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Imagine, instead of stranded passengers, stranded money. Imagine, instead of volcanic ash creating doubts about the safety of flying, a poor auction, bankruptcy, financial fraud charge, or regulatory change creating doubts about the safety of investments. Just as planes don't have to crash, concern itself is enough to stop the flow of passengers; investments don't have to go bust, concern itself is enough to stop the flow of money.

BRUSSELS (Reuters) - Disruption of air traffic because of the spread of volcanic ash from Iceland worsened on Saturday with no landings or takeoffs possible for civilian aircraft in most of northern and central Europe.

The European aviation control agency Eurocontrol said it expected about 5,000 flights in European airspace on Saturday, against 22,000 normally. This compared with 10,400 flights against a normal 28,000 on Friday it said, adjusting figures from an earlier statement.

During an internet chat with the In-Laws in Singapore I discovered that air traffic disruptions in Northern Europe had clogged Singapore's Changi airport with stranded travelers- a reflection, no doubt, of many busy airports around the world. This real world experience seems to me a great metaphor to explain disruptions in the flow of funds which operate on similar principles but don't manifest in such easily seen ways.

Due to the grounding of flights in Europe, passengers all over the world are stuck where they are. Whatever tasks await them at their destinations will either not get done or will have to be done by others.

Imagine, instead of stranded passengers, stranded money. Imagine, instead of volcanic ash creating doubts about the safety of flying, a poor auction, bankruptcy, financial fraud charge, or regulatory change creating doubts about the safety of investments. Just as planes don't have to crash, concern itself is enough to stop the flow of passengers; investments don't have to go bust, concern itself is enough to stop the flow of money.

Air traffic congestion brought on by safety concerns is one cause of a significant decline in the velocity of travel. Similarly, monetary congestion brought on by safety concerns is one cause of a significant decline in the velocity of money.

Stranded passengers mean work may be undone, meetings may be postponed, and dates may be cancelled. Stranded money means the same things- bills may be unpaid, investments may be postponed, and equity and security issues may be cancelled.

Due to the interconnectedness of the world through air travel, problems in one part of the world affect the whole. So it is with our interconnected world of finance.

One issue of concern, no doubt, for quite a few stranded passengers is their available reserves. Will the family at home have enough money to pay their bills while some members are gone? Will the stranded passengers have enough available cash to satisfy their needs?

Paraphrasing Warren Buffett, it's only when volcanic ash grounds planes that you find out who's been flying naked.

When the flow of funds is similarly disrupted, reserves are key. The nearer financial entities operate to insolvency the less able they are to deal with disruptions in cash flow. This is the principle behind reserve requirements in banking, and it applies to all financial entities, from a Professor stranded in London to a Hedge Fund waiting for settlement- without sufficient reserves, small defaults can cascade into global problems. Thus are some financial market crashes precipitated.

Indeed, we may well find that this round of air traffic congestion leads to a growing flow of funds disruption. The metaphor may become life.

Chaos theorists refer to the butterfly effect- how a butterfly's flapping wings may change the weather on the other side of the world. This would be the volcano effect- how volcanic ash precipitated a market crash on the other side of (or the entire) world.

There are three key determinants to the extent of this financial chaos effect: 1) the degree to which a critical mass of people are operating near insolvency 2) the degree of payment interconnectedness 3) the duration of the congestion.

In my view, the first two determinants are quite high, only the duration remains unknown.

If only there were Human Central Banks who could conjure up simulated people where needed in the same way Monetary Central Banks conjure up money. Conjuring up people to relieve declining velocity of travel, however, would over-populate the world with people in the same way that monetary stimulus to relieve declining velocity of money over-populates the world with money.

What was that about Death Panels.....

Source: Chaos Theory: Could a Volcano Crash the Markets?