Yes, “It” Did Happen Again

The title of Visiting Senior Scholar Jan Kregel’s working paper is a reference to Hyman P. Minsky’s book Can “It” Happen Again? The Minskian “it” is the debt deflation scenario that led to the Great Depression, and Kregel makes the case that the recent Asian crisis is just such a scenario.

Minsky defined three types of financing. Hedge financing is a position in which a firm’s expected cash flow always exceeds the financing costs and operating expenses by a wide margin of safety. Speculative financing is a position in which a firm has a positive net present value, but the expected cash flow will not be sufficient to meet all financial commitments in all periods. Ponzi financing is a position in which a firm has to borrow funds just to meet its current cash flow commitments. According to Minsky, a change in macroeconomic variables, such as the interest rate, can change a firm’s financial position from hedge to speculative or even to Ponzi by reducing the present value of the firm’s current cash flow and increasing its cash flow commitments. A bank will respond to a deterioration of the financial position of its debtors by reducing lending and attempting to recall lending. If so, firms will find themselves in Ponzi positions and will be forced to sell assets just to meet their current cash flow commitments. Selling assets creates a generalized downward pressure on output and asset prices. Thus, the term “debt deflation.”

According to Kregel, the above scenario could also result from a depreciation in the exchange rate if firms have a high proportion of imported inputs or foreign debt—and this is precisely what happened in Asia in 1997.