Friday 14 September 2012

The ESM as a function of Chaos

The European Stability Mechanism has been given the green light from a legal perspective and the markets are mostly relieved. Yet many see also danger. Since the ESM is part of the wider European economy and is therefore subject to the principles inherent in complex, dynamic systems, it is possible to examine its status in terms of Chaos, the technical term for this kind of environment, and so identify the challenge it faces.

A large-scale complex and dynamic system relies on the interdependency of its functional elements, which is another way of saying that those subsystems must be able to productively communicate with each other in order to maintain the feedback mechanism the system relies on. The larger the system, the greater the probability that the necessary synchronisation cannot be sustained because one or some of the elements enter a state not in congruence with the rest. 

There are essentially two ways in which the possibility for incongruence can be checked.
Either there exists a sufficiently strong authority which ensures that any subsystem adheres to its performance envelope and so prevents incongruent states from emerging, or the entire system is homogenous enough so that its parts autonomously adhere to the overall standard and/or theme.

The foregoing has been expressed generically on purpose to emphasise the universality of these principles.

As far as the EU is concerned, the ESM represents an entity that is designed to allow for and administer financial subsystems that failed.

In terms of complex systems we have Europe's financial framework (at that scale a subsystem in itself compared to the EU), containing further subsystems representing their particular euro-zone counterparts. Since the ESM is supposed to come into effect in case of failure (some economies have indeed already failed to live up to their intended designs), the mutual congruence is not given to begin with. Furthermore, the mechanism is meant to provide a functional envelope that is capable of overcoming discrepancies in its host system and correct them - and all this while still ensuring the internal integrity of each subsystem in question. That is the challenge.

Although there are many details - particularly in the current context - that have been omitted here, they are of a content-related nature. In other words, they are details relating to specific banks and their customers, their type of involvement in their own economies and the exposure to the outside, the types of businesses with their own performances and the exact components that make up a failure. Nevertheless, in terms of principle behaviour of and within complex dynamic systems the scenario runs along the lines described.

In the essay on Europe, written in 2006, the overall situation has been outlined with certain problems listed as potential developments inherent in such a system. As the ensuing years have shown, some of them did eventuate.

The present situation is once again a particular state of affairs, a phase state of the self-same system, which contains the potential for certain outcomes. In technical terms they can be seen as latent states, that is states for which the preconditions exist but which have not achieved a sufficient degree of import and/or bias for them to influence their surrounds.
Should that happen, that particular subsystem will have entered a new state and as such will change its host to some extent.

As far as governments are concerned, and its administrative derivatives such as the boards of banks, the idea still persists that an economy is essentially a form of some mechanical apparatus where an adjustment here and some input there have predictable consequences.

Unfortunately, quite the opposite is true. Economies are chaotic systems, they progress along their timelines via affinity relationships, the clustering and/or dispersal of functional modules, and pattern-seeking phase states subject to the occasional bifurcation or break point. 

Since such dynamics do not lend themselves to budget forecasts, political speeches, or investment newsletters, this part of reality gets shunted out of our consciousness. The result, failed policies, constant political arguments and confusing debates, social unrest even, remains an ongoing fare of nations.

No wonder economist Steve Keen calls his field the "naked emperor of the social sciences"*), and again not surprisingly, only few have the courage to agree with him.

*) Steve Keen, Debunking Economics, the naked emperor of the social sciences, Zed Books, London, 2004.

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