Currency Wars: The Making of the Next Global Crisis (33 page)
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Authors: James Rickards
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BOOK: Currency Wars: The Making of the Next Global Crisis
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The result in this test case of repudiation by a hundred people is that nothing would happen. This is because the lowest critical threshold shared by any group of individuals in the system is represented by T = 500. This means that it takes repudiation by five hundred people or more to cause this first group to also repudiate the dollar. Since only one hundred people have repudiated the dollar in our hypothetical case, the critical threshold of T = 500 for the most sensitive group has not been reached and the group as a whole is unaffected by the behavior of the one hundred. Since all of the remaining T values are higher than T = 500, the behavior of those groups is also unaffected. None of the critical thresholds has been triggered. This is an example of a random event dying out in the system. Something happened initially, yet nothing else happened as a result. If the largest group that would initially repudiate the dollar is fixed at one hundred, this system is said to be subcritical, meaning it is not vulnerable to a chain reaction of dollar repudiation.
Consider a second hypothetical case, shown in Table 2 below. The groupings of individuals by size of group are identical to Table 1. This system of critical thresholds is identical to the system in Table 1 with
two small differences
. The critical threshold for the first group has been changed from T = 500 people to T = 100 people. The critical threshold for the second group has been changed from T = 10,000 people to T = 1,000 people, while all the other values of T for the remaining three groups are unchanged. Put differently, we have changed the preferences of 0.3 percent of the population and left the preferences of 99.7 percent of the population unchanged. Here is the new table of thresholds with the two small changes shown in bold:
two small differences
. The critical threshold for the first group has been changed from T = 500 people to T = 100 people. The critical threshold for the second group has been changed from T = 10,000 people to T = 1,000 people, while all the other values of T for the remaining three groups are unchanged. Put differently, we have changed the preferences of 0.3 percent of the population and left the preferences of 99.7 percent of the population unchanged. Here is the new table of thresholds with the two small changes shown in bold:
Table 2: HYPOTHETICAL CRITICAL THRESHOLDS (T) FOR DOLLAR REPUDIATION IN U.S. POPULATION
Now what happens when the same one hundred citizens repudiate the dollar as in the first case? In this second case, one hundred rejections will trigger the critical threshold for one thousand people who now also reject the dollar. Metaphorically, more people are running from the movie theater. This new rejection by a thousand people now triggers the critical threshold for the next one million people, and they too repudiate the dollar. Now that one million have repudiated the dollar, the next threshold of one hundred thousand is easily surpassed, and an additional ten million people repudiate the dollar. At this point, the collapse is unstoppable. With ten million people repudiating the dollar, another one hundred million join in, and soon thereafter the remaining two hundred million repudiate at once—the rejection of the dollar by the entire U.S. population is complete. The dollar has collapsed both internally and internationally as a monetary unit. This second system is said to be supercritical, and has collapsed catastrophically.
A number of important caveats apply. These thresholds are hypothetical; the actual values of T are unknown and possibly unknowable. The T values were broken into five bands for convenience. In the real world, there would be millions of separate critical thresholds, so the reality is immensely more complex than shown here. The process of collapse might not be immediate from threshold to threshold but might play out over time as information spreads slowly and reaction times vary.
None of these caveats, however, detracts from the main point, which is that
minutely small changes in initial conditions can lead to catastrophically different results.
In the first case there was no reaction to the initial repudiation by a hundred people, while in the second example the entire system collapsed. Yet the catalyst was the same, as were the preferences of 99.7 percent of the people. Small changes in the preferences of just 0.3 percent of the population were enough to change the outcome from nonevent to complete collapse. The system went from subcritical to supercritical based on almost zero systemic change.
minutely small changes in initial conditions can lead to catastrophically different results.
In the first case there was no reaction to the initial repudiation by a hundred people, while in the second example the entire system collapsed. Yet the catalyst was the same, as were the preferences of 99.7 percent of the people. Small changes in the preferences of just 0.3 percent of the population were enough to change the outcome from nonevent to complete collapse. The system went from subcritical to supercritical based on almost zero systemic change.
This is a sobering thought for central bankers and proponents of deficits. Policy makers often work from models that assume policies can continue in a steplike manner without unpredictable nonlinear breakdowns. Money printing and inflation are considered to be the answer to the lack of aggregate demand. Deficits are considered to be an acceptable policy tool to increase aggregate demand by stimulus spending in the public sector. Printing money and deficit spending continue from year to year as if the system is always subcritical and more of the same will have no extreme impact. The model shows this is not necessarily true. A phase transition from stability to collapse can begin in imperceptible ways based on tiny changes in individual preferences impossible to detect in real time. These weaknesses are not discovered until the system actually collapses. But then it is too late.
With this example of how complex systems operate and how vulnerable the dollar may be to a loss of confidence, we can now look to the front lines of the currency war to see how these theoretical constructs might manifest in the real world.
The history of Currency Wars I and II shows that currency wars are last-ditch responses to much larger macroeconomic problems. Over the past one hundred years, those problems have involved excessive and unpayable debts. Today, for the third time in a century, the debt overhang is choking growth and inciting currency war, and the problem is global. Europe’s sovereign borrowers and banks are in worse shape than those in America. Housing booms in Ireland, Spain and elsewhere were as reckless as the boom in the United States. Even China, which has enjoyed relatively strong growth and large trade surpluses in recent years, has an overleveraged shadow banking system run by provincial authorities, a massively expanding money supply and a housing bubble that could burst at any moment.
The post-2010 world may be different in many ways from the 1920s and the 1970s, but the massive overhang of unpayable, unsustainable debt is producing the same dynamic of deleveraging and deflation by the private sector offset by efforts at inflation and devaluation by governments. The fact that these policies of inflation and devaluation have led to economic debacles in the past does not stop them from being tried again.
What are the prospects for avoiding these adverse outcomes? How might the global debt overhang be reduced in a way that could encourage growth? Some analysts posit that the political struggle on government spending is just posturing and that once matters become urgent and key elections are over sober minds will sit down and do the right thing. Others rely on highly debatable projections of growth, interest rates, unemployment and other key factors to put deficits on a glide path to sustainability. There is good reason to view these forecasts with doubt, even pessimism. The reason has to do with the dynamics of society itself. Just as currency wars and capital markets are examples of complex systems, so those systems form part of larger complex systems with which they interact. The structure and dynamics of these larger systems are the same—except the scale is greater and the potential for collapse greater still.
Complexity theorists Eric J. Chaisson and Joseph A. Tainter supply the tools required to understand why spending discipline will likely fail and why currency wars and a dollar collapse may follow. Chaisson, an astrophysicist, is a leading theorist of complexity in evolution. Tainter, an anthropologist, is also a leading theorist of complexity as it relates to the collapse of civilization. Their theories, taken together and applied to capital markets as affected by contemporary politics, should give us pause.
Chaisson considers all complex systems from the cosmic to the subatomic and zeroes in on life generally and humans in particular as being among the most complex systems ever discovered. In his book
Cosmic Evolution,
he considers the energy requirements associated with increasing complexity and, in particular, the “energy density” of a system, which relates energy, time, complexity and scale.
Cosmic Evolution,
he considers the energy requirements associated with increasing complexity and, in particular, the “energy density” of a system, which relates energy, time, complexity and scale.
Chaisson posits that the universe is best understood as the constant flow of energy between radiation and matter. The flow dynamics create more energy than is needed in the conversion, providing “free energy” needed to support complexity. Chaisson’s contribution was to define complexity empirically as a ratio of free energy flow to density in a system. Stated simply, the more complex a system is, the more energy it needs to maintain its size and space. Chaisson’s theories are well supported, starting with the original laws of thermodynamics through more recent sophisticated local observations of increasing order and complexity in the universe.
It is well understood that the sun uses far more energy than a human brain. Yet the sun is vastly more massive than a brain. When these differences in mass are taken into account, it turns out that the brain uses 75,000 times as much energy as the sun, measured in Chaisson’s standard units. Chaisson has also identified one entity vastly more complex than the human brain: society itself in its civilized form. This is not surprising; after all, a society of brainy individuals should produce something more complex than the individuals themselves. This is wholly consistent with complexity theory, civilization being just an emergent property of individual agents with the whole greater than the sum of its parts. Chaisson’s key finding is that civilization, adjusted for density, uses 250,000 times the energy used by the sun and one million times the energy used by the Milky Way.
To see the implications of this for macroeconomics and capital markets, begin with the understanding that money is stored energy. The classic definition of money includes the expression “store of value,” but exactly what value is being stored? Typically value is the output of labor and capital, both of which are energy intensive. In the simplest case, a baker makes a loaf of bread using ingredients, equipment and her own labor, all of which use energy or are the product of other forms of energy. When the baker sells the loaf for money, the money represents the stored energy that went into making the bread. This energy can be unlocked when the baker purchases some goods or services, such as house painting, by paying the painter. The energy in the money is now released in the form of the time, effort, equipment and materials of the painter. Money works exactly like a battery. A battery takes a charge of energy, stores it for a period of time and rereleases the energy when needed. Money stores energy in the same way.
This translation of energy into money is needed to apply Chaisson’s work to the actual operation of markets and society. Chaisson deals at the highest macro level by estimating the total mass, density and energy flow of human society. At the level of individual economic interactions within society, it is necessary to have a unit to measure Chaisson’s free energy flows. Money is the most convenient and quantifiable unit for this purpose.
The anthropologist Joseph A. Tainter picks up this thread by proposing a related yet subtler input-output flow analysis that also utilizes complexity theory. An understanding of Tainter’s theory is also facilitated by the use of the money-as-energy model.
Tainter’s specialty is the collapse of civilizations. That’s been a favorite theme of historians and students since Herodotus documented the rise and fall of ancient Persia in the fifth century BC. In his most ambitious work,
The Collapse of Complex Societies,
Tainter analyzes the collapse of twenty-seven separate civilizations over a 4,500-year period, from the little-known Kachin civilization of highland Burma to the widely known cases of the Roman Empire and ancient Egypt. He considers an enormous range of possible factors explaining collapse, including resource depletion, natural disaster, invasions, economic distress, social dysfunction, religion and bureaucratic incompetence. His work is a tour de force of the history, supposed causes and processes of civilizational collapse.
The Collapse of Complex Societies,
Tainter analyzes the collapse of twenty-seven separate civilizations over a 4,500-year period, from the little-known Kachin civilization of highland Burma to the widely known cases of the Roman Empire and ancient Egypt. He considers an enormous range of possible factors explaining collapse, including resource depletion, natural disaster, invasions, economic distress, social dysfunction, religion and bureaucratic incompetence. His work is a tour de force of the history, supposed causes and processes of civilizational collapse.
Tainter stakes out some of the same ground as Chaisson and complexity theorists in general by demonstrating that civilizations are complex systems. He demonstrates that as the complexity of society increases, the inputs needed to maintain society increase exponentially—exactly what Chaisson would later quantify with regard to complexity in general. By inputs, Tainter refers not specifically to units of energy the way Chaisson does, but to a variety of potentially stored energy values, including labor, irrigation, crops and commodities, all of which can be converted into money and frequently are for transactional purposes. Tainter, however, takes the analysis a step further and shows that not only do inputs increase exponentially with the scale of civilization, but the outputs of civilizations and governments
decline
per unit of input when measured in terms of public goods and services provided.
decline
per unit of input when measured in terms of public goods and services provided.
Here is a phenomenon familiar to every first-semester microeconomics student—the law of diminishing returns. In effect, society asks its members to pay progressively
more
in taxes and they get progressively
less
in government services. The phenomenon of marginal returns produces an arc that rises nicely at first, then flattens out, and then declines. In this thesis, the familiar arc of marginal returns mirrors the arc of the rise, decline and fall of civilizations.
more
in taxes and they get progressively
less
in government services. The phenomenon of marginal returns produces an arc that rises nicely at first, then flattens out, and then declines. In this thesis, the familiar arc of marginal returns mirrors the arc of the rise, decline and fall of civilizations.
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