Friday, July 03, 2009

Essentially, what Watts (what? Only three wots? That’s not very bright!) should be arguing is that the global financial system got to the point where:

• It is self-sustaining and self-replicating.
• Self-referential and circular functions had become undetectable and unmeasurable.
• Responses of the system to external stimuli were becoming increasingly chaotic as a result.

Then it is not a case of individual companies being “too big to fail”. That is a political crock, reasoned to justify governmental intervention of a particular kind and for equally political purposes. At the political level, that kind of intervention can be justified provided that the rationale is honest – it is for political reasons that A is too big to fail. The cause of the failure might well be unforeseen circumstances arising from the global financial system. That is accepted. That is not the reason for the intervention; that is political, whoever does it.

Intervention, at its best, can do no more than try to hold the system in its current form of “equilibrium” whatever that might be. Any action that might disturb that equilibrium runs the risk of the global system going haywire or imploding. No one can point at any part of the global financial system as say “There is the initial cause – the tree that fell on the powerline”, as Watts has pointed out. However, his attempt at divining the cause to Lehmans’ door is as correct and effective as blaming the Pharoahs.

What must be considered here is that if the US government allowed Lehmans (or any of the other “too big to fail” financial companies) to fail (and similarly in Britain, in Japan, in Europe) then the consequential catastrophic failure of the global financial system would have been laid squarely (and fairly) at the respective government’s doorstep. To not recognise that as a primary political motive is shortsighted and just plain wrong. If the catastrophic failure had occurred (as it may still) the outcome for the likes of the US and other western nations would be bleak indeed. The main beneficiaries would be those economies with little to lose and the resources to take charge – led by China and India, perhaps Russia and South Africa if they could get their political houses in order.

The second consideration is that China currently owns some USD4 trillion of the US in the form of US Government Bonds. Add to that the likely indirect investment in the US private sector (by investment in banks that have on-lent the funds) and a very large part of the US is “owned” by (mortgaged to) China. And it must be said that the current Administration would be responsible for only a small part of that debt. The best part of it has gone up in smoke (literally) “in defence of freedom and the American Way” in Iraq and Afghanistan.

So, to all those who want to criticise their governments for their actions and reactions to prevent the potential collapse of the global financial system I want to propose the following –

1. If the present system is allowed to collapse, then there has to be some way of rebuilding it with the safeguards that are missing from the present system. As there has been very little in the way of commentary on what form it may take, it is useless to try and impose this or that political outlook on the future.
2. If the present system is allowed to collapse, the “owners” of the new system are likely to be those who have the resources – natural and/or economic – that will give them the power to control the system. As I have said, that could well lead to the present “masters” being overturned with totally unpredictable results.
3. The difficulty with the present system stems from size, rather than individual elements. I have posted on that aspect previously, and it requires no repeating here. It is the comprehension of the size that is the problem.

In the first episode I compared the global financial system with a Persian Carpet.
We can see the pattern, the inter-relationships, made by the thousands of individual tufts. We can even estimate the total number of tufts that there might be in the whole carpet.

But what happens if we examine one tuft. Enlarge it many many times – holy Mandelbrot!! It looks almost like the original carpet! This time around though, instead of looking at the whole carpet we have a small group – perhaps a nation, a city, perhaps a commodity market, perhaps an international company. It interacts with neighbouring tufts, with the “tufts” from which it is made, and via the carpet backing with other more distant tufts.

Now, repeat the same exercise. This time instead of organisations as the basis, consider the idea of information. The Persian carpet is the “summary” of the global financial markets. Think of it as a financial report. The individual tuft is the financial report set of an individual organisation. It presents information that is based upon a large number of individual transactions. Each of the threads within that tuft could be a category of income or expense, or transactions with another tuft. One has to know the rules for the tuft (how it works, what it contains) before it makes sense. In the context of the total carpet that tuft means very little. Removal of the tuft does change the carpet, it diminishes it.

Now, if you want to chage the pattern of that carpet, where do you start? Which tuft is the first to be moved, or removed? If you come across a tuft that is particularly worn, how do you go about replacing it so that the pattern is maintained, the integrity of the carpet remains?

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