Expert Explains In Detail How The Next Shock Will Shatter The Global Economy

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The eurozone is on a path into a deep recession. As one of the largest and most advanced economies in the world, its centrality to a system of highly-interconnected global supply chains is taken for granted.

 

David Korowicz, a physicist and human-systems ecologist, recently authored a lengthy 78-page white paper titled: “Trade-Off: Financial System Supply-Chain Cross-Contagion: a study in global systemic collapse.”

It explores the increasing systemic risk brewing in the global financial and trade systems. Using complex systems analysis, he explains how within weeks of the next major economic shock, like a major bank failure or a country exiting the eurozone, contagion would quickly spread through global supply chains, causing an “irreversible global economic collapse.”

Korowicz warns that in the next crisis, “neither wealth nor geography is a protection. Our evolved co-dependencies mean that we are all in this together.”

We read the paper and boiled it down to its key points.

The number of connections in the global economy is skyrocketing

Ancient Native American tribes produced a few hundred “cultural artifacts”–the physical things around you–while today’s New Yorkers produce tens of billions of such artifacts.

In 2005, there were 2 billion connected devices. Five years later, that number had tripled to 6 billion, and it’s expected that by 2015 the number will be 16 billion.

Supply chain interactions–as parts are manufactured and put together into bigger parts of even bigger goods and so on–are in the tens of billions.

Financial shocks can spread across the world in seconds

Several examples in recent years–like the collapse of Lehman Brothers in 2008 or the “flash crash” in the stock market in 2010–show how quickly financial turmoil can spread across highly interconnected markets.

Cities don’t keep emergency stockpiles of food and other goods anymore

Modern cities only keep around three days worth of food for its population on hand.

Advanced economies use incredibly efficient “Just-In-Time” logistics systems because they can track real time demand for goods automatically from check-out counters to factories who can adjust to these changing signals.

The danger of “Just-In-Time” logistics is that there isn’t a lot of inventory available for emergency situations.

Sovereign nations and banking systems are hot-wired for rapid contagion

Sovereign nations backstopping insolvent banks doesn’t remove the risks associated with a debt default–the risks are simply displaced andmagnified over time.

Spain is a good example. The country bails out its banks, but in the process increases its own debt. This, in turn, causes concern over the fiscal health of the country, which causes its bonds to sell off. The banks it just bailed out, who have been buying up Spanish bonds, are more insolvent due to the decrease in asset values.

Banks across the developed world are holding increasing amounts of their country’s sovereign debt, thus increasing overall system risks.

The global economic environment can no longer support the weak links in the chain

Other countries have faced problems of debt default before–like Argentina in 2002.

Because the world economy was relatively healthy and stable, it was able to absorb the impact of Argentina’s debt default.

The world economy is no longer healthy and stable. All signs point to a global slowdown looming ahead as Europe’s recession spills over into Asia, causing growth to slow there. Thus, another default would not be absorbed so easily.

Economic contraction is fundamentally incompatible with the international financial and monetary systems

The global economy is based upon credit expansion–new debt must be issued to service the interest on old debts.

When the economy is contracting, as it is in Europe, the ability to service old debts disappears and debtors become insolvent.

This changes the dynamics of the financial system, introducing the possibility of defaults and haircuts on debt, which can be highly destabilizing.

The stability of the global economy entirely depends on rising energy flows

The stability of the global economy entirely depends on rising energy flows

Korowicz writes that “maintaining complexity is a battle against entropic decay, and growing complexity is a battle against the universal tendency towards disorder.”

Equilibrium doesn’t exist in complex adaptive systems like the global economy–things are changing constantly.

Increasing complexity pushes a system further and further away from equilibrium–and it takes increasing amounts of energy to support that trend, or else a system will “fall back” toward its equilibrium.

The idea that we are behind the wheel of a complex economy is a myth

The idea that we are behind the wheel of a complex economy is a myth

The tens of billions of supply chain interactions that happen all around us, for example, are too numerous and complex for anyone to fully see and understand.

Policy decisions mostly rely on outdated economic models that are “parametrized” for the stable conditions in which they were developed.

Korowicz writes that “as the risk of major systemic change grows, those models will likely prove increasingly erroneous as the system moves out of its historical equilibrium.”

The structure of the global economy is contingent on historical conditions continuing

The structure of the global economy is contingent on historical conditions continuing

Negative feedback loops–automatic stabilizers–are designed to soften the blow of economic shocks and return a system back to a stable domain.

However, if automatic stabilizers fail, then positive feedback loops can arise, where negative events feed on each other to produce more negative events.

For example, failing to isolate the effects of a bank failure can lead to a cascading wave of failures throughout a financial system as it departs too far from the stable domain in which it must operate.

Positive feedback loops mean infrastructure declines at an accelerating pace in a contraction

Economic contraction feeds on itself. Korowicz explains how this sort of process is carried out:

As the economy contracts, then the customers of the utility have less to spend. A decline in revenue would mean that the utility income relative to the fixed costs would fall. If they want to maintain the network, they may have to raise the price of their service; this would drive away some customers, and cause others to use less services. Thus the utility revenue would fall further, requiring further price rises, spending falls and so on. If the utility cannot afford to maintain the network, the service deteriorates making it less attractive for customers, who drop out, reducing income and so on.

Economic crisis causes social fragmentation and spreads fear

Korowicz writes that “A suspicion of ‘outsiders’ and increasing nationalism are common features of an economic crisis.”

This is rapidly occurring in Europe as the crisis grows. Germans point fingers at the Greeks, while Greeks point fingers back at the Germans. Indeed, they do not identify as fellow Europeans but as nationalist entities.

When the economy is contracting, it decreases the incentive for relative strangers to keep their word to others. Greece has less incentive now to make good on its debts than it did when times were good because they no longer benefit like they once did.

The banking system is insanely concentrated

75 percent of payment flows between banks on an average day are conducted among only 0.1 percent of the banks in the US Fedwire payment system.

This is a symptom ofpreferential attachment–highly-connected nodes in a system are more likely to attract additional connections.

Korowicz notes that “big banks have greater economies of scale and bargaining power, so can attract more business than their smaller rivals with better deals or market crowd-out.”

The world is running out of cheap energy sources

The world is running out of cheap energy sources

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Increasing deepwater drilling activity and pursuit of extracting resources through more expensive means suggests that we are running out of cheap sources of oil.

If new oil fields don’t offer a sufficient energy return on energy invested–i.e., if it takes more energy input to extract the oil than the extracted oil even provides, then it will necessarily remain undeveloped.

Korowicz says that “peak oil is not primarily concerned with reserves, but flow rates.” If the oil stops flowing, economic activity ceases.

Food constraints are causing severe social and behavioral stress

Global food supplies are facing increasingly severe constraints. Major droughts in producing regions like the U.S. and India don’t help matters.

Neither do estimates that, according to Korowicz, “between six and ten fossil fuel calories are used to produce every calorie of food,” which due to increasing energy constraints is a cause for concern.

The Arab world has already seen major uprisings, partly due to soaring food costs which consume large portions of the population’s budget. Korowicz writes that “no society wants to test the veracity of the old adage that we are only nine meals from anarchy.”

Whenever the next crisis comes, it will be massive and the world won’t be prepared

Korowicz hits on some familiar themes:

  1. “As financial and monetary systems become more unstable, the risks associated with doing anything significant to change or alter the course increase.”
  2. “The actions taken to prevent a crisis, or preparations for dealing with the aftermath of a crisis, may help precipitate the crisis.”
  3. “The growing stress in our very complex globalised economy means it is much less resilient.”
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If a country like Greece went into disorderly default…

If a country like Greece went into disorderly default...

Insolvent banks in that country would shut their doors

Insolvent banks in that country would shut their doors

People and businesses would be limited to the cash they have handy

People and businesses would be limited to the cash they have handy

Grocery stores, pharmacies, and gas stations would be hit with panic buying

Grocery stores, pharmacies, and gas stations would be hit with panic buying

Cell phones would stop working as mobile phone credit would get used up

Cell phones would stop working as mobile phone credit would get used up

Public transport would be restricted as gasoline shortages would arise

Public transport would be restricted as gasoline shortages would arise

Imports would collapse as credit would dry up

Imports would collapse as credit would dry up

Contagion would spread to the next weakest countries

Contagion would spread to the next weakest countries

In these countries, fear of insolvency would cause credit to dry up

In these countries, fear of insolvency would cause credit to dry up

Then, supply chain linkages would start to fail as companies would have trouble financing production of new goods

Then, supply chain linkages would start to fail as companies would have trouble financing production of new goods

Banks in developed countries furthest away from the epicenter would have to be bailed out

Banks in developed countries furthest away from the epicenter would have to be bailed out

Critical infrastructure would be affected as supply chains deteriorated, which would accelerate the contagion

Critical infrastructure would be affected as supply chains deteriorated, which would accelerate the contagion

Businesses would shut down production as critical inputs would become increasingly unavailable

Businesses would shut down production as critical inputs would become increasingly unavailable

The cascading effect through global supply chains would shatter global trade

The cascading effect through global supply chains would shatter global trade

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