I came across an insightful article by John Mauldin, one of the most widely followed newsletter authors in the investment world. As a student of the markets, I first stumbled upon his work more than 20 years ago, when “Thoughts from the Frontline” was one of the first free investment newsletters distributed via email. I have learned a lot from him.
The topic he explores in this piece may also resonate with some of my investors given its relevance to current market dynamics.
Here is a section:
Minsky described three stages in the credit cycle that leads to a Minsky Moment.
The hedge finance stage: In this economic period, borrowers can repay their debts with revenue or cash on hand. They have enough cash flow to cover both the principal and interest on their loans.
The speculative finance stage: Borrowers can still pay interest on their loans but must continually roll over the principal. They have no choice at this point but to rely on the assumption (or hope) that they can refinance or borrow new funds to cover their principal.
The Ponzi finance stage: Borrowers can only repay their debts by increasing their debt or selling borrowed assets at fire sale prices since many are in the same position and the market knows you must sell, giving you no bargaining position.
Borrowers do not have enough cash coming in to cover either the principal or interest payments on their loans. They can now only rely on the appreciation of their assets or the willingness of lenders to provide additional funding.
Once an economy reaches the third stage, if prices do not go up and lenders stop lending, then the Minsky moment arrives.
We are right now in the late portion of the speculative finance stage. Debtors (in this case the US government) assume they will have the income needed or the printing press to service their debts and will be able to refinance if needed.
For now, they are right. This will change. As I said above, governments and markets and investors can be complacent longer than you can bet against them. We are in an era of complacency.