A Creepy World
Great research was recently published by Didier Sornette and Peter Cauwels on a general framework to understanding financial markets and social systems. Sornette is Professor on the Chair of Entrepreneurial Risks at Swiss Federal Institute of Technology, Director of the Financial Crisis Observatory, and spoke about predicting financial crisis (video) at TED last June.
Before a critical threshold is reached, these parameters slowly drift, hardly changing the stress in the system, which has, at that point, a quasi-stable characteristic, only disturbed by noise. This gives us an illusion of control, we think that we understand the system and we assume that it will continue behaving as we expect it to for the indefinite future. We make naïve forecasts based on simple extrapolated trends without a real fundamental understanding of the underlying processes. Forecasters are happy and proud that they manage to find a trend and can fit a curve to it, without realizing that in fact they are blind. Examples are the credo that stocks always go up in the long run, the concept that inflation is contained because the velocity of money is low, the idea that governmental debt can always be refunded in the capital markets or that house prices always go up.
The real risks and opportunities in our modern, interconnected society can only be better understood if we get out of this fallacy. Only then will we be able to see and interpret the generic symptoms that occur when a system approaches criticality. (SSRN)