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Thursday Complexity PostSeptember 12, 2013

Economists See Clear Skies as Financial Hurricanes Brew:

"An Intellectual Blind Spot to the Power of Positive Feedback"

As the glacial ice in Greenland melts, there is less white surface reflecting sunlight back into the atmosphere. There is more dark water, and that absorbs heat, causing more ice to melt. Scientists are discovering that even in years without record-breaking temperatures highs, a self-amplifying cycle of warming and meting can persist because of positive feedback mechanisms in the interactions of ice, water, temperature and sunlight.


Mark Buchanan, physicist, author and scholar of complex systems, says positive feedback is behind almost everything that makes our world rich, surprising and dynamic. In his newest book Forecast: What Physics, Meteorology and the Natural Sciences Can Teach Us About Economics, Buchanan writes that positive feedback makes "seeds sprout and grow into trees, matches burst into flame, and single cells divide and proliferate into living thinking human beings. It drives political revolution and new religions, and it makes perfectly peaceful blue skies give rise, with little warning, to storms of terrifying violence..."  


He believes an intellectual blind spot to the power of positive feedback has held back our understanding of human systems and social sciences. Economics is often misunderstood, he asserts, because theorists in the field have viewed economic systems as inherently stable and self-regulating and they've thought that people make rational economic decisions with full awareness of future possibilities. Even after the financial meltdown of 2008, he writes, many economists have strained to rationalize those views in spite of evidence that debunks them. With his prediction that future crises are inevitable unless economic models are changed to take into account what's been learned about other complex systems, Buchanan imparts urgency to his insights that markets follow power law distributions and small events can trigger huge consequences.


In a detailed analysis of the May 2010 "flash crash," for instance, Buchanan shows positive feedback was among the forces involved when the Dow Jones Industrial Average plunged nearly 1,000 points (9 percent of its total value) in 13 minutes and 27 seconds. Within 21 minutes stock values rose back to previous levels, but anyone unfortunate enough to unknowingly sell as prices hit rock bottom suffered serious losses. Buchanan tells the story of one investor who was "mugged" by the crash, losing $15,000 in a matter of seconds. The cause of the crash remains controversial, though government reports found no evidence of illegal manipulation or any "fat finger" mistake caused by someone hitting a wrong button. Buchanan explains that high frequency trading (HFT), which made up 73 percent of the volume of trading in 2010, usually produces greater liquidity in the market-except when it doesn't.

Markets work best when money and assets flow easily among buyers and sellers without delays and obstructions, and when that happens, the market is called liquid. Generally, speed is good. But exceptions are possible. A high percentage of trading now takes place at the speed of light. Hundreds of companies sell algorithmic trading platforms that execute trades so fast virtually no time elapses between the push of a button and the completion of the trade.  


Buchanan explains that the bid-ask spread in trading reflects how much market makers think they need to charge to make a profit. In turbulent period, HFT market makers charge more, so the spread widens. In the flash crash the spread ballooned, and HFT firms with algorithms running on autopilot fled the market. Trading came crashing to a halt and liquidity disappeared. Buchanan describes the positive feed back effect: more volatility meant less liquidity, which brought more volatility, and which brought less liquidity. Physicists have found wilder behavior in stock movements, and more mini crashes, in very short time periods since 2005. Buchanan suggests as trading moves to inhumanly short time scales, increasing "black swan" events in microscopic time can be expected.  


Brain science has shown that people don't respond well to things that happen in less than a second, Buchanan writes, and what happens in markets in sub-second times may reflect a fundamental change as trading "becomes uncoupled from the influence of human decision making."   


Physics and meteorology hold clues to the working of economic systems, though Buchanan doesn't suggest any one explanatory theory. If a predictive model were developed, he says, its existence would change how people behave, making its predictions inaccurate. Meteorologists have different models and theories for different aspects of weather, such as tornadoes and thunderstorms on the plains, hurricanes developing at sea, or a blanket of fog over the earth's surface, and their predictions have vastly improved. In the same way, he writes, economists need an assortment of models and theories to understand differing economic phenomena--rapid fluctuations driven by high frequency trading, daily movements driven by trend-following speculators or instabilities that form over months or years as a result of social change, such as the trend in sub prime lending. Forecast is provocative, carefully researched, absorbing and lucidly written. Buchanan illuminates complex material and tells stories that give it a human face.   

Join Mark Buchanan on PlexusCalls Tomorrow!

Remember PlexusCalls!

Friday, September 13, 2013 - 1-2 PM ET  
Register to receive your call-in number and pin:  
Weather, Natural Systems and the Economy    
Guests: Mark Buchanan and Jeffrey Goldstein 

Author Mark Buchanan and Adelphi University Professor Jeffrey Goldstein will discuss Buchanan's new book Forecast: What Physics, Meteorology and the Natural Sciences Can Teach Us About Economics.

Mark Buchanan is a physicist and author who writes about physics, mathematics, social science and biology. He is a scholar of nonlinear dynamics, Hamiltonian systems theory and plasma dynamics. Most of his writing deals with the idea that concepts from physics help us understand the world-everything from bacterial colonies to ecosystems to human communities and business organizations, are complex systems with interacting parts. In Forecast, he emphasizes the essential instability of markets, and the powerful role that positive feedback plays not only in economics and finance, but in the disruptions and unpredictable events that make our world surprising and interesting, for better and worse. His three other books are The Social Atom, Nexus and Ubiquity. He has also written more than 100 articles in publications ranging from Nature and Science to the Harvard Business Review, and the New York Times. Read Buchanan's blog, The Physics of Finance.


Jeffrey A. Goldstein is Full Professor of Decision Sciences at the Robert B. Willumstad School of Business at Adelphi University. He is author or editor of numerous books including: Complexity and the Nexus of Leadership: Leveraging Nonlinear Science to Create Ecologies of Innovation;Complexity Science and Social Entrepreneurship: Adding Social Value through Systems Thinking;  Complex Systems Leadership Theory; Classic Complexity; 8 Annual Volumes of Emergence: Complexity and Organization; and The Unshackled Organization. He is co-editor-in-chief and one of the founders of the quarterly international journal "Emergence: Complexity and Organization." He serves on the Board of Trustees of the empirical research journal "Nonlinear Dynamics, Psychology, and the Life Sciences" and is author of hundreds of publications and presentations/papers. He has lectured at eminent universities throughout the world (e.g., recently at Funda��o Dom Cabral, Belo Horizonte, Brazil, University of Nottingham-Ningbo, China, Rockefeller University, NY, and Johns Hopkins University, Baltimore, Maryland); is consultant to public and private organizations; and the co-founder and co-director of Institute for Research in Complexity and Society.   


Healthcare PlexusCalls 
Wednesday, September 18, 2013 - 1-2 PM ET  
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Information Flow and Learning in Healthcare: Social Quality Improvement       
Guests: Brian McGowan and Jeff Cohn  

Brian and Jeff will join the call to talk about what they are learning about learning, ways to improve information flow, and the role social media can play in helping both healthcare providers and patients keep up with emerging ideas in the complex realm of health and healthcare. Read more including their complete bios.


Visit the Plexus Institute Calendar for a detailed schedule of PlexusCalls, Healthcare PlexusCalls, Nursing Network PlexusCalls and other upcoming events from Plexus Institute and others.  


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