Financial instability

Human civilisation is now officially too stupid to be allowed to continue:

There's only a handful of lenders in Australia that are accepting cryptocurrencies as collateral for loans.

While there's no clear and present danger to Australia's financial system, the federal government and regulators are watching them.

"Crypto assets can be highly volatile," ASIC told the ABC.

"Lenders securing loans with crypto may risk the collateral becoming insufficient to cover the loan if the value of the crypto drops quickly.

"For consumers, this means a higher risk of having your loan called back early, and needing to sell your crypto assets to cover a default."

But here's the problem.

The industry's keen to grow, but economists have told the ABC the further the industry grows, the more it will present a major risk to Australia's financial stability.

"What the law needs to do, what regulators need to do, is to ensure that people who are not especially sophisticated, or who don't have the capacity to understand and assess the risks that they might be exposed to aren't sucked in by unscrupulous operators," Saul Eslake says.

The Financial Instability Hypothesis (FIH) has both empirical and theoretical aspects that challenge the classic precepts of Smith and Walras, who implied that the economy can be best understood by assuming that it is constantly an equilibrium-seeking and sustaining system. The theoretical argument of the FIH emerges from the characterization of the economy as a capitalist economy with extensive capital assets and a sophisticated financial system.

In spite of the complexity of financial relations, the key determinant of system behavior remains the level of profits: the FIH incorporates a view in which aggregate demand determines profits. Hence, aggregate profits equal aggregate investment plus the government deficit. The FIH, therefore, considers the impact of debt on system behavior and also includes the manner in which debt is validated.

Minsky identifies hedge, speculative, and Ponzi finance as distinct income-debt relations for economic units. He asserts that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system: conversely, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a "deviation-amplifying" system. Thus, the FIH suggests that over periods of prolonged prosperity, capitalist economies tend to move from a financial structure dominated by hedge finance (stable) to a structure that increasingly emphasizes speculative and Ponzi finance (unstable). The FIH is a model of a capitalist economy that does not rely on exogenous shocks to generate business cycles of varying severity: business cycles of history are compounded out of (i) the internal dynamics of capitalist economies, and (ii) the system of interventions and regulations that are designed to keep the economy operating within reasonable bounds.

This Article works to debunk the myth of finance as intermediated scarce private capital and offers an alternative, more up-to-date theoretical framework for understanding the structure and operation of our financial system. We argue that, contrary to contemporary orthodoxy, modern finance is not primarily scarce, privately provided, and intermediated, but is, in its most consequential respects, indefinitely extensible, publicly supplied, and publicly disseminated. At its core, the modern financial system is effectively a public-private partnership that is most accurately, if unavoidably metaphorically, interpreted as a franchise arrangement. Pursuant to this arrangement, the sovereign public, as franchisor, effectively licenses private financial institutions, as franchisees, to dispense a vital and indefinitely extensible public resource: the sovereign’s full faith and credit.