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“What’s past is prologue” Reminder

Updated: Sep 11, 2019




Fisher, Irving. THE DEBT-DEFLATION THEORY OF GREAT DEPRESSIONS (Illustrated) . Unknown. Kindle Edition.


· Thus over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money. That is, over-indebtedness may lend importance to over-investment or to over-speculation. The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt. (TRG: Metastasize to Private Equity 2019?)

· The over-indebtedness hitherto presupposed must have had its starters. It may be started by many causes, of which the most common appears to be new opportunities to invest at a big prospective profit, as compared with ordinary profits and interest, such as through new inventions, new industries, development of new resources, opening of new lands or new markets. Easy money is the great cause of over-borrowing. When an investor thinks he can make over 100 per cent per annum by borrowing at 6 per cent, he will be tempted to borrow, and to invest or speculate with borrowed money. This was a prime cause leading to the over-indebtedness of 1929. Inventions and technological improvements created wonderful investment opportunities, and so caused big debts. (TRG: DotCom2? Uber, GrubHub, DoorDash, Snap, etc.)

· When the starter consists of new opportunities to make unusually profitable investments, the bubble of debt tends to be blown bigger and faster than when the starter is great misfortune causing merely non-productive debts. The only notable exception is a great war and even then chiefly because it leads after it is over to productive debts for reconstruction purposes.

· The public psychology of going into debt for gain passes through several more or less distinct phases: (a) the lure of big prospective dividends or gains in income in the remote future; (b) the hope of selling at a profit, and realizing a capital gain in the immediate future; (c)the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible. When it is too late the dupes discover scandals like the Hatry, Krueger, and Insull scandals. At least one book has been written to prove that crises are due to frauds of clever promoters. But probably these frauds could never have become so great without the original starters of real opportunities to invest lucratively. There is probably always a very real basis for the "new era" psychology before it runs away with its victims. This was certainly the case before 1929.

o Pantheon Investments insertion: Private greed replaced by institutional “private equity greed” where private equity is made whole in months and investors hope. Private Equity taps the debt markets to increase debt to pay it’s investment back, leaving debt holders on the line for “hopeful” future profits.

· In summary, we find that: (1) economic changes include steady trends and unsteady occasional disturbances which act as starters for cyclical oscillations of innumerable kinds; (2) among the many occasional disturbances, are new opportunities to invest, especially because of new inventions; (3) these, with other causes, sometimes conspire to lead to a great volume of over-indebtedness; (4) this, in turn, leads to attempts to liquidate; (5) these, in turn, lead (unless counteracted by reflation) to falling prices or a swelling dollar; (6) the dollar may swell faster than the number of dollars owed shrinks; (7) in that case, liquidation does not really liquidate but actually aggravates the debts, and the depression grows worse instead of better, as indicated by all nine factors; (8) the ways out are either via laissez faire (bankruptcy) or scientific medication (reflation), and reflation might just as well have been applied in the first place.

Minsky, Hyman. The Stability, Instability Hypothesis

· Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified.

o Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows: the greater the weight of equity financing in the liability structure, the greater the likelihood that the unit is a hedge financing unit.

o Speculative finance units are units that can meet their payment commitments on "income account" on their liabilities, even as they cannot repay the principle out of income cash flows. Such units need to "roll over" their liabilities: (e.g. issue new debt to meet commitments on maturing debt). Governments with floating debts, corporations with floating issues of commercial paper, and banks are typically hedge units.

o For Ponzi units, the cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts.

It can be shown that if hedge financing dominates, then the economy may well be an equilibrium seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system. The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. 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.

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.

I wrote of the documentary “SuperSizeMe” at McDonalds. The protagonist ate at McDonalds every meal for 30 days and when asked if he would like his order “supersized,” he responded yes every time. Within three weeks he gained weight and his doctor told him his liver was worse than an alcoholic. Whose organs are susceptible today? 1) Private Equity: The public psychology of going into debt for gain passes through several more or less distinct phases: (a) the lure of big prospective dividends or gains in income currently in the remote future; (b) the hope of selling at a profit, and realizing a capital gain in the immediate future; (c)the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible Fisher, Irving. THE DEBT-DEFLATION THEORY OF GREAT DEPRESSIONS 2) Unicorn IPOs: (a) the lure of big prospective dividends (Private Equity) or gains in income in the remote future; (b) the hope of selling at a profit, and realizing a capital gain in the immediate future; (c)the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible Fisher, Irving. THE DEBT-DEFLATION THEORY OF GREAT DEPRESSIONS.

At the same time, a prominent hedge fund manager asked me, “What’s the difference of being two years early and wrong? Nothing!” Timing is important, especially with institutional accounts.

Please peruse these debt calculations: https://www.iif.com/Portals/0/Files/content/GDM_Aug2019_vf.pdf They propose caution like visiting the doctor and weighing 300 pounds. All may be good, but further tests are warranted.



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