Natural selection at work in our financial system

Now that the August liquidity crunch is several weeks in the past, everybody is jumping in with an opinion about what it meant, and how well or poorly it was handled.  Harold James, Princeton's Professor of History and International Affairs, has jumped in with one of the more intriguing analyses I've seen.  He gives us a critique of the various historical perspectives in his recent article, The Perils of Financial Historicism.

The August events caused rarely-seen tremors in the short term securities markets, and have been evoking comparisons to the panic of 1907, and to the banking collapse of 1931—but Professor James says there are better parallels than those two:

Neither of these apparent historical parallels is convincing. We are not living in 1907, when the gold standard limited the ability of central banks to supply additional liquidity. Nor, following the fastest five-year period of economic growth in human history, are collapsing prices endangering the financial system, as they did during the Great Depression...

If today’s credit crunch has historical parallels, they are closer to nineteenth-century “normal crises” like 1837, 1847, or 1857. In those panics, financial innovation caused uncertainty and nervousness, but also induced an important and beneficial learning process. The financial institutions that survived the crises went on to play a crucial role in pushing further development, and they had enhanced reputations because they withstood a crisis.

So, it appears that our financial system is just as much of an evolving, complex adaptive system as the rest of the economy—as Eric Beinhocker has convincingly described in his excellent book.  Now that I've watched economic evolution shift into high gear for several weeks, I'll have to pull Beinhocker's book down off the shelf and give myself a refresher this weekend; it's one of the best books I've read in years.

Comments

[Kevin]

I'm working through Beinhocker's book now. Pretty interesting stuff so far.

[JorgXMcKie]

Not all complex systems are evolutionary systems, but many are. All evolution really needs is variation, a selection method, and a reward for success. Looks to me that the current US financial system certainly meets all of those.

In addition, it helps if it is possible to either seek variation or a mechanism exists to insert variation into the system. The financial system has that. (Gene mixing through sexual reproduction makes makes evolution much faster in sexual species than in asexual species, in most conditions.) The US financial system has that.

Additional feedback systems also help increase 'useful' evolution (in the system of making it possible for the system to continue to exist into the future.) The US financial system has that.

In short, the US financial is, through evolution, becoming more and more stable, successful, and likely to continue.

[A Tanatar]

Couldn't agree more. Though, I tend to think that so far XXI century looks very XIX-century-ish.