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4 easy steps to an economic crisis with no systems thinking

Posted by Bala Deshpande on Mon, Feb 21, 2011 @ 04:40 PM

business analytics for economic crisesEconomic crises come in two flavors: one - when a sovereign nation decides to downgrade its currency or worse default on its debt; and two - from asset bubbles.

Of course these two flavors are closely tied to one another, like a chicken and its egg. Both of these mechanisms have one factor that is the hallmark of all systems with high complexity - network effects.

In the days before the word inflation became too common in the lexicon, kingdoms would adopt the following trick to reduce or renege on their debts: Simply trim the size (and weight) of their existing coins and denominate them the same way as before. The picture below explains the mechanics...

devaluing currency to avoid economic crisis

The trick would not always work, in which case the kings took the easier route of simply defaulting! Edward III of England resorted to this technique when the bankers of Florence and Venice to whom he owed money demanded payment. This was in the 1390s. His ploy did not go over well with his creditors and the result was - war and economic collapse in Europe. (As if this wasnt enough, the bubonic plague decided the timing was right as well to make its appearance!).

Then as now, credit froze, the people who needed it the most were the ones badly hit and commerce evaporated. The net effect from this crisis in conjunction with the plague was of course the population was decimated by nearly 35% in less than 100 years! A vicious example of the dangers of ignoring network effects inherent in high complexity systems. Also a result of lack of systems thinking!

The second mode of economic crisis - Asset Speculation, is even more insidious than the first. This is because it happens when no one is looking and everyone is enjoying the party. Nouriel Roubini and Stephen Mihm do a wonderful job of providing a nice framework sequence to understand this type of crisis:

Step 1, Availability of Easy money that will in

Step 2, fuel an asset bubble which, stoked by greed will lead to

Step 3, which is widespread fraud and finally to

Step 4, or loss of confidence and you know the rest!

21st century global citizens have every reason to be vigilant and learn from history. Especially when business analytics tools for systems thinking are so easily and cheaply available. The key challenge is identifying the correct tools and techniques to get the most value. 

Here is one way to find out which tools are right for your business analytics problem.

Topics: business analytics, self organized criticality, systems thinking, economic crisis, economic recessions, global economic fragility

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