A black swan event is not necessarily required to cause a crash. Based on pure credit dynamics only, an inevitable plateauing of prices must occur as debt thresholds are reached, and no further sustained acceleration is possible, sans raiding super accounts etc., which really is the last throw of the dice.

So, the Minsky moment/panic/herd running for the door emerges as the consensus is established that prices are on a definite downward trend.

Of course, anything external can amplify this, or be a trigger in and of itself, with the obvious things being Terms of Trade, a collapse as China’s credit bubble implodes on the back of a land Ponzi (about now) and so on.

This was our summary in the theory section, based on the research we canvassed for the plateau and contraction phase. (It looks like it is all coming into play now.)

Key Events and Factors in the Contraction Phase of the Asset Cycle

Credit Stabilisation

Deceleration and then eventual stabilisation in private investment and consumption detracts from aggregate demand and causes economic contraction in a credit-based economy; an effect worsened by excess productive capacity and a surplus labour pool.

Asset Price Plateau and Excess Inventory/Overproduction

Asset prices plateau and then steadily fall, with debt to equity ratios rising. Asset markets experiencing significant overproduction during the credit cycle experience an excess of sellers over buyers, swelling inventory and falling turnover.

Weakening Profits/Incomes and Pessimism

Ponzi finance units experience deterioration in income flows associated with their investment and a negative consensus forms as prices soften.

Falling Asset Prices and the ‘Minsky Moment’

Continual falls in asset prices cause investors to reassess the market critically. Sale of the most marginal investments sets the tone for the entire asset market. This may lead to a ‘Minsky moment’, wherein investors simultaneously attempt to exit the market in a moment of panic. Few suitable counter-parties are found to meet high asking prices and a negative consensus emerges regarding the asset class.

Asset Bull-Traps

Temporary recoveries in asset prices may emerge during short-lived bursts of accelerating debt, but prices will persistently deflate if credit growth continually grows at a slower pace than nominal GDP, stabilises, or a trend of negative credit growth is established (a persistently large and negative credit impulse/accelerator).

Keynesian Savings Paradox

The negative wealth effect is established by falls in net business and household wealth, reinforcing the prevailing pessimism and loss of private sector confidence. A Keynesian savings paradox may emerge, characterised by limited discretionary spending/investment and the hoarding of cash deposits, exacerbating falling monetary velocity.

Credit Growth Contraction and Deleveraging Trend

A persistent deceleration in credit growth and a private sector preference for repaying debt establishes a deleveraging trend and overall private investment falls. Balance sheet repair is extended in duration due to onerous debt burdens.

Falling Monetary Velocity and Deflationary Pressures

Debt deflation (falling asset prices) is compounded by persistent deleveraging, the associated fall in monetary velocity and the destruction of credit as loans are increasingly repaid or defaulted on.

A low interest environment exacerbates deflationary pressures because household and business incomes will not artificially rise to ease debt burdens.

Debt Liquidation/Distress Selling and Rising Unemployment

Debt is liquidated by distressed sellers and aggravated by: a worsening labour market, a falling number of Ponzi investors transacting in the market, private sector over-indebtedness (debt saturation), financier inability to lend/source additional funds and rising interest rates reflecting increased credit risk.

Weak Business Conditions and Rising Bankruptcies

The fall in aggregate demand associated with declining private sector borrowing leads to a reduction in business profits, growing inventory and rising unemployment. Falling prices for goods and services results in decreasing profits and a lower net worth of businesses, meaning those who operate on small margins soon capitulate.

Small to medium enterprises fare worse than large businesses that generally have greater buffers to withstand the downturn. The financial sector experiences a steep rise in impaired assets and personal/business insolvencies and bankruptcies.

Cost Cutting and Price Deflation

Weakening business income streams prompt margin cutting and asset sales to reduce debt, and many enter default arrangements during a significant downturn. Other negative effects include a reduction in wages or hours for workers, firing of workers, and lower margins in an attempt to remain solvent. The household sector has little flexibility to cut margins or sell assets to reduce debt, accelerating personal defaults during a downturn.

Financier Pessimism and Subdued Economic Activity

Reductions in trade, output and employment reinforce the process of debt liquidation in the business and household sectors. Financial sector pessimism is reinforced by capital write-downs in asset values and surging bad debts. Credit rationing on fear of future losses inhibits economic recovery.

Failure of Ponzi Financiers and Insurers

Thinly capitalised financial institutions and insurers with significant exposures to Ponzi assets often fail without government intervention due to ballooning bad debts and inadequate capital reserves

Government Spending and Automatic Stabilisers

Government debt may rise significantly during periods of private sector deleveraging to compensate for reduced demand. The public sector deleverages once the investor and financier classes have sufficiently purged toxic private debt burdens.

Deleveraging End and Transition to Hedge Finance

After a sufficient period of debt deleveraging (debts no longer drag on economic growth) and asset prices approach fair valuation based on fundamentals (P/E, P/R and P/I ratios), the economy again enters the calm investment phase. Politicians and regulators enable a repeat of the boom-bust asset cycle by letting prudential standards ease over time, paving the way for speculation to be repeated on an often larger scale. Financiers forget the excesses of the past and begin their credit cycle again.

–   Paul D Egan & Philip Soos in “Bubble Economics: Australian Land Speculation 1830 – 2013”


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