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For Complex Economies, No More Band-Aid Solutions

By Hallie Golden

In 1940, when a windstorm sent the Tacoma Narrows Bridge violently swinging, officials could have tried to stop it, explained Roy Niederhoffer, the Founder and President of R.G. Niederhoffer Capital Management, at the Blouin Creative Leadership Summit last Friday. They could have set up an army of fans to blow wind in the opposite direction, but of course they did not. They knew that this solution would only solve the problem in the short-term, if at all. The bridge ended up crashing into the waves of Washington’s Puget Sound, but its destruction resulted in engineers across the world learning safer ways to build suspension bridges.

Niederhoffer drew a parallel between this and the financial crisis of 2007-08.

“The problem that we have is there’s an illusion that we can control these highly complicated, non-linear dynamic systems that are the world’s interconnected financial markets,” Niederhoffer said at the Future of Finance panel. “You cannot do that.”

The meeting began with the moderator, Matthew Bishop, the U.S. business editor and New York bureau chief for The Economist, asking the eight delegates three main questions: What is the ability of governments to stand behind financial systems? Are regulations well designed? How should risk be managed in a modern economy?

The answers to all these questions revealed the common belief that officials need to think long-term and simply let the crisis play out. Instead of short-term solutions akin to setting up an array of fans to counteract the wind, the European Union needs to stop meddling with the natural behavior of the financial system and focus on creating institutions strong enough to handle any future storms.

“They’ve [EU] come up with a way of printing money that’s not too obvious,” Paul Judge, chairman of Schroder Income Growth Fund PLC, said. “You just press a button on the computer, and money is magically produced, and it’s pretty painless. … Of course in the long term, it isn’t.”

Judge explained that the country that is well known for taking the long-term perspective is China. In the next seven years, Judge predicted, China will begin purchasing European and possibly even North American banks.

Given the consensus of the incomprehensible complexity of our modern financial system, it’s not surprising that other detailed predictions were few and far between. Paul Wilmott, CEO of Wilmott.com and founder of Wilmott Journal, explained that although they can’t accurately forecast many specifics, they do have an idea of when a major financial transformation will occur. “Expect things to happen in the span of a human generation,” Wilmott said.

But why a human generation? Wilmott concluded that it won’t be fixed until a new generation comes to power with new ideas. Wilmott did dare to offer one prediction—the “things” he referred to will be the collapse of the Euro. Or as he put it: “The stupidest idea in the world.”

Leo Tilman, president of L.M. Tilman & Co., added a hypothesis into the mix by referencing Nassim Taleb, author of The Black Swan. He argued that the minute you start to suppress something artificially, you create an environment prone to bigger and bigger  “black swans”—or rare and unpredictable events—and you’re less able to deal with their negative consequences. For Tilman, these black swans are severe economic problems, which the Western governments were able to hold off for many years but now have hit at full force. By kicking the can down the road on important economic issues, Western governments have been unable to deal effectively with unpredictable black swans that led to the global financial crisis and the Eurocrisis, which some of the speakers said could cause the European Union to break up, or, at the very least, lose a couple of countries.

“All of us are getting a sense that whether it comes from too big to fail institutions that are getting bigger or bailouts of auto companies or monetary policy or support of certain dictatorships but not the others, it’s an unsustainable, unnatural suppression of the natural behavior of that system,” Tilman said.

Later that day at the Economic Actors conference, Nobel Prize-winning economist Edmund Phelps supported a similar outlook. He explained that America’s focus on short-term plans is nothing new but has been a policy pattern for many decades. This policy pattern may be closely related to politicians’ desperation to fix problems quickly in order to be reelected. Politicians tend to try quick fixes for the economy, like tax cuts, but they don’t last. “Bush threw everything but the kitchen sink, and succeeded in doing it beyond expectations, but it wasn’t sustainable,” Phelps said.

 He went on to explain that the U.S. is too focused on minor mechanical tweaks, rather than looking at the overall big picture. In order to have economic recovery, officials should refer back to the country’s history. From the early 19th century until about 1965, the U.S. was in the heart of what Phelps referred to as its “glorious decades.” Phelps said the key to returning to the prosperity of these “glorious decades” is to “somehow recreate those modern values.” One of the ways to do this is to increase productivity, which, he explained, had been slowing down since the 1970s. But by doing this and by increasing innovation, “things will be fine again, and most things will fall in place and we’ll again have prosperity.”

In response Bishop, the moderator, said with a smile “okay, well that’s certainly big picture.” His statement was followed by loud audience laughter that emphasized a frustration with an abundance of big-picture ideals but no faith in governments to live up to them any time soon.  

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Hallie Golden is an Editorial Associate at World Policy Journal.

   

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