Financial crises occur every nine years on average and each time they occur they reset finance theory – fiduciaries should beware.
This is the central theme of a book Crisis and Complexity written by Ross Barry, the head of research at First State Super, which explores a dozen economic and financial catastrophes since the Mississippi Bubble of 1720 and how each reset economic and finance theory.
Pacey and fascinating articles on the crashes of 1929, 1987, 2000 and 2008 and more make up the first 200 pages, after which Barry makes his thesis that these crashes show financial markets are complex adaptive systems, with a natural tendency not towards equilibrium, but towards instability.
Such instability brings the recurring triumph of complexity over the genius of the great economists and financial theorists such as Markowitz, Keynes and Friedman, says Barry.
He persuasively suggests investors naturally, but vainly seek the same certainty about economics that Isaac Newton provided for physics. This desire for certainty, says Barry, is often the cause of many investors being lulled into stock market bubbles.
He criticises the capital asset pricing model, for presenting the world as made up of a set of rational agents acting independently, such that the whole market can be understood by deconstructing it into its constituent parts and studying each part in isolation. He says this ignores the “connectivity of agents” and leaves no room for the pattern of energy in markets.
He writes: “The financial industry typically gravitates en masse toward the most widely accepted, well-tested model de jour” and that only when these “prevailing fundamental laws fail catastrophically” are alternative models sought.
And he warns the next extreme financial crisis is not far away. He speculates that this could be a climate change driven crisis, but he is most concerned at a breakdown of government finances in Europe and Japan possibly in 2016/17.
Rather than leave the reader hanging on this gloomy thought, Barry is optimistic for the concept of Universal Ownership, where the world’s largest sovereign wealth funds and pension funds take on a larger part of the functions performed by government and regulators. Such long-term investors, he posits, will have a better alignment with the public and world, than many of the reckless, greedy and short-term thinking financial institutions, he portrays in his history of major financial crises.
Crisis and Complexity is available for $19.29 from www.rossbarry.com.au, it will soon also be available on Amazon.