The journal Nature published an insightful research article on Systemic risk in banking ecosystems that added valuable insight into what went wrong in the 2008 financial collapse. Invited comments on a forum page Financial systems: Ecology and economics added other insights on what did or could go wrong.
My comment pointed out that trying to fix what went wrong in prior financial system failures to prevent the next, is what led to the next not the solution, for a curiously visible reason. A link to Dmitri Orlov’s new video on what happens if these kinds of systemic contradictions are not attended to, and my comment, are below as well.
The curious omission by Haldane and May, as well as by Johnson and Lux in their critiques, is not considering the place of this financial collapse in history.
This was only the biggest and most recent instance of extreme over-inflated financial expectations collapsing the environment they were part of.
It was just one of a great many self-similar panics and collapses, large and small throughout history. It’s been an interest of mine for over 30 years.
People historically have never quite understood them and so have been unable to learn from them. So though they are clearly self-inflicted they keep repeating.
I think it’s an error to not ask if, as in the past, fixing what went wrong this time will fail to correct some other underlying problem. The evidence is that fixing what went wrong the time before is the solution that always failed, and did not prevent the next one.
What seems like a common element in financial panics of the past, as well as the collapses of whole advanced economic systems, is:
investors looking for investments they can trust to yield a positive return, compounded their returns until they become untrustworthy.
It leads to errors of self-inflating perceived value, passing false information in circles, and then the collapse of over inflated value, a kind of “information disease”. *Yaneer Bar-Yam said “Good point!” and Stan Salthe “A GREAT statement! ”
Keynes pointed to a curiously obvious but very much “hidden in sight” mechanism of just that kind, built into the core of modern market economies. They have a need for stable positive interest rates to attract savings and investment, and people rely on continually adding their financial earnings to their savings to give them growing returns.
The problem is that when real growth slows for some physical cause, then financial growth will continue as long as financial earnings continue to be saved.
That would naturally lead to a systemic crisis of multiplying obligations for an underperforming assets, though, and a loss of confidence. The implication is that when the growth of the physical economy slows due to natural resistance, then financial growth needs to be restrained to match, by sufficient spending from financial savings.
Keynes described that in Chapter 16 of The General Theory, having first introduced the idea with his “Widow’s cruse” parable in the Treaties on Money. People have not understood it ever since, lacking a good way to perceive differences between the performance of the physical and financial economies.
I think that’s now quite visible in the enormous catalog of erupting new costs of environmental mitigation, resource security and inter-societal economic conflicts all over, contrasted with continued escalating financial expectations as fast as ever. There’s a growing split.
I hope this aspect of the problem can begin to be discussed. I also wrote a note with a little more about Keynes’ thinking on it as a comment on the editorial on Natural Wealthin this issue (also below). My own research can be found at [synapse9.com] andsearching for my mentioning Keynes on my site and blog.
The same issue of Nature included an Editorial on Natural Wealth addressing
Ecological models can be used to guide economic policy — but should they?
There seem to be lots of people asking if ecological models can explain or prevent systemic economic collapses from an understanding of ecological ones. The problem presented by complex systems isn’t that we have not found what equations they follow, though, it’s that they don’t really follow equations.
People have not caught onto what that means yet. I wrote the Encyclopedia of the Earth article on Complex Systems and have three other papers pending or published from last year that present several sides of a better approach. www.synapse9.com/phpub.htm
We could think of economies as the organization that develops from the actively creative learning of people as they search their changing environments for opportunity. Most people say, “Hey you can’t write an equation for that!”, and that is precisely the point.
What you can do is monitor that to see what opportunities and constraints the search processes of the system working as a whole are discovering. It’s a more “diagnostic” approach than a struggle to reduce what is irreducible to equations.
J.M Keynes pointed out, and was ridiculed for, a curiously clairvoyant observation about money at the climax of productive investment. He invented a parable from a biblical verse about Elijah, “the widow’s cruse” (cruse meaning “cup” in the King James Bible).
It’s about an old women who could little afford an added guest. To ease her worry Elijah gave her inexhaustible cup of oil and bowl of flour for her hospitality, for comparing, allegorically, the widow’s fear in accepting Elijah as guest in her home to the great concession it would take for “the rich” to stop adding to their financial savings at ever increasing rates as the world economy becomes unable to fulfill the promises being made on its behalf.
When you take a diagnostic approach to how complex systems behave on their own, you don’t need to represent them with equations and can more simply check to see what they are responding to. You can ask if the economy as a physical system can follow one growth path, and as a financial system an entirely different one.
Keynes simple answer to that was, no of course not, as the physical economy slowed growth either investment savings would stop growing because either because net rates of return, or the net rate of savings, would go to zero.
It could seem, maybe, that our whole world of financial institutions adding to their virtual wealth by leaps and bounds every minute, is behaving like a frightened old woman. Perhaps too, it is assurances that the world won’t end rather than attacks that they need to persuade them, to spend their earnings enough to balance the global equations of finance again.
Most of my stories treat it as the hesitancy of a novice to go to their own graduation, stepping from an immature to mature stage of development. That follows from what appears to be the normal succession of emergent systems that start with self-inflating growth to then mature to find new relationships in a new environment.
2/5/11 A new video from Dmitry Orlov describes his view of what happens to a society if it does not attend to it’s systemic contradictions. I find it rather insightful, and though extreme by some standards not unrealistic our improbable given our true present circumstance. I recommended it. My posted comment was:
You have such a good general sense of how a cultural environment would behave if it’s own ecology as an economic system is pushed to collapse. I wonder why you seem to still miss the value of studying the two diametrically opposed faces of financial regulation.
The purpose of financial regulation starts as being to stabilize the multiplication of real wealth. Then the same effort turns into a task of stabilizing the multiplying financial obligations of the economy as it struggles against mounting difficulty, and so multiplying the strains on the working parts of the economy and its environment.
The cause is following rules that at one time mean one thing and in new conditions, without changing the rules, then mean another. The purpose gets misplaced, and it’s not hard to trace it if you look closely. A regulatory system that naturally makes its own environment unmanageable leads to its own collapse, of course.