Developed financial markets, where it is possible to buy and sell shares and other financial assets many times a day, imply the possibility of speculative investments. What is essential for speculative calculations is not the long-term productivity of capital goods but short-term changes in the prices of stocks and other financial assets and anticipation of others’ expectations about changes in relative asset values (ibid., pp. 147–163). The development of financial markets makes the dynamics of savings, investments and interest rates more complicated and contradictory. When speculation in this sense prevails, financial markets become increasingly volatile and crisis-prone. Increased uncertainty and crises affect anticipations of the future and usually decrease the marginal productivity of capital and thereby investments. This has multiplying negative effects on other economic activities (although may, from a neo-Schumpeterian perspective, also release funds for risk investments in innovations).
Roughly in accordance with the neo-Schumpeterian account of historical phases, but giving finance much more autonomy, Minsky (1982, pp. 166–177) maintains that at times of long wave of growth and affluence, financial markets begin to develop in a more speculative and crisis-prone direction. Capitalism generates innovations also in finance, not only in production and exchange. New financial instruments and other innovations often presuppose de- and re-regulation. Consequently, there is a relation between the development of financial markets and the rise of orthodoxy to prevalence. Classical orthodoxy assumed that money is merely a good among other goods and therefore believes that the Smithian ‘invisible hand’ also guides free trade of money. Orthodoxy also assumes that real economy determines the prices of money and financial assets. In this fashion, the neoclassical orthodoxy has maintained that financial and other markets are either in a simultaneous (Pareto-optimal) equilibrium or moving towards such an equilibrium if there have been disturbances or movements of correction (Toporowski, 2002).
Minsky’s (1982) model about the determination of investments explains why developed
financial markets themselves tend to produce economic crisis, recessions and unemployment. Banks create money when they give loans against future revenues and profits. The monetary system is stable only as long as streams of revenue and profit enable firms to meet their financial liabilities (ibid., p. 22). Financial actors try to innovate new forms of profitable finance, which typically increase velocity of circulation and decrease liquidity. Many capital goods have been bought at least in part on credit. This makes their value dependent also on developments in financial markets, which in turn are contingent on actors’ expectations about the future, commonness of speculative orientation and general degree of involvement in debt. Speculative activities sensitize actors on alterations in expectations about the future while noone can predict the future because the development of asset values is always uncertain in open systems and determined in significant part by actors’ expectations and anticipations (ibid., pp. 59–69). The higher the liabilities in relation to revenues and liquidity, the more unstable the financial system becomes. Relatively small changes in interest rates or revenues may make some actors A insolvent and they can in turn endanger the solvency of those actors B who are expecting due payments from A. In the midst of mounting difficulties many have to opt for ‘Ponzi finance’, i.e. they have to take expensive short-term loans merely in order to meet their financial liabilities. Rapid rise in Ponzi finance indicates a crisis in the near future. Relatively small absolute changes in interest rates, streams of revenue and wealth can thus trigger a financial crisis (ibid., pp. 162–177). In other words, financial innovations and increasing involvement in debt make the financial system more chaotic. The ‘development’ of financial markets takes capital and resources from other sectors of the economy, while increasing risks under uncertainty. Typically, at some point the distinction between speculative investments and swindle may be blurred and all sorts of scandals start to be increasingly common. For these and other reasons confidence in the continuation of the bubble may start to falter. Some may switch to speculating on decline and in some contexts these anticipations may become self-fulfilling. Small errors in calculations or unexpected changes can thereby make some financial actors quite easily insolvent (for instance, in the 1998 crisis the Long Term Capital Management, with the basic capital of US$4 billion, had created liabilities of US$200 billion-worth that it suddenly could not meet, thus risking the solvency of a number of banks and other major investors). To stress the basic point, in developed financial markets relatively minor problems or changes may trigger a major crisis.
