Complex things are more fragile, says Nassim Taleb, author of the books The Black Swan and Antifragile. Your computer and its misbehaviours are daily proof. You can click on the same button as yesterday only to get completely different results. And encoded error messages are absolutely no help.
But there are many different kinds of complexity. For example, a complex economy can be less fragile than a simple one. You're much more likely to survive a potato famine if you also grow turnips and squash.
The difference between good and bad complexity comes down to centralisation. If you're reliant on a central linchpin and you add complexity, you're playing with fire. That's because, in a complex system, it's difficult to see how things interrelate. You don't know what relies on what.
The US housing bubble makes all this easy to understand. The linchpin was rising house prices. As long as house prices rose, all would be well. Anyone struggling to repay their mortgage could sell out and keep the profits. So under rising house prices, it paid to lend to anyone. And anyone could borrow and get rich. Once rich, you could spend money. And that's how the economy grew.
But the mortgage market began to get complex. In an attempt to keep growing, it came up with interest-only mortgages, sub-prime loans, SPVs, CDOs, synthetic CDOs, leveraged synthetic CDOs and all the rest of the acronyms that began to flourish. Very few seemed to realise that this development began to drive house prices to unsustainable levels. The complexity of the mortgage market hid the fact that the entire economy relied on rising house prices, which in turn relied on more and more debt. Eventually, the linchpin began to carry too much weight.
As soon as people stopped borrowing, the linchpin snapped. Once house prices stopped going up in the US (around 2006), the crash in the rest of the economy was assured. Suddenly, all that complexity became a problem because it all relied on the one factor - rising house prices.
But back in 2007, hardly anyone expected flat house prices in the US to cause a global financial crisis, even triggering a sovereign debt crisis in Europe. Heck, much of Australia's mining boom can be put down to China's stimulus package, which was put in place to deal with the GFC. It's odd how things can be interrelated in a complex system.
But what if you take away the central linchpin from the beginning? What if all that complexity hadn't been built up on top of the belief that house prices always go up? What if you have a decentralised economy that is diverse?
You'd have a situation where it doesn't pay to lend to people who can't repay their debt. We know that sounds like a novel idea, but it's true. And without the economy being built on a debt binge, the crisis would not have happened. At least not in the way it did.
How does all this apply to Australia? Well, we've got an economy reliant on resources and financial services. Our mining boom serves China, a centrally planned economy, and our financial industry is controlled by the rate rigging Reserve Bank of Australia. In other words, there is plenty of centralisation.
As for fragility, financial systems have a habit of collapsing, which is why central banks were invented. And the resources curse isn't called a curse for nothing. Mining is a boom and bust industry.
As for complexity, Australia isn't really a bastion of financial innovation. And mining isn't the most complicated industry.
It's difficult to know just how reliant the rest of our economy is on the two boom industries. Perhaps manufacturing, agriculture and whatever else Australia does would flourish without banks and miners sucking up all the capital. It's more likely that our economy is reliant on the prosperity of the mining and financial industry.
Australia's economy is fragile, centralised and complex.
for The Daily Reckoning Australia