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David Knox Barker is the founder of Market Cycle Dynamics, LLC, and the publisher and editor of The International Market Cycle Dynamics Letter. Barker is one of the world's foremost experts on market cycles and the global economic long wave. He is the author of The K Wave; Profiting from the... More
My company:
Market Cycle Dynamics, LLC
My blog:
MCD Weekly Briefing Blog
My book:
The K Wave; Profiting from the Cyclical Booms and Busts in the Global Economy - eBook
  • The Edge of Chaos 0 comments
    Feb 19, 2011 11:33 PM

    Nobel economist Friedrich Hayek’s most enduring legacy is his defense of classical liberalism and free market capitalism. The Road to Serfdom is Hayek’s case against central planning, something he viewed as a product of human design as opposed to human action. Hayek and his mentor Ludwig von Mises were the preeminent writers and thinkers of the Austrian school of economics and political economy.

    Hayek also made major contributions to complex systems theory, specifically related to what he called the spontaneous order of markets. He does not always get credit for his advanced thinking on complex systems theory. This oversight may change in the future, as the recognition that global markets are dynamic complex systems is certain to experience a renaissance in the near future.

    Complex systems theory is an approach to scientific problems in any field of endeavor that studies how the individual parts in a system give rise to the behavior of the whole system. Understanding how central banks pumping trillions of dollars into developed markets that in turn trigger food inflation and food shortages around the world, and the resulting revolutions, is a matter of interest for complex systems theorists.

     Complex Systems

    Spontaneous order is the natural emergence of order out of seeming chaos. Complex systems and spontaneous order go hand in hand. These two concepts explain progress and setbacks in economic growth and development in both the developed world and emerging markets, i.e., the global system. Our understanding of spontaneous order in markets and the complex systems it produces is in the early stages.

    The fact that the complex system of global markets came close to total meltdown in 2008-2009, and that major systemic risks remain and are likely building, means keeping an open mind regarding markets as complex systems is an imperative. There is a growing hope that the central planners and human designers at the central banks in both the developed and emerging world have the situation under control, but the growing number of spontaneous revolutions around the world suggest it is a bit early to make that call.  

    This is where things get interesting for those interested in a global system of human freedom and liberty. Hayek proposed that in a free market spontaneous order emerges out of chaos based on self-interested human action. Trillions of self-interested human decisions produce the activity in global markets on a daily basis. Hayek recognized that this spontaneous order is part of complex system development. Spontaneous order emerges from chaos.

    The crisis of 2008-2009 revealed that the price mechanism of markets is greatly distorted by the interference of human design. Fiscal and monetary interventionism produces malinvestment. Overvalued homes around the world and the bad mortgage debt they spawned are one example. The price mechanism failed and was unreliable for effective human action. Chaos is only a few trading days away in a complex system distorted by human design and interventionism when confidence heads south.

    The free market domain of the spontaneous order of human action lies between the error prone realm of central planning by human design on the one hand, and chaos and anarchy on the other. Central planning is not self-interested; it is falsely presented as representing the collective interest, but in fact typically just watches out for special interest, most recently the big banks that continue to leverage their zero interest money, pushing up the price of commodities and food around the world.

    Clearly, free markets have suffered a major setback, and there are a growing number of examples of central planning that trades self-interested human action for anarchy around the globe. Free human action produces a dynamic stable system of risk and reward at the edge of chaos. Central planning by human design produces global crisis and anarchy.

    In a true free global marketplace, a self-interested supply of human capital and financial capital determines whether ideas and investments are worth pursing. Entrepreneurs must calculate their costs in the limited resources that are available. If the ideas become products or services, the pricing mechanisms of markets work their magic. Fast-paced free markets determine which products and services are winners and which ones are losers, whether cars, houses, i-Pads, hamburgers or art. It sometimes looks like chaos, but spontaneous order emerges. One way of looking at the rapidly changing domain of spontaneous order in markets is that it is a dynamic force, always on the edge of chaos, always changing, producing healthy competition.

    No one person or organization can allocate the resources of such a large complex system as the global economy, but there are invariably those that believe they can. Central planning that steps in and takes control from the free market, prevents the natural spontaneous order that allocates resources by rewarding those that most effectively fill market needs with the right mix of price and quality in their products and services. A study of history suggests that the outcome of central planning is not order, but is in fact chaos and destruction of everything we hold dear. Central planning prevents the price mechanisms from working, and the complex system breaks down, imploding from the weight of its contradictions.

    The regimes that have recently experienced revolution, like Tunisia and Egypt, were states dominated by the central planning of dictators. The dominoes are lining up for the failure of central planning everywhere around the world. Yemen, Bahrain, Iran, Saudi Arabia and even the citizens of Wisconsin realize the complex system of the global economy is in a state of flux. The consequences of central planning in the developed world are destroying the pricing mechanism for commodities, labor and financial assets in global markets. The world has become destabilized; global spontaneous order rooted in the free markets of the developed world has been compromised.  

    Decades of the suppression of human freedom and liberty has undermined spontaneous order in the global economy and is making many countries far more unstable than their leadership or analysts realize. Chaos is the result of the inherent instability of central planing. Fortunately, the complex system of the global economy has created new information technology in the form of the Internet and social networking. New forms of connectivity are triggering the spontaneous organization of the lovers of human freedom and liberty everywhere. There are great risks. These movements could rapidly turn failed unstable central planning into chaos. Free markets must be allowed to flourish to counter potential anarchy. These movements will not settle for new regimes of central planning.  

     The Edge of Chaos

    The battle lines being drawn between chaos and spontaneous order in stable complex systems brings up the economic calculation problem, first proposed by von Mises, but effectively expounded by Hayek. In short, the economic calculation problem is that central planning simply cannot know how to allocate resources. The reason is that central planning does not have a valid pricing mechanism. A good example is that the market cannot properly price risk when central banks step in and arbitrarily purchase bad debts, injecting billions into global markets. When politicians and their appointees play favorites, picking winners and arbitrarily determining the losers, any notion of market price and real value go out the window. 

    Hayek directly connected his thinking on the necessity of the price mechanism for a functioning market and economy and his ideas of the spontaneous order of markets. The search for price in a free market is what produces the spontaneous order. Financial markets serve as the pricing mechanism of financial assets. When the U.S. central bank takes on a third mandate to force prices of financial assets higher by maintaining a zero interest rate policy and quantitative easing in order to produce a virtuous circle, they are greatly distorting the pricing mechanism of markets for debt and equities. They are effectively destroying the critically important feedback loops and the pricing mechanism of markets. Spontaneous order is no longer spontaneous when the pricing mechanism is highjacked by human design.

    It is important to recognize that technical analysis of stocks, bonds and currencies is the study of the pricing mechanism of markets. Hayek recognized that the pricing mechanism was critically important to a functioning and dynamic economy. Once you recognize that markets are the product of spontaneous order, it must also be recognized that technical analysis of financial markets is the search for order in the pricing mechanism, and recognizes that the pricing function can be tracked and analyzed.

    Anyone that has studied market prices and the Fibonacci ratios in market prices recognizes that Fibonacci ratios exert a powerful influence on the pricing mechanism. In many respects, Fibonacci ratios appear to be central to the pricing mechanism. Fibonacci ratios are known to express the growth and decay of living things. This applies to the ebb and flow of national, regional and global markets.

    Regarding the spontaneous order of markets and market cycles, the late PQ Wall put forward a rather bold proposal. What he essentially claimed was that the spontaneous order of markets and the complex systems they reflect produce recurring market cycles that fit together like a puzzle. He was essentially proposing natural law for the pricing mechanism of markets. What this reasoning suggests is that Hayek’s spontaneous order in markets can actually be identified, quantified, and successfully tracked using the tools of technical analysis in the price mechanism of financial markets.

    PQ’s proposed framework of cycles has been analyzed using new Fibonacci methods to study his family of cycles in price and time. Extensive research has uncovered that the cycles in his framework have “ideal” lengths. These ideal lengths are expected to reflect the natural forces of the spontaneous order in markets. They represent a framework for the complex system of cycles in a free market economy. PQ Wall’s approach to cycles, when combined with the idea of “ideal” lengths, with degrees of freedom governed by Fibonacci ratios, represents natural law in the spontaneous ordering of markets. Cycle analysis using Fibonacci methods in price and time opens a Pandora ’s Box of cycle tracking tools for investors and traders.

    Market cycles are simply a reflection of the spontaneous order that exists in markets on the edge of chaos. The Kondratieff (Kondratiev) long wave, the long wave season, the Kitchin cycle (aka business cycle), and the Wall cycle (aka 20-week cycle) are all examples of the spontaneous order produced by human action in markets. The Wall cycle is a miniature Kondratieff long wave, both of these cycles are ignored at the peril of investors and traders.  

    Recent years of global crisis have witnessed the greatest efforts in human design since the New Deal. In many respects, human design implemented by the U.S. Federal Reserve, ECB and Bank of China in recent years make Roosevelt’s New Deal look like child’s play. The third mandate of keeping markets rising is striking at the very heart of spontaneous order that depends on the pricing mechanism of markets.

    The economic calculation problem suggests that central banks cannot know what equity prices should be, but their goal is to keep them rising. Stock prices can no longer be completely trusted as a reflection of true market forces. Sophisticated investors and traders are taking their chips off the table and going home. The complex system of the global economy is being strained to the breaking point. The human design and central planning of zero interest rates and quantitative easing are confusing self-interested human action. By manipulating the pricing mechanism of markets, the central planners are pushing global markets from stable human action driven complex systems on the edge of chaos toward anarchy, which is always the inevitable result of central planning.

    A violent feedback loop in the complex system of human action is unfolding globally. However, the impending global debt collapse has the potential to produce a modern day Jubilee. There is evidence that the violent global convulsion of human action we are in the midst of will accelerate into 2012, and central planning and human design will meet their just demise.

    Beyond the unfolding global crisis, a new golden age of spontaneous order and global prosperity will dawn. A global human action driven free market revolution has begun. It is sweeping the world, and appears to have now arrived in the United States. The central planners are doomed. The edge of chaos will give birth to The Great Republic.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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