Why economic alarmists are dangerous, and what has to happen for the financial system or economy to collapse.
In this episode you’ll learn:
- What is an alarmist.
- What is confirmation bias.
- What is the velocity of money what influences it.
- What are purchasing manager indices (PMI) and how do they correlate to the direction of the economy.
- What is the cyclically adjusted price-to-earnings (CAPE) ratio and how long has it taken for markets sell-offs to occur after CAPE ratio exceeded 25.5 in the U.S.
- What is recency bias
- What are complex adaptive systems and why are they hierarchical.
Alarmists and the Economics of Collapse
An economic alarmist is someone who seeks to excite fear and panic in others about an imminent financial or economic collapse.
Many alarmists are sincere in their beliefs and feel compelled to warn others about the perceived danger.
Of course, professional alarmists are not opposed to making money off their fear mongering by selling products and services such as books, DVDs and survivalist gear.
Confirmation and Recency Bias
My problem with alarmists is they are so vested in their worldview that they suffer from a severe case of confirmation bias.
Confirmation bias is when individuals, often unconsciously, seek out and interpret information that confirms their point of view while ignoring or misinterpreting data that disconfirms it.
The glass is never half full for alarmists but perpetually close to shattering.
Alarmists also suffer from recency bias, which is the tendency to think events from the recent past will continue in the future.
Given the severity and emotional turmoil of the Great Recession and near global economic collapse, there is a natural inclination to believe another economic disaster is just around the corner.
Living in constant worry that a financial disaster is imminent is both stressful and exhausting.
At the same time, countries, societies, economies and ecosystems do and have collapsed. But it is rare and in this article I’ll explain why.
Complex Adaptive Systems
Economies, countries and ecosystems are complex adaptive systems.
Complex adaptive systems are decentralized organizations comprised of a wide variety of agents and variables that are interconnected.
Complex adaptive systems are hierarchical in that smaller elements within the system come together through their interactions to form larger elements.
For example, in an ecosystem, leaves join together with branches to form the crown of a tree, a small collection of trees forms a patch, patches form stands, stands of trees comprise a forest and a forest is part of a landscape that also includes grasslands, lakes and streams.
At each level of an ecosystem and other complex adaptive systems, there is a continual adaptive cycle of growth, conservation, restructuring and renewal.
These adaptive cycles occur at differing temporal and spatial scales.
The degree and rapidity of change is much greater at smaller scales, such as for leaves —with millions of leaves within a forest dying and growing annually.
Change is much slower at the level of the forest with the number of trees that die each year being a small fraction of the number of leaves. It can often take several years for a tree to die.
Even more rare is for an entire forest to die off as contagious disturbances such as wildfires or disease tend to leave some trees unscathed.
Similarly within the economy, the number of employees losing and getting new jobs or families filing bankruptcy is much greater both in number and frequency than businesses or industries that go bankrupt and begin again.
Bankruptcy of a city or state is even more rare. And for a country to default on its debt is very rare indeed. Yet, it does happen.
Patterns and developments that lead to the transformation or even collapse at the top level of the hierarchy can take decades or even centuries to develop.
That is because most errors, distress and collapse occur at the smallest local scale where the damage is limited and doesn’t spread to the entire system.
This makes the entire system robust, but not invulnerable.
How Societies Collapse
The economy and human society differ from nature in that they grow in complexity at a much faster pace.
Joseph A. Tainter, an American anthropologist and pioneer in the study of collapse, writes in Complexity, Problem Solving and Sustainable Societies, “A society that is more complex has more sub-groups and social roles, more networks among groups of individuals, more horizontal and vertical controls, higher flow of information, greater centralization of information, more specialization and greater interdependence of parts.”
Societies become more complex because there are benefits to complexity.
Greater specialization and complexity lead to more food, leisure and human creativity.
Tainter points out there are also costs to greater complexity, both in terms of time and energy.
“As a society increases in complexity, it expands investment in such things as resource production, information processing, administration and defense.”
More complex societies require greater coordination, which takes time and money. It also requires greater expenditures on energy, such as fuel to transport goods and services, rather than using items that can be sourced locally.
Societies can reach a point where the marginal benefit of increased complexity declines.
When more and more investment in greater complexity (often funded with debt) leads to fewer and fewer benefits, a society can become economically weakened and have insufficient reserves to meet and overcome adversity or crisis.
In addition, Tainter writes “diminishing returns make complexity less attractive and breed disaffection. As taxes and other costs rise and there are fewer benefits at the local level, more and more people are attracted to the idea of being independent. The society decomposes as people pursue their immediate needs rather than the long-term goals of leadership.”
Does the U.S. or other nations meet the conditions Tainter describes that make them vulnerable to collapse within the next six months as some alarmists warn?
It is highly unlikely given the glacial scale at which societies and regimes collapse. The Western Roman Empire declined for several hundred years before it finally fell.