The Inevitable Minsky Moment

Economist, traveler and general nice guy John Mauldin recently talked about Hyman Minsky, whose theory of economic instability I'd known of, but hadn't thought about in a while. Minky's Financial Instability Hypothesis is one of those ideas which seem to sum up things simply, elegantly and accurately, with an enticing hint of paradox. Minsky's hypothesis basically goes like this:

Stability leads to instability. The more stable an economic trend is, the more people will come to depend on it. The more they depend on it, the more they invest in it. The more they invest in it, the more imbalanced things become. The longer this goes on, the bigger the inevitable crash when it happens. The moment of collapse has been coined as "The Minsky Moment."

Here's an illustration. Imagine you are on a cruise ship with thousands of passengers on board. At one stage of the trip, passengers begin to notice the view from the port side is particularly pleasing. More and more passengers line up on the rail on the port side to enjoy the view. Due to their weight, the ship begins to lean slightly to port, enhancing the view, making it easier to stay on the port side, and less likely to move to the starboard side, since the view there is now obscured. Passengers begin to call their friends and family on board to join them. Even so, the ship, being well-constructed, holds its current pitch. Waiters and stewards now keep mostly to port, bringing food, drinks and deck chairs. The band moves to port side, and its music attracts even more people. As the trend continues, the remaining laggards, not wanting to miss out, join the party. Someone warns that the situation cannot continue. But everyone ignores him, as they are now fully invested in the belief that things will continue the way they are. Just then the ship capsizes. The trend is over. The Minsky Moment has occurred.  

In the analogy, the ship's view is the current promising economic trend. The problem is the more attractive the trend the more people tend to get over-invested in it, and the more inevitable the collapse becomes. This explains business cycles, bubbles, and even the ongoing up and down nature of stocks charts on every time frame. The excesses of the boom are the seeds of the bust. It's built into the nature of things. 

The end of the trend is inevitable. The question is not if, but when. The key then is knowing when to get on board and when to jump ship.