The Return of The Bear

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Fig­ure 1: Asset Prices ver­sus Con­sumer Prices since 1890















Far be it from me to under­es­ti­mate the stock mar­ket’s capac­i­ty to pluck the embers of delu­sion from the fire of real­i­ty. How­ev­er, the crash in the past few days may be evi­dence that san­i­ty is final­ly mak­ing a come­back. What many hoped was a new Bull Mar­ket was instead a clas­sic Bear Mar­ket ral­ly, fuelled by the mar­ket’s capac­i­ty for self-delu­sion, accel­er­at­ing pri­vate debt, and—thanks to QE2—an ample sup­ply of gov­ern­ment-cre­at­ed liq­uid­i­ty.

(Click here for this post in PDF or Word; some of the data is linked in this Excel file.)

That Ral­ly end­ed bru­tal­ly in the last week. The S&P500 has fall­en almost 250 points in a just two weeks, and is just a cou­ple of per cent from a ful­ly-fledged Bear Mar­ket.

Fig­ure 2: “Buy & Hold” any­one?

The belief that the finan­cial cri­sis was behind us, that growth had resumed, and that a new bull mar­ket was war­rant­ed, have final­ly wilt­ed in the face of the real­i­ty that growth is tepid at best, and like­ly to give way to the dread­ed “Dou­ble Dip”. The “Great Recession”—which Ken­neth Rogoff cor­rect­ly not­ed should real­ly be called the Sec­ond Great Con­trac­tion—is there­fore still with us, and will not end until pri­vate debt lev­els are dra­mat­i­cal­ly low­er than today’s 260 per cent of GDP (see Fig­ure 4).

Fig­ure 3: Growth peters out

With real­i­ty back in vogue, it’s time to revis­it some of the key insights of the one great eco­nom­ic real­ist of the last 50 years, Hyman Min­sky. A good place to start is Fig­ure 1 above, which shows the rela­tion­ship between asset prices and con­sumer prices in Amer­i­ca over the last 120 years.

One essen­tial aspect of Min­sky’s Finan­cial Insta­bil­i­ty Hypoth­e­sis was the argu­ment that there are two price lev­els in cap­i­tal­ism: con­sumer prices, which are large­ly set by a markup on the costs of pro­duc­tion, and asset prices, which are deter­mined by expec­ta­tions and lever­age. Over the very long term, these two price lev­els have to con­verge, because ulti­mate­ly the debt that finances asset pur­chas­es must be ser­viced by the sale of goods and services—you can’t for­ev­er delay the Day of Reck­on­ing by bor­row­ing more mon­ey. But in the short term, a wedge can be dri­ven between them by ris­ing lever­age.

Unfor­tu­nate­ly, in mod­ern cap­i­tal­ism, the short term can last a very long time. In Amer­i­ca’s case, this short term last­ed 50 years, as debt rose from 43 per cent of GDP in 1945 to over 300 per cent in ear­ly 2009. The finance sec­tor always has a pro­cliv­i­ty to fund Ponzi Schemes, but since World War II this has been aid­ed and abet­ted by a gov­ern­ment and cen­tral bank nexus that sees ris­ing asset prices as a good thing.

The most egre­gious cheer­leader for asset price infla­tion was Alan Greenspan. That’s why I’ve marked Greenspan on Fig­ure 1 and Fig­ure 4: if his res­cue of Wall Street after the 1987 Stock Mar­ket Crash had­n’t occurred, it is quite pos­si­ble that the unwind­ing of this spec­u­la­tive debt bub­ble could have begun twen­ty years ear­li­er.

Fig­ure 4: US Pri­vate Debt to GDP since 1920

A mini-Depres­sion would have result­ed, as delever­ag­ing drove aggre­gate demand below aggre­gate sup­ply, but it would have been a much milder event than both the Great Depres­sion and what we are expe­ri­enc­ing now. The debt to GDP ratio in 1987 was slight­ly low­er than at the start of the Great Depres­sion (159 ver­sus 172 per cent), infla­tion was high­er (4.5 per cent ver­sus half a per cent), and the “auto­mat­ic sta­bi­liz­ers” of gov­ern­ment spend­ing and tax­a­tion would have atten­u­at­ed the sever­i­ty of the drop in aggre­gate demand.

Instead, Greenspan’s rescue—and the “Greenspan Put” that result­ed from numer­ous oth­er rescues—encouraged the great­est debt bub­ble in his­to­ry to form. This in turn drove the great­est diver­gence between asset and con­sumer prices that we’ve ever seen.

The cri­sis began in late 2007 because ris­ing asset prices require not mere­ly ris­ing debt, but accel­er­at­ing debt. The great accel­er­a­tion in debt that the Fed­er­al Reserve encour­aged and the US finan­cial sys­tem eager­ly financed, end­ed in 2008 (see Fig­ure 5). From 1950 till 2008, the Cred­it Accelerator—the ratio of the accel­er­a­tion in pri­vate debt to GDP—averaged 1.1 per cent. In the depths of the down­turn, it hit minus 26 per cent. With the motive force of accel­er­at­ing debt removed, asset prices began their long over­due crash back to earth.

Fig­ure 5: Accel­er­a­tion of Debt and the Bear Mar­ket Ral­ly


How­ev­er the share mar­ket rebound­ed again because, part­ly under the influ­ence of gov­ern­ment and Cen­tral Bank pol­i­cy, pri­vate debt accel­er­at­ed once more even though, in the aggre­gate, pri­vate debt was still falling. The annu­al Cred­it Accel­er­a­tor turned around from minus 26 per cent in 2010 to plus 3 per cent in ear­ly 2011.

Fig­ure 6: Pri­vate debt accel­er­at­ed even though the lev­el was still falling


This in turn fed into the stock mar­ket, caus­ing one of the biggest year-on-year ral­lies ever seen (see Fig­ure 7). But it could not be sus­tained because, if debt con­tin­ued to accel­er­ate, then ulti­mate­ly the lev­el of debt rel­a­tive to income would again start to rise. With all sec­tors of the US econ­o­my maxed out on cred­it (apart from the Gov­ern­ment itself), this was­n’t going to hap­pen. The impe­tus from the Cred­it Accel­er­a­tor thus ran out, and the Stock Mar­ket began its plunge back toward real­i­ty.

Fig­ure 7: Accel­er­at­ing debt dri­ves ris­ing share prices–and decel­er­at­ing debt caus­es crash­es


The stock mar­ket could eas­i­ly bounce again from its cur­rent lev­els if, once again, the rate of decline of debt slows down. But in an envi­ron­ment where delever­ag­ing dom­i­nates, decel­er­a­tion will be the dom­i­nant trend in debt, and the unwind­ing of asset prices back towards con­sumer prices will con­tin­ue.

How far could it go? Take anoth­er look at Fig­ure 1. The CPI-deflat­ed share mar­ket index aver­aged 113 from 1890 till 1950, with no trend at all: by 1950 it was back to the lev­el of 1890. But from 1950 on, it rose till a peak of 438 in 1966—which is the year that Hyman Min­sky iden­ti­fied as the point at which the US passed from a finan­cial­ly robust to a finan­cial­ly frag­ile sys­tem. Writ­ing in 1982, he observed that:

A close exam­i­na­tion of expe­ri­ence since World War II shows that the era quite nat­u­ral­ly falls into two parts. The first part, which ran for almost twen­ty years (1948–1966), was an era of large­ly tran­quil progress. This was fol­lowed by an era of increas­ing tur­bu­lence, which has con­tin­ued until today. (Hyman P. Min­sky, 1982, p. 6). (Note #)

From then, it slid back towards the long term norm, under the influ­ence of the eco­nom­ic chaos of the late 60s to ear­ly 80s, only to take off in 1984 when debt began to accel­er­ate marked­ly once more (See the inflex­ion point in 1984 in Fig­ure 4). From its post-1966 low of 157 in mid-1982, the CPI-deflat­ed S&P500 index rose to 471 in 1994 as the 1990s reces­sion end­ed, and then took off towards the stratos­phere dur­ing the Telecom­mu­ni­ca­tions and Dot­Com bub­bles of the 1990s. Its peak of 1256 in mid-2000 was more than ten times the pre-1950 aver­age.

Even after the falls of the past week, it is still at 709, while pri­vate debt, even after falling by 40% of GDP since 2009, is still 90 per cent of GDP above the lev­el that pre­cip­i­tat­ed the Great Depression—leaving plen­ty of ener­gy in the debt-delever­ag­ing process to take asset prices fur­ther down.

There CPI-deflat­ed share index does­n’t have to return to the lev­el of 1890–1950—especially since com­pa­nies like Berk­shire-Hath­away that don’t pay div­i­dends give a legit­i­mate rea­son for share prices to rise rel­a­tive to con­sumer prices over time (Note ##). But a fall of at least anoth­er 50 per cent is need­ed sim­ply to bring the ratio back to its 1960s lev­el.

Wel­come to the Bear Mar­ket and the Sec­ond Great Con­trac­tion.


Min­sky, Hyman P. 1982. “Can ‘It’ Hap­pen Again? A Reprise.” Chal­lenge, 25 (3), 5–13.


# Min­sky elab­o­rat­ed that “Instead of an infla­tion­ary explo­sion at the war’s end, there was a grad­ual and often ten­ta­tive expan­sion of debt-financed spend­ing by house­holds and busi­ness firms. The new­found liq­uid­i­ty was grad­u­al­ly absorbed, and the reg­u­la­tions and stan­dards that deter­mined per­mis­si­ble con­tracts were grad­u­al­ly relaxed. Only as the suc­cess­ful per­for­mance of the econ­o­my atten­u­at­ed the fear of anoth­er great depres­sion did house­holds, busi­ness­es, and finan­cial insti­tu­tions increase the ratios of debts to income and of debts to liq­uid assets so that these ratios rose to lev­els that had ruled pri­or to the Great Depres­sion. As the finan­cial sys­tem became more heav­i­ly weight­ed with lay­ered pri­vate debts, the sus­cep­ti­bil­i­ty of the finan­cial struc­ture to dis­tur­bances increased. With these   dis­tur­bances, the econ­o­my moved to the tur­bu­lent regime that still rules.” (pp. 7- 8; empha­sis added)

## How­ev­er these firms are in the minor­i­ty; they atten­u­ate the degree of diver­gence between share and con­sumer prices, but they are a sideshow com­pared to the explo­sion in the ratio since 1982.

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.