Asset Price Bubbles and Minsky Approach to Asia Crisis

8/3/2019 Asset Price Bubbles and Minsky Approach to Asia Crisis

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Asset Bubbles and Minsky Crises in East Asia:

A Spatialized Minsky Approach

Gary A. Dymski*

Associate Professor of EconomicsUniversity of California, Riverside

Riverside CA 92521-0427 USA

[email protected]

April 1999

ABSTRACT

Some economists have suggested that the economic crises in East Asia were preceded by

asset bubbles because of some nations inadequate bank supervision and myopic (or

even criminal) bank lending behavior. Others have developed an alternative approach

based on Hyman Minskys financial instability hypothesis: in this view, these nations

have experienced boom-bust financial cycles, with asset-price booms generating Minsky

crises and eventually a series of crashes. Minskys policy prescriptions for financial

cycles big banks and big governmentthen present remedies for these nations

ills.

This paper also applies Minskys ideas to the Asian financial crisis, but modifies them to

to incorporate cross-border financial flows. Ironically, this modification is based on

earlier work done by Minsky himself in the mid-1960s. This extension of Minskys

framework shows first that asset bubbles can arise whenever cross-border inflows offinancial claims on capital exceeds the growth rate of real asset production. Since cross-

border imbalances occur frequently, asset bubbles and/or asset-price deflations are ever-

present tendencies. Second, shifting cross-border flows can bring about Minsky crises

even without Minsky cycles. Finally, this paper shows that Minskys big bank and big

government prescription for recovery is more difficult to apply when cross-border

constraints matter. Japans ability to apply these remedies in the current Asian crisis is

complicated in ways that do not arise in the U.S. case highlighted in Minskys work.

*The research reported here was supported by the Pacific Rim Research Program of the

University of California and by the Center for Global Partnership. The author has receivedhelpful comments on earlier versions of this manuscript from Jim Crotty, Tokutaro Shibata,

Fernando Carvalho, Fernando Costa, and Luiz Fernando de Paula, from participants in seminars

at Seoul National University, Fukyong National University, Ehime University, the University of

Tokyo, UNICAMP, and the Federal University of Rio de Janeiro, and from all the participants in

the March 1999 Housing Finance Futures conference held at the University of California,

Riverside. All remaining errors are the authors responsibility.


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The most significant economic event of the era since World War II is something that has not

happened: there has not been a deep and long-lasting depression.

--Hyman Minsky, Can It Happen Again? A Reprise (1982)

All things I pick up

Are moving, awash upon

The beach at low tide

-- Chiyojo (trans. from the Japanese by Buchanan, 1973, page 69)

1. Introduction

In one way, the Asian financial crisis has had a paradoxical effect on the economics

profession. It has been a boon, giving rise to many new questions and some new answers. For a

profession which increasingly uses rhetorical puzzles as launching points for theoreticalinquiry, the Asian crisis has been a godsend: why did Southeast Asian equities markets with

different fundamentals all lose value? Why did the Korean won collapse? Why was Brazil

dragged in?

However, the Asian crisis has jarred economists confidence that they understand the

issues that policy-makers and economic agents now face in the real world. For one thing,

economists efforts to explain this crisis have demonstrated their models ambiguity as much as

their relevance.1 Further, this crisis challenges behavioral assumptions that many economists

regard as self-evident. For example, the interrelated ideas that asset prices respond to

fundamentals and that financial investors are rational have been profoundly damaged. The World

Bank and IMF, two institutions whose economists have largely celebrated the centrality offundamentals in economic outcomes, have put out a series of working papers on (expectationally

arational, fundamentals-defying) contagion effects in Asian currency and asset markets. Finally,

1For example, Krugman (1998) explains the Asian financial crisis as the result of an asset bubble

resulting from perverse credit-market outcomes; when these nations domestic banks underwrote

risky projects, they ignored the possibility of failure, and thus drove asset prices out of sight. The

culprits in these price spirals, and hence in the crisis, are thus banks, bank regulatory systems,

and East Asian governments provisions against bank failure. The asset bubbles burst when low

returns generated bank losses that governments were unable or unwilling to absorb, setting off

contagion effects ranging from depositor flight to currency crisis.Before the current crisis,

however, incentive-based models with asymmetric information have been used to explain why

East Asias banking structures have supported (not undermined) the East Asian miracle. For

example, Stiglitz and Uy wrote, financial sector interventions in East Asia incorporated

design features that improved the chances of success and reduced opportunities for abuse;

interventions that did not work out were dropped unhesitatingly; and policies were adapted to

reflect changing economic conditions (Stiglitz and Uy, 1996: 249).


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the continually evolving character of this crisis has revealed many economic insights to be valid

only for one moment: in effect, they are written on wet sand at low tide.

The persistence of economic effects that werent supposed to happen has generated new

interest in alternative approaches to financial phenomena; and the ideas of Hyman P. Minsky

about financial crises, long overlooked by mainstream financial economists, have in this

reconsideration come to the fore. Akyuz (1998) and Kregel (1998), among others, havedemonstrated the significance of Minskian financial instability in the Asian financial crisis.

This paper too uses Minskys ideas to explain the role of asset bubbles in creating,

transmitting, and resolving financial crises in Japan and Korea. At the same time, this paper

suggests some alterations to Minskys core ideas about the emergence and resolution of asset

bubbles and boom-bust financial cycles. Specifically, exploring the role of financial instability in

the Japanese and Korean crises requires that Minskys core framework be spatializedthat is,

it must take explicit account of spatial economic borders and foreign-exchange constraints.

Minskys core financial boom-bust model is aspatial--it implicitly assumes that the financial

cycle plays itself out in a closed, homogeneous economy.2

Once we have allowed for trade imbalances and factor flows across borders, it is easy to

see that cross-border imbalances in capital movements can be an independent contributing source

of financial fragility, aside from the financial fragility that arises due to the economys cyclical

momentum. Ironically, Minsky himself suggested the building blocks of a spatially-aware

approach in work predating most of his writing on financial instability per se; in effect this paper

unites two strands of thought that Minsky left unconnected. We go on to argue that financial

fragility and instability in an economy depends not just on the business cycle factors emphasized

by Minsky, but also on the real/financial-sector tensions inherent in flows of capital across its

borders. Whether asset bubbles and tendencies toward financial crisis emerge depends in part on

any economys institutional mechanisms for channeling inflows of capital into investment

outlets. The paper concludes by considering whether Minskys policy prescriptions can beapplied in the case of the spatialized financial and economic crisis of East Asia.

2. The Minskian approach to financial fragility and asset bubbles

The twin entry points for any model building on the work of Hyman Minsky are

Keynesian uncertainty and real time. Keynesian uncertainty refers to the key methodological

insight in Keynes General Theory (1936): the future is uncertain because events that unfold in

real time do not obey pre-given probability distributions. For example, there is no way to know

objectively whether asset prices are rising because the fundamentals are improving, or instead

because the fundamentals are being evaluated differently. In a world with uncertainty, people

cannot be fully rational because parametric information is not out there to be had. Real time, inturn, means that agents seeking to accumulate wealth must purchase and hold partially or wholly

illiquid assets for a series of short periods, during which market conditions may change

substantially. Because of these two characteristics of the lived environment, humans will

fluctuate between being willing to make irreversible commitments, and instead seeking liquid

assets that maximize flexibility and minimize exposure to risk. Uncertainty also has implications

2 The ideas developed here are indebted to the insights of Gray and Gray (1994).


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for how agents form expectations and make decisions: for one thing, they cannot formulate

expectations of asset values that are time-invariant; further, they will have some degree of

disbelief in their own estimates, as well as some doubt that these estimates will guide market

price formation.

An immediate implication of this dual entry point is that it becomes impossible to know

when a given market is subject to a bubble. For even the perceived line separating sound fromunsound investments is inconstant and shifting through time; and there is no objective grounds

for deciding. As Grant observes, Every loan, even if fully secured, is a kind of speculation. (5,

1992) When decisions are made under uncertainty, the passage of time always threatens to

undermine well-laid plans. We make our way through this world under a condition of

fundamental uncertainty that denies us knowledge about those things we most need to know.

These dimensions of an uncertain economic environment immediately suggest the

importance of institutional structures. As Crotty (1993) has emphasized, people construct rules of

thumb to guide their behavior; when widely adopted, these conventions can create conditional

stability for periods of time by channeling behaviors in a way that bounds the consequences of

uncertainty. These conventions provide people with assurance that they are minimizing theirexposure to mistakes and permit them to make longer-term commitments (such as purchases of

land and fixed assets). Crotty goes on to observe that while conventions will bound uncertainty,

they do not reduce it to probabilistic risk; indeed, the very conventions that generate conditional

stability for a time eventually have behavioral consequences that undermine that apparent

stability and bring us face to face again with the consequences of uncertainty.3

Minskys financial instability hypothesis. But economic events are not only molded by

behavioral conventions; they unfold within aggregate structural settings that both give shape to

economic dynamics and set limits on feasible outcomes. Many theorists have followed Keynes

and Kalecki in observing that the relation between investment and saving can give rise to

business cycles. Further, Keynes observation that economic agents will discount liquidity inperiods of economic growth and rising asset values, but run to liquidity when these magnitudes

turn down, suggests a financial source of cyclical fluctuation. This was exposited definitively by

Hyman Minsky (1975). He showed that just as expectations vary with the state of the business

cycle, balance-sheet relationships too evolve systematically during the cycle. Initially, balance

sheets are robust because assets are conservatively priced and debt commitments modest; but

during the course of an expansion phase, asset prices rise and debt burdens grow until finally

liability commitments outpace asset returns and a downturn is induced. An economy becomes

more financially fragile as an expansion proceeds, with the consequence that a period of financial

instability is eventually reached: asset values fall, and a debt-deflation cycle may be unleashed.

In Minskys model, the evolution of balance sheets over the cycle would be accompaniedby a cyclical pattern in the relationship between the stock-market and production-cost prices of

capital assets, which he terms PKand PIrespectively. Minsky argues that as a boom period

proceeds, an asset bubble emerges: specifically, the asset bubble arises when the ratio (PK/P

I)

exceeds one for an extended period of time. Figure 1 shows a stylized picture of a Minsky crisis,

3An example of a self-undermining rule of thumb is the notion that real estate in a given market

area is at once the highest-return and safest asset one can hold.


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emphasizing the key role of asset bubbles in cyclical fluctuations. The rapid pace of output

growth eventually exhausts industrial capacity and forces firms to take on debt to expand

production. The combination of euphoric expectations and competitive pressure drives up

debt/income ratios and asset prices simultaneously; leverage is rewarded. When the collapse

comes, it comes fast.

Note that two financial characteristics define the difference between prosperity and crash:the collapse of the (PK/PI) ratio and the collapse of asset prices relative to liabilities. Income

flows too are low relative to debt obligations. DefiningL as liabilities, the crash period can be

characterized as one in which PK< PI= L. In the debt-deflation state, the inability to serviceL

leads to defaults, forcing the sale of assets on markets with few buyers, sinking PKfurther. Note

that a contraction in real prices (a fall in PI) will only worsen the burden of debt. We denote this

crash state herein as aMinsky crisis. Minskys writings on financial dynamics suggest that a

Minsky cycle (as described in Figure 1) precedes a Minsky crisis; implicitly, a Minsky crisis can

be generated in Minskys work by a prior Minsky cycle.

Responding to Minsky crises: the big bank and big government. Minsky crises have

devastating effects on advanced economies with sophisticated and interlinked financial markets.Consequently, recurring outbreaks of these crises lead to several systematic adaptations and

institutional changes. Minsky (1975, 1986) described these adaptations in his 1970s and 1980s

writing on financial instability; Kregel (1998) has suggested the colorful terms big bank and

big government for the two central developments. Big bank means the intervention of a

central bank as a lender of last resort, providing liquidity to support banks ability to provide

credit to businesses that would otherwise default on their loans and cease to function. To

intervene in this way, the central bank must provide as much liquidity as is required to meet

financially fragile cash-flow needs; and of equal importance, market participants must perceive

the big bank as being willing to play this role.

The second adaptation is the rise of big government. Minsky shows howcountercyclical government spending by a public sector that constitutes a significant share of

aggregate demand can check the tendency toward debt-deflation that emerges in the crisis. If

liquidity provision by banks and the central bank in the face of a crisis is to stabilize cash flows,

someone must spend it that is, exchange liquidity for goods; and if business firms have little

capacity to spend, and households are too scared to spend, then government can spend. This

blocks the panic that otherwise emerges, and creates a floor on prices that previously would have

been driven (as in the Great Depression) substantially below their current levels. The importance

of big government in economic dynamics was so fundamental that Minsky divided the

performance of the US economy into two periods: a small government era from the end of the

Civil War to the Depression; and a big government era dating from World War II. It is indeed

true that government spending as a share of GDP rose from about 5% prior to World War II to20% or more thereafter.

Pollin and Dymski (1994) show that, as Minsky suggests, many key aggregate variables

in the US economy demonstrate very different cyclical behavior in the two eras. In particular,

cyclical downturns in the small government era were typically accompanied by falling prices,

debt deflation, and high bankruptcy rates among banks and non-financial firms alike. Because of

the deflationary trend of prices, the real cost of capital rose precipitously in the turndown.


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However, in the big government era, cyclical downturns had different effects. Because of the

intervention of the big bank and big government, price levels did not fall, nor did debt deflation

occur. The average real cost of capital changed little in recessionary periods during the 1947-79

period. Non-financial business failure rates were vastly reduced, and bank failure rates almost nil.

This depiction of the big-government era makes it seem that the problems associated with

macroeconomic and financial instability should recede into insignificance in this era. However,Pollin and Dymski went on to argue that the macroeconomic effects of the big-government/big-

bank era were somewhat ambiguous, and that this eras macroeconomic benefits weakened

substantially after 1980. For one thing, the reduction of business and bank failure rates was a

mixed blessing: failures have the effect of cleansing balance sheets and opening the field for new

capital investments; and weak businesses and banks that dont fail will continue to do business.

For another thing, the price of avoiding the debt-deflations that killed off so many institutions in

the small-government era was a persistent upward bias in the level of prices. This persistent

inflationary pressure had deleterious effects on US competitiveness, and it was among the factors

undercutting political support for the large-scale countercyclical fiscal policies and for welfare

state policies.

Pollin and Dymski also observed that tension began to emerge in the 1980s between the

Federal Reserves lender-of-last-resort role and its monetary-policy role. When pushed, the Fed

function as lender of last resort overrode its macroeconomic-policy commitments. In effect, the

policy steps required to maintain financial stability became increasingly divorced from the policy

steps required to maintain stable macroeconomic growth. This uncoupling was due in large part

to the stresses placed on US banks and savings and loans by credit-market crises which could be

traced to the effects of deregulation and to the globalization of US financial relations. We

concluded that these changes had the cumulative effect of reducing the effectiveness of the tools

available to government to respond effectively to episodes of macroeconomic and financial

instability. The combined big-bank/big-government response to episodes of turbulence was

becoming instead a big-bank-only response which focused on a narrower set of trigger events.Big-government stabilization became less feasible for several reasons: taxpayer revolts, reduced

welfare benefits, and shifts in political ideology.

3. Spatializing Minskys model

These warning signs about the effectiveness of big-bank/big-government policies in the

face of macroeconomic and financial instability will be explored further in the discussion of the

East Asian crisis which follows. We first must suggest some modifications in Minskys boom-

bust model, to permit it to be better able to encompass events observed recently in Korea, Japan,

and other countries affected in the current global financial crisis.

Two modifications are necessary. First, Minskys core model does not include the

possibly significant difficulties associated with current-account/reserve relationships. Minskys

mature model took a closed-economy approach because the U.S. was, for him, the paradigm case

of a large economy with mature financial markets. But in recent experience, financial crises are

especially likely in immature (Malaysia) or semi-mature (Korea); and current-account/reserve

relationships are crucial in these open economies. In turn, the currency-crisis model ignores the

impact of balance sheet and debt-income imbalances on target country asset prices. The second

blind spot is complementary: because of the imbalances that may arise in cross-border financial


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flows, a Minsky crisis may arise even if not preceded by a Minsky cycle. So the two

modifications suggested here both imply that there are more paths to Minsky crisis than Minskys

own characteristic interpretation anticipates; and these depend crucially on the particularities of

historical time and place that underly financial flows.

Here we focus first on some structural factors associated with the emergence of asset

bubbles; then we turn to factors associated with Minsky crises. The key structural feature of assetbubbles is that they are inherently spatial as well as temporal phenomena. Specifically, we want

to understand economies as bordered spaces. The idea is very general: any contiguous enclosed

spatial area can be treated analytically as a bordered economy. The term is intentionally plastic: a

country is a bordered economy, but so is a city within a country; a neighborhood within a city; a

street within a neighborhood; and even a home along a street. Every bordered economy has a

current account balance which may be unstable due to the cross-border migration of factors of

production and wealth. And even when wealth and labor dont flow across one border of an

economy (such as the national boundary), these factors do flow across intra-national boundaries.

It is highly unlikely that the incremental resources required to fuel a given regions economic

growth can all be found within its borders. Interestingly, this idea originated with Minskys own

(1965) analysis of California high growth rate relative to the rest of the U.S.4

The spatial segmentation that characterizes the division of income flows and asset and

liability stocks gives rise to various structural complications for bordered economies, especially

when flows across spatial borders are unbalanced. In neoclassical trade and finance theory, cross-

border relationships are very simple--either a nation has an export surplus, and chooses between

building up foreign exchange reserves or buying foreign assets; or it has an export deficit and

must allow foreigners to acquire its assets. The country in question is viewed as passively

adjusting to these flow equilibria. If movements of assets and goods are not impeded, regions

with high consumption propensities will sell off their assets to support their spending habits; and

vice versa. The countries in this simple story are just placeholders in a global

consumption/saving-portfolio balance problem. The assets are out there and the right prices forthem can be found as long as exchange rates and domestic asset prices are free to adjust.

But there is more to these processes. As Minsky always emphasized, asset accumulation

requires liability growth. Further, assets and liabilities must balance on the flow and stock

balance sheets of nations, as well as those of regions within nations. The nominal value of the

capital assets emitted in a given region or nation may notindeed is unlikely to--correspond

precisely to these assets production cost. This leads to the central point. There is no reason to

expect nominal and real assets to correspond over time: hence asset bubbles and/or asset

collapses are omnipresent in bordered economies. Bubbles thus continually affect economic

outcomes; their impact is a matter of degree and perception, not kind.

This alternative approach to bubbles rests both on the idea of bordered economies and on

the idea that cross-border wealth flows are not real flows, but nominal flows--abstract wealth

claims chasing real assets. Wealth itself is an inherently abstract concept, disembedded from

the particular assets in which it is stored at any point in time. Capital mobility involves

4Minsky pointed out that one of the truisms of economics is that the current account balance

balances (1965). On this approach to regional growth, also see Thirlwall (1980).


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movement in the geographic ownership pattern of wealth claims, not a shift in the spatial locus of

real capital itself. This applies whether the capital movement in question consists of a reserve

shift due to household migration, of foreign direct investment, or of portfolio investment.

Several factors explain why asset bubbles arise in some bordered economies but not

others. The first is the pattern of regional economic growth. We consider two scenarios vis--vis

the growth rates of a bordered economy and of the region surrounding it: the bordered economycan grow faster than the surrounding region; or it can grow at the same pace. The faster-growth

case here encompasses two cases: first, that the surrounding region is growing, but the bordered

economy is growing faster; second, that the surrounding region is declining, in which case the

bordered economy qualifies as a high-growth area even if it is declining less quickly. These two

cases of uneven economic growth can give rise to asset bubbles in the bordered economy.

Table 1 sets out the possible relationships between asset bubbles and high-growth

economies. The factors emphasized in other models--asset bubbles due to asymmetric-

information problems and to unregulated banking marketsare independent of the uneven-

growth case, as shown in cell (1,2). Interest in Table 1 centers on the next three possibilities.

Note first that uneven growth could arise without asset bubbles in the faster-growing area, aslong as its growth rate reflected superior productive capacity. An area with more skilled labor

and more capital can generate more product and income than less well-endowed neighbors, all

else equal; Japan in the 1970s is a case in point. Independent of productive capacity, however, an

asset bubble may form in a bordered region due to its receiving wealth inflows at a higher rate

than the surrounding region (of course, these inflows could originate within this surrounding

region). This upward pressure on asset prices (relative to the real cost of producing assets) is

evident, for example, in the virtually global rural-to-urban migration of the past four decades.

Intra-national or international immigration, like that from foreign countries and other U.S. states

into California can also generate asset-price pressure of this type. We can define a boom economy

as a high-growth economy whose rapid growth is attributable in part or whole to significant,

sustained inflows of labor and wealth.

To understand the applicability of this framework to the current financial crisis, it is

important to see that the capital-inflow scenario can also work in reverse. Suppose, for example,

that all economies in a given region experience capital flight, including the failure of overseas

lenders to renew short-term credits. Suppose further than one bordered area within this region has

less capital flight than the region as a whole. Unless this bordered economy has some other

advantages in productivity or capacity, its asset prices may be viewed as too highbubble prices--

in the perverse sense that they have declined less than have other capital-asset prices in the

region. And even when a bordered economy has avoided declines as large as those afflicting the

remainder of the region, capital flight again can turn its asset prices into bubble prices. So the

asset-bubble process works two ways, on the way up and on the way down.

As Table 2 illustrates, the cross-border wealth flows of interest here are typically both

intra-national and inter-national. The vertical dimension of Table 2 shows that wealth (and/or

population) can move into a boom region from a hinterland or rustbelt region within a

nation. This is equivalent, as Minsky (1965) points out, to a movement of funds across national

borders under a strict gold standard. Every region is, of course, part of a nation that itself has a

capital-account balance. If exports and imports balance, no wealth moves; and if exports are


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greater than imports, then either foreign exchange will build up or foreign assets will be

purchased. In the extreme cases constituted by 1980s California and 1980s and 1990s Seoul,

wealth enters the boom economy across both intra-national and inter-national borders. At the

other extreme is a region systematically losing wealth to more rapidly-growing regions within a

nation that is a net buyer of overseas assetsthe case of rural Japan. Even when an economy has

negative foreign savings, intra-national wealth shifts can create boom and hinterland economies

within the nationthe case of Tokyo. The other ambiguous case combines a national tradedeficit with a regional capital (and possibly population) outflow--the case of the U.S. Midwestern

rustbelt in the 1980s.

There are important feedbacks between the pace of capital in- and outflows and the

relative rate of growth of any economic region. Indeed, Keynes notion of a currency union can

be understood here as precisely an effort to resolve imbalances by forcing adjustments on the part

of countries with trade surpluses (capital outflows). Apart from wealth flows and economic

growth, other spatial factors can help generate or block asset bubbles. Two such factors are

singled out in Table 3. Table 3 focuses attention on factors affecting the rate of transformation of

cross-border wealth flows into real capital assets. The cases of foreign direct investment and

portfolio investment are differentiated. With foreign direct investment, financial inflows leaddirectly to the purchase or construction of real assets. Examples are phenomena as overseas

firms construction of new factories and Midwestern families purchases of Los Angeles homes.

Portfolio investment is more problematic because the claim is only on financial assets per se.

One key factor identified here is the strength of the bordered economys intermediation capacity:

the lending capacity of its banks, the strength of borrower-lender relationships, and so on. A

second key is pertinent to international capital flows: the presence or absence of controls or

conditions for capital inflows and outflows. Inward capital controls and a strong intermediation

sector can be used to improve the financial-real capital compression rate. Inflows, even when

they take the form of portfolio investments, can be longer-term in nature, generating increases in

the real-asset base and multiplier benefits for other companies. Conversely, with weak banks and

no controls over capital movements, the amount of financial-real compression is likely to besmall, all else equal.

Our discussion has emphasized capital flows across borders; but movements of people

across borders adds another dimension to boom-economy dynamics. While the interrelations

between wealth and population movements deserve a lengthy discussion, here we make two

points. First, a boom (capital-absorbing) economy like California grows seemingly without effort

most of the time because it enjoys a steady stream of migrants who bring both their labor power

and their wealth along with them. So Californias productive capacity expands even as more

nominal wealth pours in. Second, a boom economy that enjoys inward migration and hence

labor-absorption is more capable of sustained growth than a boom economy with a stationary

population. Both factors of production are expanding in the former case, but only capital--oractually, wealth claims on capital--in the latter case. A boom economy without labor in-migration

must continually shift to a higher capital/labor ratio to avoid asset-bubbles or unused resources.

This of course is the case of Japan in the 1960s, as it shifts its textile manufactures to Korea; it is

the case of Japan in the 1970s, as it automates its factories; it is the case of Japan in the 1980s, as

it builds up productive capacity and office space too much, and suffers the collapse of a bubble.


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Spatializing Minskian financial fragility. In his mature work on financial instability,

Minsky argued that assets may often be overvalued in the late stages of a sustained period of

cyclical expansion. Minsky asserts that the more powerful the boom, the greater the potential for

an asset bubble; and the more rapid the growth of a bubble, the more certain are participants that

the sky will not fall, the more likely a crash. So success breeds success, and this breeds fragility

and eventually the reversal of the growth-generating conditions. At the core of this financial

instability hypothesis is irreversibility. Agents in an overheated economy are carrying forwardasset positions acquired in the past, which tie them to balance sheet commitments in the present

period. They must meet commitments in real time on those asset positions--and these units

viability depends on meeting these commitments in a timely manner. The downturn is driven by

both the asset and the liability side.

The spatial conception developed here adds to Minskys notions about financial fragility

in two ways. First, it suggests a new source of financially-fragile asset bubbles, independent of

Minskys cyclical conception. Combining uncertainty with a structural approach to bordered

economies, recognizing that most economies have wealth and/or labor inflows or outflows, and

acknowledging that asset-augmentation capacity varies widely, leads to the conclusion that asset

bubbles arise everywhere. So boom economies are commonplace, not rare; and boom economiesare very likely to become bubble economies; and boom economies are therefore likely to be

financially fragile. Minsky himself recognized this in a 1965 volume predating his 1975 volume

on Keynes and the financial instability hypothesis. Minsky wrote:

Californias growth .. requires that capital be imported. The markedly greater growth rate

of California proportional to the rest of the country has swamped, and will continue to

swamp, the export surplus that California would enjoy if the two grew at the same rate.

The reserve base of the states banks would tend to be dissipated unless it was

supplemented by reserves acquired by way of capital imports. To import capital,

California must either generate liabilities of the kind accepted throughout the country, or

the migrants must carry with them sufficient capital to maintain the reserve base of theregions banks. (Minsky, 1965: 99)

Because of uncertainty, the notion of an excessively high or low state of expectations

cannot be well-defined, for there is no stable set of fundamentals to serve as a reference point.

And even if one were to point to a set of firm characteristics as fundamentals, we have argued

that border balances also matter. Indeed, there can be an asset bubble due to cross-border

pressures even in the absence of expectational error--that is, as a purely structural supply and

demand phenomenon. So real/nominal imbalances occur all the time; they become quantitatively

important when enough wealth seeks out assets in a particular place with inflexible labor supplies

that this places labor/capital wealth/asset relationships are disrupted. Then Minskys point about

the liability side comes into play--the liability structures that geniuses of leverage exploited in thehigh-growth days become nooses for aggressive-growth firms when low growth hits.

The second amendment to Minskys financial instability framework involves the

recognition that border constraints create broader possibilities for asset-price reversals and

Minsky crisis. Table 4 summarizes the relationships developed here. The middle row of Table 4

presents the view of the Minsky cycle and crisis emphasized by Minsky himself. There are,

however, two more rows. The top row illustrates the case of an economy that is in surplus vis--


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vis the rest of the world.5 Such an economy is unlikely to have an asset bubble unless its asset

prices are pulled up by an overseas asset bubble. This could occur if this economys wealth-

owners are consistently buying financial and other assets in overseas markets; if prices there are

high, domestic securities prices may rise to attract wealth-owners savings. The boom economy

case occupies the bottom row. As noted, a boom economy can encourage the development of a

domestic asset bubble independent of the Minsky cycle. This bubble can then be punctured,

setting off a Minsky crisis, if wealth inflows slow gradually or are suddenly reversed in a capital-flight episode.

Implications for big-government, big-bank policies. Spatializing the Minsky

framework emphasizes complications that arise because of open-economy relations, and

unexplored by Minsky. He liked to say that the sky did not fall after different episodes of

financial disorder on Wall Street, such as the 1987 Crash. Preventing the sky from falling was a

Federal Reserve playing a lender-of-last-resort role with the worlds reserve currency, the dollar.

Such interventions promised to stabilize the unstable economy, in Minskys phrase, at the cost of

occasional inflationary pressure.

Section 2 has already discussed how Minskys suggested interventions for counteringfinancial disorder became less effective in the 1980s, with big government receding in

importance and big bank interventions alone available to block financial disorders. Some

additional problematic side-effects of big-bank/big-government interventions must be

considered due to the special features of bordered economies. In particular, interventions by the

Federal Reserve as lender-of-last-resort have an effect on exchange-market equilibria. Increasing

liquidity without limit also increases the relative supply of dollars. What happens depends on

whether a fixed or a flexible exchange-rate regime exists. If the former, then more dollars will

end up offshore in foreign nations reserve holdings, and the trade balance will worsen. This

creates the possibility of devaluation and makes foreign governments more reluctant to hold the

dollars. If the latter, then the dollar will fall in value. This will, in turn, improve the US trade

balance. Insofar as lender-of-last-resort interventions began in the fixed-exchange rate, theseinterventions would have been among the factors gradually undermining the Bretton Woods

system.

A second significant change in Minskys suggested interventions also arises because of

the existence of multiple national currencies. This second change follows not from currency

supply-demand balances, but from the fact that some currencies are more acceptable than others

as international monies. The ability of any central bank to play a lender-of-last-resort role is

circumcribed if that central bank provides liquidity that wealth-holders are not content to hold. A

central bank in this categoryfor example, the Bank of Brazilcan issue its currency (reals)

only insofar as it is willing to convert those reals freely into dollars (or whatever other currency

may be demanded by those in a position to sell reals).

This process works both ways. A government which issues a currency that is in demand

by wealth-holders has a special privilege, essentially the ultimate seignorage right. This is the

5 Because of intra-national capital flows, an economy as a whole can occupy one row, while a

region within it occupies another. Japan, for example, chronically sits in the top row, while

Tokyo falls into the bottom row.


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11

case with the US in the current period. We have noted that big government spending has

shrunk as a response to financial disorder. This implies that inflating away debt is no longer (or

is less frequently) a feasible response to a Minsky crisis (a build-up of debt relative to asset

values). This can mean that a debt overhang will simply persist. Fortunately for the US, the

special circumstance of its dollar (and the ability of the US government to credibly underwrite

asset-market risks) makes it easy to bundle and sell dollar-denominated debt to wealth-holders.

Could the savings-and-loan crisis have been resolved so speedily without this special situation?

A final set of constraints makes it more difficult to contain financial instability in the

open-economy setting set out in Table 4. The presence of overseas asset owners who can engage

in flightwhether a crawl or a sprint--away from local financial assets (and thus generate

Minsky crises) reduces local authorities room for maneuver. This flight, if large enough, can

bring on a Minsky crisis and trigger a debt-deflation regardless of what domestic asset owners

do, and regardless of the state of the local economic cycle. And because the local central bank

lacks the ability to act as lender-of-last-resort by issuing dollars, the complications thicken.

Indeed, the collapse of asset prices as foreign investors retreat will have a double effect since it

will also destabilize currency values.

The next two sections focus on the emergence of asset bubbles in Japan and Korea in the

late 1980s, and the relationship of these bubbles to these nations subsequent crises in the 1990s.

To what extent are Minsky cycles and Minsky crises among the root causes of these crises?

Section 6 will discuss the thorny question of what policy steps might be taken to ease these

financial and macroeconomic crises.

4. Boom and bubble and the crisis in Japanese growth

The post-1984 Japanese asset bubble involved both stock-market and land prices. Figure

2 shows annual change in land prices in Japan in the Tokyo metropolis. This figure demonstrates

the rapid emergence of a bubble in the late 1980s. It also shows that Tokyo land prices have risenfaster in upswings and declined faster in downswings. In turn, the Nikkei and Tokyo stock-price

averages moved up even more sharply than did Tokyo land prices in the late 1980s, spiked in

1989, moved rapidly downward until 1992, and recovered some value in subsequent years.6

One interesting feature of Japans experience is that the bubble in its market for land

persisted. One reason for this may be Japans historic restrictions on equity-market participation.

Consumers savings have had relatively few places to go, so real-estate prices might be expected

to move with other consumer savings outlets. The inflation-adjusted increase in housing prices

has been virtually identical, on average, to the return on time deposits and the cost of housing

loans from 1971 to the present. Housing prices have, however, been extremely variable; this

suggests, in effect, that Japanese households able to afford homes have to weigh safe, stabletime-deposit returns against a risky, time-varying return on a home. With this observation in

mind, note the prediction of Table 2 vis--vis Japan: due in part to capital-flow pressures, a land-

price bubble was likely, and that its most likely locus is in housing prices in Tokyo. Behind the

equity-price bubble, in turn, lie two other structural factors: the Plaza Accord, which turned many

6To understand the intensity of trends in Tokyo, note that while the new housing price/annual

income ratio was 4.4 in Japan in 1989, in Tokyo that year it was 7.4 (Kanemoto 1997: 615).


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12

Japanese intermediaries investment behavior inward; and the Japanese banking practice of

lending primarily on collateral value.

What is the consequence of an asset bubble that hangs on without crashing? The people

who live in Japan must bear it, a burden that comes at considerable cost. Figure 3 investigates

two aspects of this cost. It first depicts the estimated percentage of housing price financed, on

average. A trend line fit to these data points shows that this percentage has been hovered around58% from 1971 to 1996. This figure also depicts the average ratio of housing price to the average

income of home buyers. There is a clear upward trend here; the housing-price/income ratio drifts

upward from just over 2.0 in the early 1970s to just under 3.5 in the mid-1990s. There is

evidence here of the growing budgetary stress on households trying to buy homes. Figure 4

further supports this conclusion with data on the ratio of savings and of liabilities to income,

1960 to 1996. This figure shows savings-to-income and liabilities-to-income ratios for non-

worker households and for worker households with liabilities. For non-worker households, the

savings-to-income ratio is substantially higher than the liability-to-income ratio, and the

savings/liability gap grows over time. But for worker households, the liability-to-income ratio is

at least as high as the savings-to-income ratio--and it may be much higher. In other words,

liability burdens are increasingly heavy on households who own homes, far outpacing savings. Itseems that most younger Japanese households either face futures without secure housing, or

futures in which provisions for housing create considerable financial stress. Calculations not

shown here suggest lower-income Japanese households are especially exposed to financial

fragility of this sort.

In sum, the striking fact about the Japanese asset bubble of the 1980s is its continuing

grip on Japans economy. Resolving this widespread Minsky crisis requires measures either to

stabilize and increase asset values and/or to reduce the effective weight of debt loads. Neither

step has been taken. In California, a combination of population/wealth in-migration and

industrial innovation have permitted asset-value recovery and renewed income growth. Such

crisis-resolution mechanisms have not been deployed in Japan, for several reasons. Rural-urbanmigration is largely spent. Japans population is graying, and any in-migration in recent years has

largely involved temporary service-sector workers. This leaves measures to increase spending.

One possibility is industrial renewal; but with Japans industrial groups ossified, the stimulus for

such a renewal would have to come from start-up and independent firms. Such firms have been

among the most affected by the bubble: in many cases their collateral assets have declined in

value and compromised their creditworthiness; and where such firms have remained viable the

banks on which they depend for credit are unable to lend due to loan losses and shrunken capital

value.7 With financially fragile banks unable to support industrial innovation, recent Japanese

government reform plans have focused on two elements: first, using large-bank mergers

combined with securitization of bad-loan portfolios to recapitalize banks and renew their lending

capacity; second, using a fiscal stimulus to lift incomes and trigger a Keynesian multiplierprocess.

Thus far, a two-pronged economic recovery package of this sort has not proven politically

viable. The fiscal-policy initiatives proposed have involved modest stimuli, and temporary

7Tier-one capital in Japanese banks consists in part of equity holdings. A rise in the Nikkei thus

increases bank capital and loan-making capacity, and vice versa for a fall in the Nikkei.


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13

measures. This has left the Japanese public without confidence in these stimulus packages

efficacy and caused them to become still more conservative in their spending habits, putting

more downward pressure on demand and pushing asset prices toward deflation rather than the

required reflation. Meanwhile, government efforts to rescue banks by permitting mergers and/or

bad-loan sales has met political resistance; policies permitting big businesses to work out their

problems are regarded with skepticism by Japanese voters (whose post-bubble plight is

illustrated in Figure 4). The household sector itself has its hands tied. While housing prices havedeclined, so have home-buyers incomes. Financial fragility has increased steadily for Japanese

households, even as job security has lessened and unemployment increased. In the past four

years, the yen has steadily fallen against the dollar as the crisis has lingered. It is as if the prior

value of the yen itself and the previous glowing assessments of the Japanese model were

themselves a bubble that has now burst. In sum, the Japanese economy is in the midst of

intertwined general economic and Minsky crises, whose end is not in sight.

5. Boom and bubble and the Korean crisis

If the Japanese financial crisis has been a long, grinding crisis playing out over a period of

years, the Korean financial crisis appeared like a tsunami that broke over the heads of the Koreanpeople in late 1997. This crisis had many of the hallmarks of a classic currency crisis. On the

surface, it would seem that foreign investors realized that currency values were unsustainable

given the Korean economys persistent trade deficit and declining reserves; their withdrawal

triggered a precipitous decline in the value of the won from its former bubble level.

Such an assessment of Koreas financial crisis should be resisted, however, for several

reasons. For one thing, the pace of overseas long-term investments in Korea slowed in the past

several years, as Figure 5 shows; but at the same time the volume of short-term investments in

Korea exploded. The currency-crisis model doesnt handle this case. For another, Korea has been

a classic boom economy; as in Japan, there has been a flow of population and wealth into Seoul

from other areas in Korea. And as in the other two bubble economies considered here, an assetbubble in both equity prices and land prices emerged--but not at the end of the 1990s. Figure 6

presents the basic data for Korean land and equity-market prices in the period 1982-98, using the

same scale as for Figure 2. The Korean equity market experienced a bubble which peaked in

1989 after gaining 250% in four yearseven larger than the Japanese asset bubble. After losing

about half its value by 1992, the Korean equity market rose again to another peak in 1994. Since

then, this market has lost value in four consecutive years; the 1998 average real value of Korean

equities (using the KOSPI) has below the level of 1982. In sum, there was hardly anything

resembling a bubble that needed bursting in the period preceding Fall 1997.

While the events of recent months demand our attention, Koreas entire experience from

the 1989 bubble on deserves analysis. For whereas Japans economy experienced a late-1980schill from which it never recovered, Koreas did not. One key is that Koreas bubble was less

severe. While its equity markets hit a higher peak, these markets were less developed than

Japans; so the effects of this price collapse were less widespread; further, land prices

experienced a smaller bubble, which peaked two years after 1989. Koreas economy was

certainly as susceptible to bubble and fragility problems. In the framework developed here, and

given Koreas generally negative trade balance in the recent past, Korea clearly should be

considered as a boom economy, especially Seoul and its environs. We have emphasized that the


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14

special challenge for boom economies is to channel capital (and labor) inflows so that they do

not bid up the prices on existing capital assets and generate rent-seeking opportunities. Whereas

California historically relied on its powerful commercial banks to accomplish this conversion of

financial claims into real capital, Korea became renowned for its public and corporate sectors

success in building a world-class industrial economy. In Table-1 terms, Korea had an efficient set

of institutions for converting intra- and international wealth inflows into real asset accumulation.

Part of Koreas fascination for outsiders was its ability to accomplish this nominal/realconversion and accomplish rapid or late industrialization (Amsden, 1989) with minimal use of

arms-length market relationsto govern the market, in Wades (1990) apt phrase.

The land bubble of the early 1990s was one aspect of a profound challenge for Korea

the shortage of affordable housing, health services, and other amenities for Korean families,

especially the many lower- and middle-income families in the burgeoning urban areas. The very

success of Koreas growth strategy, which had avoided extremes of wealth and poverty, became a

threat to the widespread provision of adequate and affordable housing and other services, as

Yoon (1994) and Kim (1997) describe in detail. Pushed in part by an energetic popular

movement, Koreas government pursued an aggressive housing policy; a massive construction

effort was begun, together with progressive taxes on the sale of existing homes which socializedsome of the gains from housing-price appreciation. Real government expenditures on housing

and community development and on social welfare increased after the mid-1980s (admittedly no

faster than did expenditures on economic services and defense). This effort to build homes and

encourage ownership effectively countered the land (and housing) price bubble by putting new

real assets in place. Thousands of new housing units have been put in place; thousands more are

under construction.

The economic situation of Korea was inexorably altered in the mid-1990s as it

deregulated financial markets and took other steps to gain admission into the OECD.8

A new set

of non-bank intermediaries (the merchant banks) arose. In part these intermediaries speculated on

the arbitrage opportunities arising from regional interest-rate mismatches; in part theseintermediaries channeled off-shore funds to chaebols seeking external finance to fuel their

expansion plans. In any event, the Korean public sector lost control of the growth machine, and

Korean dynamics flipped from boom-without-bubble to bubble economy. The funds flowing

into Korea were almost entirely short-term (Figure 5). Using short-term off-shore funds to

support currency speculation and chaebol investment, since these funds required continual roll-

over, invited either a currency collapse, an attack on Korean industry, orin the event--both.

Since late 1997, the withdrawal of foreign investment and the collapse of asset and

currency values (Figure 6) has created unsustainable debt burdens for many businesses and

households. Bankruptcies are occurring at historically unprecedented levels, spurred by banks

need to reduce lending so as to build up capital-asset ratios. Firmly under the thumb of the IMF,the Korean economy is now caught in an excruciating squeeze. Real money-supply growth has

turned sharply negative after 1996; real domestic credit has declined sharply as of 1997. Price

inflation has rocketed upward as the devaluation of the won has taken hold ; the real rate of GDP

growth has fallen below zero in 1998; and the debt/GDP ratio has trended steadily upward

8A full accounting of Koreas liberalization and its consequences is beyond our scope here; see

Chang, Park, and Yoo (1998), Wade and Veneroso (1998), and Crotty and Dymski (1998).


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15

(except for a respite in 1998 attributable to the high bankruptcy rate). After Korea avoided

Minskian fragility for years through careful economic management, a Minsky crisis has now

arrived with a vengeance; and it is strangling businesses and households caught in Koreas

arrested economic development. The principal strategies being pursued in the face of this

collapse are increased ease of entry for overseas investors and, as in Japan, large bank mergers.

6. Conclusion and policy implications

Two views of Asias crisis have predominated until now. In the IMFs view, the Korean

crisis can be traced to the Korean governments excessive intervention in credit flows in the

Korean financial sector. As Koreas financial markets became more open, some of Koreas

privileged inside players made excessively risky off-shore investments; when these went bad,

money managers and investors outside of Korea reacted to Koreas unsound financial

architecture by (rationally) withdrawing their funds. Once Koreas financial practices eliminated

advantages for domestic players and ease cross-border commitments, credit and capital will flow

back to Korea from abroad. Japans financial problems, too, can be traced to its historic antipathy

to overseas capital and its non-market criteria for allocating financial resources. This view rests

on the premise that investment capital is the globally scarce resource, whose presence or absencedetermines national welfare; then any nations micro and macro policies are wrong whenever

they either inhibit capital mobility or the prerogatives of offshore bankers and investors. A

contrary view has emerged based on the twin ideas of incentive incompatibility and asymmetric

information in credit markets. The idea here is that asset bubbles and financial crises result from

behavioral pitfalls to which human economic systems are chronically prone. Asset bubbles and

financial crises then comprise a pattern repeated throughout history, mistakes made and made

again.

This paper has suggested a new contributing factor in the Asian crisis: asset bubbles can

result from imbalances between inflows of financial capital and the growth rate of real capital

assets. Far from being an unusual episode in economic dynamics, imbalances of this sort are achronic tendency in boom economiesthat is, in nations or regions that characteristically import

capital and/or people from elsewhere. In a boom economy, what stands between stable asset

prices and an asset-price collapse is an intermediation sector and/or a capital-controls policy

dedicated to channeling inflows into appropriate real-asset accumulation. When these institutions

are weakened, an asset price bubble and collapse become more likely. Indeed, we show that

Minsky crises can be triggered by cross-border shifts of capital, not just by Minsky cycles. The

interpretation of asset bubbles developed here spatializes Minskys notion of financial fragility

that is, it shows the special balance-sheet tensions that emerge when financial positions extend

across economic borders. Interestingly, this extension of Minskys well-known financial-

instability model makes use of Minskys own earlier, neglected insights into the importance of

cross-border relations in economic growth.

This revised Minskian perspective throws new light on the recent experience of Japan and

Korea, boom economies especially their recent asset bubble problems. We find that there is no

one asset-bubble story that is told and retold over the millenia, no one lesson that can immunize

policy-makers from the pitfalls of asset bubbles. Quite the opposite point is made here: asset

bubbles are a chronic tendency of boom economies, and boom economies are recurring structural

phenomena. One might argue that bubbles and busts are more likely given behavioral shifts


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16

within the banking sector. In particular, an increasing number of firms within this sector are

committed to making income by position-taking on asset projects initiated by others rather than

by investing in extensive or intensive development. The no-bubble condition becomes less and

less feasible the more wealth inflows are used to acquire existing assets on the premise that their

monopoly rents will increase. As Minsky used to put it, firms and wealth-owners increasingly

take position to make position; but expectations that asset prices will either continue to rise

(the Japanese bubble of the late 1980s), or at least hold their value while cash-flow margins areexploited (the Korean situation of the late 1990s), invariably run afoul of structural constraints

implicit in the Minsky cycle and/or in cross-border real-financial relations.

Several policy implications follow from the model developed here. First, a nation

characterized by large and sustained inflows of foreign exchange has a higher degree of financial

fragility than a nation which does not, independent of the character of those nations internal

balance-sheet relations. It is only prudent economic policy to insure that such inflows do not

create asset bubbles by seeking out scarce real assets without being put to work in augmenting

real-asset capacity. That is, a policy of inward capital-flow regulations is a prudent means of

avoiding asset-price booms and collapses.

Second, in a boom economy, a key mechanism for avoiding asset bubbles (and

subsequent collapses) is the maintenance of a banking sector capable of directing and

coordinating financial flows, instead of only reacting to flows. Loss of capacity of this sort

suggests the importance of reestablishing it; and institutions that depend on position-taking

should be reconsidered carefully in terms of their ability to affect resource flows within the

overall structure of economic activity.

Resolving the Asian crisis: Japans dilemma. The broader question addressed here is

whether the Asian crisis can be ameliorated or even blocked through the application of the big-

bank/big-government policies formulated by Minsky for the case of financial fragility. We have

already suggested that these policies have grown weaker even for the US since the deregulationera took hold in the 1980s. There are reasons to believe that these policies are even more

problematic for the Asian crisis per se. Japan is the obvious candidate for reviving East Asias

growth through the application of such policies. However, several problems impede Japans

application of these policies, even if she were willing to try them.

The use of big bank policies involves several problems. First is that the Japanese must

be willing to support the use of the yen as a reserve currency. This in turn means losing some

control over the placement of yen-denominated assets, over the locus of yen holding, and over

the terms and conditions of yen-denominated assets. All these steps will be controversial in

Japan. Further, applying big-bank policies to the Asian crisis involves a multiple-currency

problem. The asset bubbles in Asia grew up in a variety of countries; so intervention to stop theworst effects of debt deflation involves not one currency, but a chain of currencies. The problem

of supporting any one currency (say, the baht or the ringgit) with yen is that this implicitly

represents support for the government issuing this currency. This raises a moral-hazard issue that

is lacking for a central bank that takes action to defend against financial meltdowns within one

countrys borders.


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17

Another problem is that the problem of debt overhang in Japan must be resolved before it

is free to act. This in turn means either floating the debt away or inflating it away. Either course

of action runs counter to deeply-seated attitudes in Japan. Floating it away requires opening up

Japans financial markets to outside participation; so much bad debt has been built up in the

Japanese bubble that offshore bond-holders participation will be required to offload significant

amounts of this debt. This will require bundling, securitizing, and underwriting these debt claims.

Experience with securitization in other nations has shown that this is readily done by experiencedinvestment bankers ifappropriate guarantees are extended (and if prospective holders are

identified for whatever toxic waste remains after various cash tranches are stripped off). Of

course, the provision of such guarantees requires public subsidies; and this has been a political

sticking point. Once the debt is floated away to offshore holders, renewing economic growth in

Japan requires revitalizing aggregate demand.

This brings us to the other choice, inflating away the debt. Inflating away the debt

requires identifying a sector willing and able to increase aggregate expenditure. The government

sector has engaged in some increased expenditure, much of it focused on large-scale public

works projects; this spending has been criticized as ineffective. Government spending would be

more effectively used to address the problems of housing affordability and child-care availabilitywhich now bedevil Japanese households. A shift of fiscal policy toward such objectives would,

however, run counter to long-standing social conventions concerning gender roles and the limits

of state involvement. That the current arrangements are not working is evident in the ongoing

marriage strike by women of child-bearing age, which has resulted in a plummeting Japanese

birth rate (and in predictions of a declining Japanese population). What is required now is a way

out of the years-long political stalemate which has straitjacketed Japan, long after the end of the

era of income doubling has made a welfare-state system a social necessity.

If government will not spend, households and corporations are the other sectors capable

of increased aggregate demand. Household spending, however, has slowed dramatically in the

current Japanese recession, especially on consumer durables. The increased insecurity associatedwith the ending of life-time employment arrangements hardly puts people in the spending mood.

And corporate investment expenditure on Japanese goods and services will go only so far.

If a sector willing to carry Japanese aggregate-demand expansion on its back is identified,

further problems remain. A significant boost in aggregate demand will weaken Japans export

balance. Ministry of Finance (MOF) officials characteristically view a trade surplus as a means of

supporting a fiscal deficit: the idea is that the trade surplus earns the capacity for government

deficit spending. A significant shift in thinking on the part of the MOF is thus required as a

component of a new dedication to aggregate-demand expansion.

In sum, any course of action that permits Japan to ease out of its Minsky crisis, and henceto play a more active role in ameliorating Minsky crises throughout Asia, will require significant

shifts on the part of important players in Japans economic and political establishment. The

capacity of Japan to pursue Minskys policies, and the effectiveness of these policies in the

current global neo-liberal climate, is very much in question. Unless and until means of

unwinding the Minsky crises in East Asia are found, the Asian financial crisis will remain a stone

around the neck of world economic growth.

Bibliography


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Chang, Ha-Joon, Hong-Jae Park, and Chul Gyue Yoo. 1998. Interpreting the Korean crisis:financial liberalisation, industrial policy, and corporate governance. Cambridge Journal of

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Wade, Robert, and Frank Veneroso. 1998. The Asian crisis: The high debt model vs. the WallStreet-Treasury-IMF complex.New Left Review No. 228, March-April.

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Figure 1: A stylized picture of a Minsky crisis

PK=PI

Y! = 0

PK=PI

Stages: Robust Fragile Ponzi Collapse

NOTE: The variables shown are measured against cyclical trend, with time elapsing

from left to right in the diagram.

Sl

aughter ofPK/PI

ratio

Output

rowth

Debt/income

Asset price

collapse

Capacity

utilization


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Table 1: Relationships between Regional Economic

Growth Rates and Asset Bubbles

Is an asset bubble likely to form

in one economy within a region?

No Yes

Balanced regional

growth

No wealth or labor

transfers, dispersed

technology and

productivity

Moral hazard problems

in banking, inadequate

supervision

One economy grows

faster in a growing

region

Higher innovation rate

or productivity in

high-growth area

Faster wealth inflows

into growing region: The

boom economy case

Balanced regional

slowdown or

stagnation

No capital flight, or

offsetting capital

outflows and inflows

Uneven economy-by-

economy pace of capital

flight from region

Patterns in

regional

economic

growth

rates:

One region or nation

grows faster (or

declines less) than

others in a stagnant or

declining region

Higher innovation rate

or productivity in

high-growth area

Capital flight

from the region, failure

of overseas lenders to

renew short-term loans

Table 2: Cross-border wealth flows and asset price pressures

International border condition:

Net foreign savings > 0

(wealth inflows)

Net foreign savings < 0

(wealth outflows)

Wealth inflows into

this domestic region

from other domestic

regions

Strong upward asset-price

pressure:

More overseas and domestic

claims on available real assets

(1980s California,1990s

Seoul)

Possible upward asset-price

pressure:

Net acquisition of foreign

assets, more domestic claims

on available real assets

(1980s Tokyo)

Intra-

national

border

condition:

Wealth outflows

from this domesticregion to other

domestic regions

Indeterminate asset-price

pressure:

More overseas claims, butfewer domestic claims, on

available real assets

(1980s US Midwest)

Downward asset-price

pressure:

Net acquisition of foreignassets, fewer domestic claims

on available real assets

(other urban areas

in Japan)

NOTE: The asset price pressures indicated here do not take into account other influences on asset

prices, such as income growth.


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Table 3: Determinants of the Pace of Transformation of Financial Claims

into Net New Real Assets

Type of capital inflows into domestic region:

Foreign direct investment

(domestic asset constructionby overseas capital)

Portfolio investment

(domestic asset purchase byoverseas capital)

Intra-national lending and capital-emitting capacity:

Strong: robust banks,

borrower-lender relations,

and capital sources

High financial-to-real asset

transformation with local

multiplier effects

Strength of financial-to-real

asset transformation depends on

domestic allocation system

Weak: undercapitalized banks,

fragile borrower-lender links,

and few capital sources

High financial-to-real asset

transformation with small

multiplier effects

Low financial-to-real asset

transformation

Cross-border capital-flow policies:

Active: ex ante policiesencouraging long-term

investment, punishing or

preventing short-term flight

High and stable financial-to-real asset transformation

Enhanced financial-to-real assettransformation by discouraging

short-termism

Passive: no conditions or

controls vis-a-vis capital

inflows or outflows

High sensitivity of local

investment to external

conditions, govt policies

Low real-asset creation

potential

Table 4: Bordered economies, Minsky crises, and Minsky cycles

No asset bubble:

Financial prices and

real prices are aligned

Asset bubble: Financialasset prices rise above

real asset prices in an

expansion

Asset-price collapse:Financial asset prices

fall below real asset

prices

Foreign savings0,

a capital-absorbing

economy

Boom without

bubble

A bubble economy can

generate an asset bubble

due to capital inflows

Reductions in capital

inflows or sudden

capital flight can

generate Minsky crisis


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Figure 2: Land and Stock Price Index values, Japan

50

100

150

200

250

300

350

1982 1984 1986 1988 1990 1992 1994 1996

All figures are detrended by the Japanese CPI.

Tokyo land values Nikkei average Tokyo stock avg

Source: Akira Matsum oto,

Ehime University.

Index value, 1985=100

Figure 3: Japanese housing finance trends, 1971-96:

Price/income ratio and borrowing/cost ratio

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

1971 1974 1977 1980 1983 1986 1989 1992 1995

Pct financed = borrowing / (borrowing + own funds)

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

Price/income

Pct financed

Price/income trendline

Pct financed trendline

Price/income records the ratio of average house price to

average home-buyer income; percent financed records the

percentage of housing price externally financed, on average.

Left axis: Housing price/income ratio Right axis: Borrowing as % of housg cost


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Figure 4: Financial savings and liabilities relative to income, average for

Japanese households with liabilities, 1960-96

0

0.5

1

1.5

2

2.5

3

3.5

1960

1965

1970

1975

1980

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

Source: 1996 Family Savings Survey, Govt of Japan

Sav ings/incom e, worker hshds Liab's/inc, workers w/liab's (A)

Liab's/inc, workers w/liab's (B) Sav ings/incom e, non-worker hshds

Liab's/income, non-workers w/liab'sNOTE: Figures for non-worker hshds assume average incom es are the same for those with and w ithout

liabilities. The same assumption is made for worker hshds under assumption A. Assumption B assumesworker hshds with liabilities have average income levels double those of h shds without liabilities.

Left axis: Ratio of savings or liabilities to

income

Figure 5: Capital accounts, Korea, 1979-April 1998

Millions of US $ (excluding errors and omissions)

-$8,000

-$4,000

$0

$4,000

$8,000

$12,000

$16,000

1979 1981 1983 1985 1987 1989 1991 1993 1995 1997

Direct investment Portfolio investment Other capital flows

Source: Asian Development Bank.


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Figure 6: Land and Stock Price Index values, Korea,

1982-August 1998

50

100

150

200

250

300

350

1982 1984 1986 1988 1990 1992 1994 1996 1998

Figures are detrended by the Korean CPI.

Urban land prices Stock mkt average

Sources: land prices, Land Taxation in Korea (Ro,

1997); 1990-96 stock prices, Korean Stock Exchange;1982-89 stock prices, author's calculations.

Index value: 1985 = 100

Asset Price Bubbles and Minsky Approach to Asia Crisis

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