Private and Public Debt Markets in Disequilibrium Theory

Frederick Betz

doi:10.4236/tel.2015.55073

Abstract

In disequilibrium pricing of financial markets, excesses in either public debt or private debt can trigger a financial crisis, with attendant bank panics and recessions. For example, in the Euro crisis beginning in 2010, financial contagion in the sovereign bond market has spread among five nations: Greece, Ireland, Cyprus, Portugal, and Spain. But the reasons for the contagion was initially different for the countries, due to either disequilibrium pricing in public debt markets or disequilibrium pricing in private debt markets. In previous papers, we introduced a time-independent supply-demand model (three-dimensional model) for disequilibrium pricing in financial markets [1] and a steady-state disequilibrium systems model for the run-up of a financial crisis in a public debt market [2]. In this paper we construct a time-dependent disequilibrium systems model for the run-up of financial crises in a private debt market. We analyze the empirical case of the 2010-12 Euro crisis in Spain (private debt crisis) and then compare this to the empirical case of the 2010-2015 Euro crisis in Greece (public debt crisis).

Highlights

Irvin Minsky proposed a “price disequilibrium theory” for describing the dynamics of financial bubbles [3]; and the author constructed a graphic depiction of financial transactions in capital-asset markets to depict Minsky’s disequilibrium theory [1]
All the other countries impacted by the Euro crisis were cases of one or the other or a mixture of both
In the case of Spain the economy could be fixed by preventing bank runs and regulating the bank system—recapitalizing the illiquid banks, and closing down the insolvent banks

Summary

Introduction

Irvin Minsky proposed a “price disequilibrium theory” for describing the dynamics of financial bubbles [3]; and the author constructed a graphic depiction of financial transactions in capital-asset markets to depict Minsky’s disequilibrium theory [1]. The Greek tax policy was continually delinquent, never collecting sufficient revenue to fund its government services (in good economic times or bad). In 2009, Ireland at 66% (PD/GDP) and Spain at 53% (PD/GDP) and Portugal at 76% (PD/GDP) were all cases first of private debt market financial bubbles (and were not initially public debt crises). Once (a private sector) crisis hit, the private-sector financial deficit disappeared swiftly, whereas the fiscal deficit soared The explanation for the latter is that government revenue fell dramatically, and crisis-driven government spending automatically rose, as the banks were rescued. One needs to understand financial crises in both private and public debt markets to understand the Euro crisis of 2010-15. In Greece, it was a financial contagion in the public debt market. The contagions in the national private debt markets were due to housing booms, fueled by cheap Euro dollar credit

Private Debt Market—Disequilibrium Systems Model in the Case of Spain 2010

Public Debt Market—Disequilibrium Systems Model in the Case of Greece 2010

Results

Conclusions