Why it’s Great to be Rich!

Montgomery Burns - 007

Did you ever ask yourself why everyone wants to own property.  Most people will say it is because paying rent is wasted money; but while that might be the reason they tell themselves, the real reason that everyone wants to own property is because property is virtually the only way the average person gets access to leverage.

Access to Leverage

Professional Investors are always seeking low volatility assets that appreciate “reliably”  — especially if they have the ability to leverage that asset.

Throughout most of the 20th century most everyone had witnessed (usually from afar) the wealth growth that could occur through the ownership of property.  Historically property prices do not appreciate very much on a yearly basis, but they do generally rise in line with inflation.  If inflation is 2% and the buyer has access to leverage of 5 to 1, it means the buyer is making 10% per annum on his or her investment.

Thus buying property with leverage provides a good return on an initial investment even in a low inflation environment.  This return, however, gets better, much better, if the asset inflation far outstrips consumer price inflation.  If property is rising at 10% per annum, then the 5 times leveraged return is 50%!  It is easy to see why so many people want in on this action…

Easy Credit

Most people understand that expectations are a major factor in financial markets, and confidence is the major intangible in an economy as a whole.  Policymakers understand that people, and the media in particular, look at the state of financial markets as a guide to the health of the economy.  Therefore, as the conventional thinking goes, if you want to make sure people feel relatively confident about the economy, you probably need to make sure that financial markets don’t tank.

So despite their supposed belief in efficient markets, after the bust of the dot-com boom in 2000, the Fed consciously re-inflated the system by lowering interest rates, which had the side effect of making mortgages very cheap.  Coincidentally, around about the same time, banks were beginning to discover the process of “disintermediation”.

Disintermediation allowed banks to sell off their loan portfolios to third party investors (meaning that whether the loans performed or not became someone else’s problem) and this freed up capital for further loans; ultimately to people who never would have had access to leverage before.

Thus banks’ irresponsible lax extensions of credit, and central banks’ irresponsible lax oversight of the amount of credit in the system served to kick start a positive feedback effect.  Excessive positive feedback in any asset market amplifies market synchronicity which can ultimately cause a herding effect to emerge; turning the so-called “Wisdom of Crowds” into the “Madness of Mobs”

[Note: In engineering terms this is equivalent to  turning a damping force into a driving force; in a sense it is a bit like friction in reverse; heat turning into motion.]

The Transfer of Wealth

Such inefficiency in asset markets are not good for society as a whole for they usually mean that markets start behaving like a ponzi scheme.  Rapidly rising market prices are like a raging forest fire that constantly needs more fuel.  In bubble markets this fuel comes increasingly from the weaker members of society.  In the face of almost daily gains for everyone else, eventually everyone gets sucked in, even those who can’t afford it.

During the property boom, banks fuelled this ponzi scheme by recklessly lending to the ever less creditworthy; which meant that as in all ponzi schemes, the less well off were getting in last, often buying from those who got in first.  Inefficient asset market are generally speaking a very effective way of transferring wealth from the poor to the rich!…

Reflate Once Again

The less well off being allowed to participate in the leveraged game of easy money usually signals the end of yet another positive feedback driven up-cycle.  After the debacle of 2008, the Fed once again, in order to avoid a positive feedback driven down-cycle, decided to reflate; this time not only by dropped interest rates, but also by actively bidding up financial asset markets.

This time around however, although the Fed probably saved the global economy from global collapse, the only people that really benefited were those people who could still afford to own financial assets.

Unfortunately this didn’t include the vast majority of the population, who even if they were not massively in debt, found that they no longer had any access to leverage, and as a result are no longer able to participate in the game of easy money.

Furthermore as if to add insult to injury, the taxpayer ended up picking up the bill for the crash, and in general the rich don’t pay very much in tax…


So, all in all it is great to be rich!  While most people only have access to excess leverage at the arse-end of a policy-induced ponzi scheme, the rich have access to leverage all the time.   Some rich people will say that the reason for their ever-increasing wealth is that they are smarter than everyone else, but the truth is, it is so easy to get richer when you are rich, and so hard to get out of the starting blocks for everyone else…

Does Economics Suffer From Physics Envy?

Time is Money - 003

Every year when the Central Bank of Sweden hands out its “Nobel Memorial Prize in Economic Sciences”, there are always snorts of derision and cries of protest that this is “not a real Nobel Prize” and economics is “not a real science”…

The Oxford Dictionary definition of science is “the systematic study of the structure and behaviour of the physical and natural world through observation and experiment”.

Economics is sort of unique among the “social sciences” in that it attempts to apply mathematical rigor to the study of human behaviour.  This would seem to imply that economics is an exact science, like physics or chemistry; which further implies that economists are in the business of discovering “fundamental truths”…

Critics of “economic science” argue that the use of the paraphernalia of physics, like dense mathematical models, is in reality, purely “for show”; a vain attempt to give economics the elevated aura of physics (without unfortunately the same power of prediction). In fact some people would go so far as to say that “economic science” is really about as scientific as astrology and voodoo.

A bit Harsh Maybe !?…

Linear Dynamics

Physicists like to describe their science as the hardest of “hard science” because physics can claim to be governed by hard and fast scientific “Laws”.  This of course would seem to imply that many of the so-called “soft sciences” are in some way not quite as elevated, not quite as good.

In truth however we could say that physics is an “easy science”, and the soft sciences are “difficult” because the “laws” of physics only really work in the absence of “noise”, and yet the everyday world of the soft sciences is full of noise because most everything is continually battered and buffeted by “constantly changing feedback” which can generate wild “nonlinear dynamics”.

In reality all dynamics have feedback (and resultant nonlinearity), it is just that some dynamics have much less feedback than others.  Physics is, in a sense, the science of “dynamics with negligible feedback”, the science of linear dynamics” — or in other words it is the science of the nonlinear stuff that can be safely “compressed” into neat linear differential equations which express neat linear “cause and effect”.

All the mathematical laws of physics are linear approximations of nonlinear behavior.  In fact the reason that these “Laws of Physics” are actually considered to be “Universal Laws” is precisely because the dynamics behind these laws can be linearized (which then allows us to repeat experiments over and over again, with the same initial conditions, and always get the same predictable result).

Nonlinear Dynamics

Ironically, it is our inability to express the dynamics of a system in a linear form that results in us referring to that system’s behavior as being “nonlinear dynamics”.  In the simplest possible terms, linear dynamics are dynamics where the effect is proportional to the cause, and nonlinear dynamics are where the effect is disproportional to the cause.  In any system of any type, the universal causes of nonlinearity are

  1. The inability to damp down constant adaptation causes the emergence of diversity (i.e. deviations from the uniformity of equilibrium).
  2. The inability to damp down positive feedback causes the emergence of bias or “skew” (i.e. some random things can arbitrarily get reinforced).

Economics is highly nonlinear and subject to both incompressible adaptation and incompressible feedback.  This means that there are no, and never will be any “fundamental laws of economics”.  Even  the slightly move away from linearity is akin to moving away from a “law” to a “strong probability”; and economics has moved a long way away from linearity.

Economics is highly nonlinear because economies and economic activity are riddled with adaptation and feedback, which means that even probabilistic predictions can become difficult; but this is not necessarily a bad thing, because this unpredictable nonlinearity can lead to the emergence of unpredictable complexity”…

The Nature of Emergence

In an economy it is innovation that drives adaptation, and it is investment that drives positive reinforcement.

In any nonlinear system, it is hard to know what adaptations are going to occur and which of them will get reinforced through investment; and the more nonlinear the system is, the less amenable it will be to even probabilistic prediction. However this lack of predictability does not mean that we cannot have a “Qualitative Understanding” of the potential behavior of the system.

Both adaptation and positive reinforcement can independently drive emergent behavior, but it is the interplay between the two that determines “the nature of emergence”.  While diverse innovation without positive reinforcement can lead to the emergence of chaos, and reinforcement without diversity to the emergence of a bubble, the right balance between the two will always drive “the emergence of complexity”.

Matrix of EconoComplexity Dynamics

Aggregated Behaviour

Economies are effectively aggregated behaviour.  Some would argue that, left to its own devices, a society’s aggregate behaviour will self-organise the optimal economic equilibrium; but this is obviously not true, for without laws society’s aggregate behaviour can often disintegrate into chaos.

Okay, you might say, we need laws but we don’t need government nor bureaucratic interference in the economy; but this is not true either.  When it comes to financial matters, in general humans (and banks for that matter) can often behave like complete idiots, displaying a herd-like follow the crowd mentality.

The raison d’être of rational capital markets is that valuable investment funds are allocated to a diverse number of innovative business ideas, thereby generating economic complexity to the benefit of society as a whole.  But with the emergence of herding these funds (and even borrowed funds) are often almost blindly redirected and allocated into one particular area or asset class thereby generating a financial asset bubble to the detriment of society as a whole.

So when it comes to managing the economy, a hands off approach is not always the greatest idea….

Managing an Economy

When it comes to managing an economy, the question that needs to be asked is not what are the driving forces unique to economic systems, but “what the universal forces that drive all complex systems?…”

All complex systems are driven by an interplay of diversity and combination, or in other words, “complexity emerges” as a result of the diversification of uniformity and how this emergent diversity best fits together”.

So in reality, it is not really possible to truly understand economics without understanding complexity, and it is not possible to understand complexity unless we understand the interplay between  order and chaos.

Managing an economy, like managing any other complex system, is an art, or more aptly a talent, like cooking, and like cooking it needs a good chef.  A good chef knows how much of each thing he needs and how long to cook it for (to achieve optimal integration).

Too much reinforcement without diversity of innovation and we get inequality and lock-in. Too much innovation and no reinforcement and we get the chaos of many fragmented ideas (that can quickly form, but just as quickly disappear).

What we need is to ensure that “the demand for investment opportunities is, as much as possible, always in sync with the supply of good ideas”; we need to ensure just the right mixture between innovation and reinforcement to achieve the perfect dish of integrated diversity…

Economics vs. Physics

Both physicists and economists need to realise that economics is indeed a science, just not a linear science; which means it cannot rely on linear mathematics, and thus is not amenable to mathematical prediction.

Economics is a nonlinear science, a “complex system science”, and so although not predictable it is still deterministic, governed by the same universal forces that drive all complex systems.

Economics as a disciple should cease attempting to be like Physics, because although natural systems are predictable, economics systems have vast potential for “unpredictable creativity”, and with the right complexity management we harness this potential, to the benefit of all…


Today (20th January 2016) I revamped this website.  I did this because over the last number of months it became obvious to me (from feedback) that “Coarse Damping” was too contorted a term for most people to grasp, and it would be better to highlight how

Chaos and Complexity are simply

“dynamics that are difficult to compress”…

The primary result of this revamp therefore is that, within the permanent pages, I have expanded on the idea that “Chaos and Complexity” are different manifestations of systems that “coarse damp to equilibrium” by explaining that this “coarse damping” is always the result of “Incompressible Dynamics”.

Furthermore, in order to quantify the unpredictability of these incompressible dynamics, I have borrowed from Computer Science the concept of “Information Entropy”

Matrix of Entropy Dynamics - Copyright - Kieran D. Kelly

Now that I have revamped the permanent pages on this website, I intend to start blogging in earnest.

The idea behind the permanent pages is that they will hopefully act as a knowledge base, that the blog posts can reference.

The subject matter of this blog site  going forward will be “Emergent Complexity in the 21st Century”…