Essay – Money, Credit & Financial Systems

We’re fooling ourselves if we blame the recent crisis on character defects unique to our time, be it unusually lax regulators, particularly shortsighted politicians, or financial market participants avaricious beyond the norm.

Truth is, each of these qualities fluctuates with the prevailing social mood: they’re inherently pro-cyclical. When it would be ideal from society’s point of view for them to zig, they tend to zag. Nor is there much reason to think this is going to change anytime soon. We’re human, all too human, and so would be well advised to insulate critical social systems from our long-term shifts in sentiment.

Easier said than done, though. Not only because designing foolproof (or, more accurately, resilient) systems isn’t easy, but also because even assuming we do there’s every chance our progeny will find a way to undo them during the next great wave of optimism.

Still, we can but try.

Adair Turner (chairman of the UK Financial Services Authority) and Mervyn King (Governor of the Bank of England) are both acutely aware of this dilemma. Far more than any other senior financial markets officials, they try to get at the deeper underlying causes.

On Monday, October 25th, King gave a talk in New York entitled “Banking: From Bagehot to Basel, and Back Again”. Continue reading “Some further thoughts on financial reform”

Markets, indeed economies as a whole, are complex adaptive systems. Like biological ecosystems, they continuously and spontaneously order themselves in response to unfolding influences, large and small, internal and external.

When it comes to nature, we’re both part of it and a profound external influence. We shape the world around us for ill and sometimes for good, not only through deliberate actions but also, of course, merely by being here. Some of our activities and their consequences in the natural world, were we only willing to listen, could teach us much about how to better manage man-made systems such as the markets and the economy.

Forestry management provides a striking example. Our natural inclination is to put fires out wherever we can, not only to safeguard valuable property but also to protect the forests themselves and their many wild occupants.

In pursuing this practice, however, subtle changes take place over time. Dead trees and fallen branches accumulate and the undergrowth becomes thicker and much more widespread. Finally a fire occurs that we’re unable to stop, one that feeds on all the detritus to produce firestorms so powerful they can at times fundamentally change a whole ecosystem.^[1]

The analogy to our economic management in recent decades is obvious, particularly when it comes to the financial system. There too, fires were continuously put out, all with the laudable goal of sidestepping the pain and distress of downturns. Continue reading “Macroeconomic Resilience”