TheSnail

Yet Another Finger of Instability

John,

Happy Birthday. And thank you for sharing your newsletter for free. I am still amazed I was able to read your insights for no charge over the past two years.

To fully appreciate what you are saying in this article, the reader needs to distinguish between "a tipping point " - corresponding to the onset of a sand avalanche in your sand pile, or one of any number of external forces that would cause a perfectly balanced tetter-totter to tilt one way or the other - and the constraints imposed on the system, which alter the conditions under which the tipping point occurs.

Using your sandpile example, there is a significant difference between a sandpile resting on a flat surface, which has no external constraints on it, and a sandpile formed within a ring. For a properly sized ring the onset of a significantly sized sand avalanche will be delayed, relative to the number of sand grains that have fallen, due to the external constraint imposed on the system.

If we now let the ring be comprised of bricks, then each brick represents an external constraint that aids in preventing undesirable sand avalanches (or a financial system collapse). In this analogy, some of the bricks represent the laws needed to provide the proper checks and balances in a financial system. Some of the bricks represent sound monetary policies by the Fed. And so on.

As such the discussion of causes of the financial crises corresponds to the removal of bricks or constraints that provide the "guide rails" under which the system operates smoothly.

And thus I would argue that the key underlying causes of the financial crises are identifiable (i.e., which bricks are missing). And the particular grain of sand or butterfly that initiated the avalanche is of secondary importance. (Very interesting, of course, but of secondary importance.)

Fellow scientist/engineers will recognize that I am simply pointing out the importance of boundary conditions on any system. A porous boundary will hold no water. And clearly our financial system had plenty of holes in at the time the butterfly initiated the tipping point.

Regards,
Richard Geist