loss then the government will provide you with a rebate to make you whole. Interest expenses, maintenance expenses and all the rest, well don’t worry about it! The government has you.
Combine these immense perks with record low interest rates and you have an explosion of property speculation. It’s no wonder that we’ve been seeing Sydney and Melbourne on the news for obscene property prices when this is their government’s policy.
Here’s the kicker.
As the market started to reach its peak and Minsky’s theories were being tested, the government decided to simultaneously create a scapegoat and also kick it’s voters in the guts. It launched a Royal Commission into banking. All the indiscretions of one of the largest and most regulated sectors of the country was revealed. and it’s been ugly.
Under pressure and in response, the banks have naturally tightened credit criteria. The credit squeeze has begun and like America in 2007 those loans that were interest only, or on promotional rates are converting to full principal and interest loans. The banks won’t and can’t refinance customers that are struggling to meet the new repayments due to the commission imposed lending criteria and not only is the market crumbling but so are the lives of everyday people.
The Australian governments meddling in the economy and financial markets created the fuel for the fire, and then the politicians struck the match to watch their own country go up in flames. It’s classic political self interest being served at the cost of the constituents, the people.
Populism and Trump
Interestingly political apathy is rampant in Australia and populism is only a small, but growing voice. The meteoric rise of populist super powers like President Trump are yet to land on Australian shores. This doesn’t mean populism has left America absent of troubling government meddling though.
President Trump, a famed and self proclaimed deal maker is failing to make deals of real consequence and benefit. The rise of Trump and populism is like that of the People’s Party in the 1880s and 90s. The People’s Party known as ‘The Populists’, rose on the back of angry farmers and intense criticism of banks, railroads and capitalism of the time. Protectionist sentiment grew and in 1890 the McKinley Tariff was introduced. Much like the tariffs President Trump is imposing on imported goods today, the goal of protecting domestic manufacturers came at the cost of more expensive day-to-day goods for households.
The economy began to slow as the reduction in consumer purchasing power began to bite. The Sherman Silver Purchase Act was then introduced at the pressure of the populists and miners, and in 1893 it all collapsed. A recession ensued, President Cleveland had financier J.P. Morgan bail out the government and both the tariffs and silver acts were repealed. Populism’s day in the sun, came at immense cost to the rest of society.
Tesla and Tech Speculation
Like Trump, many people think that Elon Musk is unique and that speculation in unprofitable tech stocks is justified. I respect that without this investment technology wouldn’t develop at anywhere near the pace that it has. but it’s tough to say that this time is different. Especially when the dot com bust was relatively recent.
Continuing our journey into the history books I’d like to bring a different comparison to light. The speculation in technology today is surprisingly similar to the pattern of behaviour exhibited in the speculation of railroads in the late 19th century and early 20th. Think about Snapchat, Uber, Tesla, and the thousands of tech start ups and unicorns that promise the world but don’t make a profit. Let me make this clear, think of all of those business that focus on tomorrow but are losing money.
The abundance and speculation of these tech stocks is not that different to the abundance and speculation of railroads. Every investor needed to have growth railroad stocks in their portfolio. (Railroad speculation was so typical of the wealthy that even the writers of Downton Abbey leveraged it) The railroads were promising, some had big personalities leading the business but as with most budding technologies, many of them went bust. Numerous panics were induced by the collapse and warring of railroad empires.
This doesn’t mean that the technology isn’t a good investment or that all the businesses will go bust, but it means that investors must be wary. The dot com boom, the automobile, the rail road and the rest are cautionary tales.
As with the speculation in Australia and the affordability of housing, it is with speculation in technology stocks that we must ask the question of who is responsible for our decisions?
Will you shoulder the blame and burden of a bad investment. Will you wear the cost of a bad investment or will you expect Alexander Hamilton to bail you out at the cost of your neighbour?
All of this behaviour ties in to behavioural economics and also to Minsky’s theory of financial stability. In behavioural economics it’s the examination of a persons true behaviour and economic judgement that is used and not that of a mysterious perfectly rational person. It is how we as people react to our surroundings, to other people and to opportunities created by ourselves or from poor government policy.
Minsky doesn’t directly link behavioural economics with financial stability but he makes us aware of our own flaws. The theory follows that the economy moves through asset price cycles, where the prices of assets rise and fall on a cyclical basis. In the first stage of the cycle, just after a crisis, both the banks and borrowers are cautious. The wounds are still fresh in their minds. Loans are only made in modest amounts and the borrower can afford both principal and interest, the access to credit (credit criteria) is quite restrictive or tight. This stage is known as the Hedge.
As prices rise, confidence rises and the loans get a little more risky. Maybe the borrower can only afford the interest, and this is known as the Speculative. Then it culminates in the Ponzi where the borrower and lender are expecting that rises in the assets value will cover the parties for the amount being borrowed.
The Minsky moment then occurs when borrowers and lenders realise that they can’t meet the loan obligation and begin to sell assets. Asset prices fall as more and more realisations occur and stock floods the markets.
The BBC referred to this moment as being like when a cartoon character runs off a cliff. For a period, the character keeps running in mid air, still believing the ground is beneath them. Then. A pause. A realisation. and a plunge to the depths of the canyon.
These Minsky moments are happening across the world today. Two of the key markets that we explored were the speculative housing market in Australia and technology stocks in the U.S. The financial stability hypothesis is really just common sense, an objective view of human nature, it’s impact and the impact of government policy.
The role of government is not to meddle in these matters but to create a framework that considers the nature of humans and minimises the impact that speculation can have on the rest of the economy. Is it fair that taxpayers have to pay for another persons investment property? Is it fair that you have to pay for your neighbours play on the stock market? Is it fair that we all have to pay for the self interest of politicians as they pay for lavish lifestyles?
It’s October. Be prepared for financial instability. As Minsky says, stability is destabilising.
Confidence is a fickle thing and our financial system is dependant on it, but when this market crashes I hope you can take solace in the Oracle of Omaha’s words.
Be fearful when others are greedy and greedy when others are fearful
Please note this are is not financial advice, or views of any organisation, it is only the opinion of the writer. If you have any questions, or would like to see analysis on any particular topic please contact me.
Thank you for reading.