As policy makers now begin to revamp global financial and economic systems, they would be wise to consult the classic analysis of the Great Depression by economists Milton Friedman and Anna Schwartz in A Monetary History of the United States. “[E]conomic collapse,” they wrote, “often has the character of a cumulative process. Let it go beyond a certain point, and it will tend for a time to gain strength from its own development as its effects spread and return to intensify the process of collapse. Because no great strength would be required to hold back the rock that starts a landslide, it does not follow that the landslide will not be of major proportions.”
We will also have to remember that our risks go far beyond finance, and the fixes we need go far beyond financial policies. The interactions of the economy and the physical environment are similarly tightly coupled. The reckless gambles the world took on the recent financial bubble are dwarfed by the long-term gambles we have been taking by our failure to address the interconnected crises of water, energy, poverty, food, and climate change. The financial crisis should quickly and urgently open our eyes to these much greater systemic threats and the global cooperation needed to redress them.
Note: This article was originally printed with the title, "Blackouts and Cascading Failures".
This article was originally published with the title Blackouts and Cascading Failures.
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6 Comments
Add CommentA fifth element is being to often underestimate: simple frauds and Ponzi schemes. If the priority is to make money from money, at the end
Reply | Report Abuse | Link to this<a href="http://mgiannini.blogspot.com/2008/12/recession-uncovers-what-auditors-cant.html">Recession uncovers what auditors can't</a>
"Fourth, the collapse in bank lending is quickly turning into a main street calamity." I refuse, why is everybody refusing to accept that people who earn less will not have money o pay, with wages been undercut over the last three decades it was going to happen sooner or later. The problem did not start in wall street it began with industry cutting costs when cutting costs was never the issue, making better products was the issue. Detroit has cut costs thousands of times in the last thirty years but they still make garbage cars, the knowledge going into their cars is not as great as that in Japan or Germany. Sachs unfortunately is acting like a herd economist, everybody says that I might as well say the same thing lest they cut my funding.
Reply | Report Abuse | Link to thisNot true, the problem did not begin in wall street it began with industry cutting costs instead of making better products than the competition. People are saying its wall street simply because they want to introduce regulation. Pity love is really what is lacking, if the industries really loved other human beings they would have made better products rather than reducing wages that at the end meant people could not pay their mortgages.
Can somebody please stand up to these evil people who are refusing facts in front of them, make better products and stop cutting wages so that people can afford to pay the mortgages what has wall street to do with that!!!!
The truth is by blaming wall street people are trying to pull of something sinister, we will only know why later
I mean their common peoples car are garbage, the good cars like Hummer the people can never afford
Reply | Report Abuse | Link to thisJeffrey D. Sachs spins a good yarn here. Yet, his story proves false.
Reply | Report Abuse | Link to thisThe economic collapse comes as an effect from the cause -- a massive credit bubble created by the Federal Reserve.
The Federal Reserve alone holds the monopoly charter on the manufacture and distribution of money and credit.
Member banks rented too much cash relative to the earnings power of Americans to pay debt service on such rented cash.
When buying power of the U.S. dollar fell beyond a tipping point, Americans could not pay for energy and food along with mortgages, home equity loans and credit card balances -- in short, their rented cash.
Once this became clear to foreign lenders, bankers experienced a giant margin call as their foreign lenders came to see that Americans could not service their debt.
Policy makers would do well to read Murray N. Rothbard's "America's Great Depression", the definitive and correct work on the subject and ignore Milton Friedman and Anna Schwartz's false work, "A Monetary History of the United States."
Commitment to excellence by improving constantly the product quality and couple the same with cost effectiveness so that the consumer gets products progressively improving in quality, at reducing prices, is the key to keep the consumption up beat and add wealth too because the purchasing power of the currency is sustained. This leads to sustained jobs and surplus incomes to enable spending. This in my mind is very critical core issue of building up an economy.
Reply | Report Abuse | Link to thisThen the same qualities should reflect in financial services and banking too. That means Ponzi schemes and similar conscious fraudulent games should be treated as crimes and the white collar criminals should not get the extended goodwill treatment. The regulators and the systems have notoriously played shut eye even though the signs were glaring.
The quality of lending keeping in view the debtor's capacity to pay is a fundamental issue, which again was compromised and that too knowingly. It is as much failure of the state regulators as well as that of the herds on the go to make quick commissions; make hay while the sun shines.
Then highly placed economists making it out as some complex phenomenon for which no one should be accountable is admirable in the face of so much real pain around, but this attitude will only lay the foundation for the next bout of more serious and severe bubble burst.
Yes the network approach to describe the collateral damage is fine but it is not the network which caused triggered the melt down. Fundamentals were forgotten in the glitz created by some monsters of creative get-rich-quick players who produced funny money and illusory wealth.
This editorial is a refreshing and insightful addition to the otherwise regretfully shallow economic conversation that permeates the public media. Permit me to add and additional dimension to this dialogue, a comment on perils in seeking the holy grail of economic stability.
Reply | Report Abuse | Link to thisThe mathematical analysis of the stability of dynamical systems teaches us that any system with a stable operational domain, surrounded by a region of instability, can be modified by local perturbations to create a larger domain of stability, euphemistically viewed as a more stable system. This may be simply an engineering version of Whac-A-Mole. The increased stability usually comes at a cost: The "stabilized" system is subject to more catastrophic failures if the boundary of instability is ever breached. The mathematics suggests that naive engineering to increase stability often enhances the risk of more catastrophic failures.
Let us illustrate this concept with a simple example. Suppose we were condemned to wander with others in a fog near a precipice. After observing a couple of disappearances of our peers, we decide on a strategy of holding hands with several of our colleagues. As the days pass, we are reassured when an occasional solo miss-step fails to lead to tragedy, as the errant ones are quickly pulled to safety. One day, several missteps occur simultaneously, and the entire party is pulled over the cliff. The cost of the enhanced local stability is the risk of a far-reaching calamity.
We have seen this process in practice. When we tire of local electrical blackouts, we arrange for hand-holding over an extended power grid, and have observed a reduction in local blackouts, at the expense of occasional regional blackouts. Some savants suggest the cure of an international grid. We protect against local bank liquidity crises by creating central banks with the power to dispense liquidity at a national level. When that system teeters, the suggested fix is to have the central banks hold hands.
These naive approaches are attempts to apply quick fixes without understanding the underlying problem. They are akin to applying Band-Aids without investigating the nature of the wound.
Economic systems are not amenable to the same degree of mathematical analysis as the control of mechanical systems, where the applicable laws of physics are well understood. A fundamental feedback in a social system is that regardless of how well it is designed, greed may attract some participants into attempting to game the system recklessly, ignoring its perils in their quest for personal riches. Introducing mechanisms to forgive their follies may not enhance stability, but might have the opposite effect of encouraging reckless behavior. Reading numerous biographies of the financially successful, I am impressed with how often they have endured numerous bankruptcies along the path to their ultimate success. Were they brilliant or simply gambling with other people's money? I have found no accompanying literature to enlighten me about those who endured numerous bankruptcies and never achieved success. What would be the damage to the economy if we all behaved so recklessly? Is "concerted reckless action" a synonym for "financial bubble"?
Perhaps we are naive to believe that we can have a stable capitalist economy without facilitating the creative destruction of inefficient entities. Perhaps allowing easy rescues through Chapters 11 & 12 bankruptcy reorganizations postpones tragedies for individuals at the expense of the health of the entire marketplace. Perhaps even Chapter 7 bankruptcy (liquidation) should not excuse one from future repayments if there are ensuing extraordinary financial successes.
To our peril, we seem to be relying on banking technicians rather than market philosophers. Beware of "experts" who mindlessly worship at the alter of "bigger is better". Is an unintended consequence of bale-outs the encouragement of gambling with taxpayer money? Does one dare to investigate whether our current political-economic system is fundamentally flawed? For example: Do our current implementations of free market capitalism and representative democracy have inherently unstable interactions? Applying haphazard fixes without regard to understanding of the underlying problems is simply playing Whac-A-Mole with our financial system.