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.

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.
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