Wednesday, December 08, 2004

How Complex Systems Fail

The title to this post refers to a treatise by Richard I Cook, MD, of the Cognitive Technologies Laboratory at the University of Chicago. It is a fascinating take on how humans interact with complex systems, with the main goal being to change the operations of the systems to stave off failure. The irony of such efforts is that the systems invariably become more complex, with the inevitable outcome that failure is postponed at the cost of even greater consequences when failure does arrive.

As an exercise in applying the rules of complex systems developed by Cook, Jim Willie describes the current state of the global economy, and the precarious nature of the the patches, plugs and stalling tactics engineered by central bankers, governments and financial institutions to stave off the inevitable recession that is needed to re-balance the economy:

Sometimes, unfortunately, a complex system fails. Despite the best efforts to keep an evolving system together through coordinated management, and attempts to provide fail safe mechanisms along its evolutionary path, the system can weaken, degrade, and fail. Due to its enormity and multi-faceted nature, changes occur slowly and are perceived to evolve in an orderly manner. A strange public trust is instilled along the pathogenesis of breakdown, but official statements, encouragement, and assurance of constant tweaks to controls put aside public concern. The consequential impact from the potential failure can be beyond measure. Hyperbolic words such as "enormous" or "magnificent" or "staggering" really fall short in their description of the fallout damage. Experience through past crises, and reactions to them, tend to render the system more fragile and weakened, not more secure and efficient. It becomes more subject to stagnation and a pathetic state of near breakdown, which ironically comes to be accepted as the "normal" situation. Successive crises have indeed worsened over time. A worthwhile exercise might be to review a clinical treatise on the nature and evaluation of systemic failure.

The US Economy, stock & bond markets, futures contracts leveraged to them, and great derivative gears hold together the USDollar, the US Treasury Bonds, mortgages, major metals & energy commodities, and more. Many devices are designed to keep a limiting cap on prices and rates, like a huge rooftop atop a house or giant pyramid shrubs surrounding it. The entire system grows to become tremendously complex. It has evolved over several decades, and has responded to numerous unintended disturbances. Central banks provide the backdrop fail safe in a highly visible overt fashion. Derivatives provide the foundation underpinning in more secretive collusive fashion. System foundations date back to the post-Depression, post-WWII era. Latent growth and solidification took place until the gold anchor was abandoned, as the Bretton Woods Accord linking the USDollar to gold was defaulted in 1971. Most crises date back to that key event in their origins, a simple fact almost uniformly overlooked by a corrupted economic advisory function to this day. Shocks have been endured in many recent years. Small shocks occur almost on a monthly basis. The system continues, so the public regards the system as functionally capably. How many times must we hear "the system has not broken yet" ?
The United States has fully embraced the mantle to underwrite any and all international financial or economic accidents. We do not seem to adapt to change. Instead, we apply old methods to new situations and expect similar outcomes as in the past. The system has been forced to adapt during a time when the normal business cycle has been altered, if not broken. The presence of China stands clearly as the greatest new wrinkle within the system.

In The Fatal Conceit, F A Hayek posed that the major failing of socialist philosophies was the conceit that man-made schemes to plan economic activity could succeed at addressing the myriad, changing needs that a large, complex society would generate over time, whereas such needs were beyond the ability of any single set of planners to comprehend and control. You have to wonder if the current crop of economic thinkers running the show in the Administration, on Wall Street or in the Federal Reserve has come down with such a conceit. But it is the nature of democratic nations that economic cycles will become the target of governmental attempts at regulation and control. People, if given a vote, will expect their representatives to "do something" about the painful consequences of "creative destruction", that necessary renewal process that a growing economy must undergo.

Another timely book describing the folly of trying to tame the markets is When Genius Failed, the Rise and Fall of Long Term Capital Management by Roger Lowenstein.


Blogger Hey Skipper said...


I'm not sure quite how appropriate this is to an economic system. It certainly makes sense when looking at the Challenger disaster, for instance.

But the current economic system has so many moving parts that nothing, or no one, controls any more than a tiny piece of it. In the US, for instance, it seems the Fed is content to focus on keeping inflation within a narrowish band.

I think what should be more noteworthy is the absence of economic crises; or, rather, the limited scope of such as there have been. Maybe all we had to learn from the depression are a few simple lessons: maintain liquidity, stifling trade is self defeating, and watch those margin trades.

Someone far funnier than I said not too long ago "Stock market crashes have successfully predicted twelve of the last three recessions."

December 13, 2004 5:14 PM  

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