We can probably all agree that modern day financial systems are complex, but what that actually means isn't something that everyone agrees on. Typically, though, a system characterised by complexity isn't something that anyone's designed – it emerges, it adapts spontaneously and it produces stunningly unexpected outcomes when no one's expecting them. Which, let's face it, sounds a lot like modern finance. The problem is that many economists are focusing on how they manage this system when, in reality, it's impossible to do so. It's like trying to contain swine flu using a butterfly net.
Complexity Is Not Engineering
When many people, including economists, discuss complex systems they often use analogies with complicated engineered systems like aircraft or nuclear power systems. Now these are definitely complicated, with many, many interacting parts, the failure of any of which may compromise its integrity. However, complicated human engineered systems are not truly complex. For the most part the designers of these systems go out of their way to make sure that they don't exhibit the trademark unpredictability and non-linear outcomes of complexity. Indeed, the very fact that these systems have a designer is a sure sign that they're not truly complex. This was the problem that Charles Darwin solved – how do complex things like human beings come into existence if not through the guidance of a designer? The answer, of course, is that complexity can arise through interaction with the environment as long as there's some means of adaptation. These are the trademarks of complex adaptive systems. Darwin was concerned with biological evolution, but the global financial system is of the same type.
Complex Means Adaptive
There are two noteworthy things about complex adaptive systems. The first is that they're complex. The second is that they're adaptive. And while that may be a statement of the bloody obvious it's one that seems to escape many financiers studying the subject. The ability of the system to adapt, often in completely unpredictable ways, means that you can't model it and you can't foresee the outcomes of any strategy of intervention. It's all completely unknowable in advance. Once you accept this it becomes suddenly apparent that a huge swathe of modern finance is complete rubbish. For example, in a complex system you expect to see "tipping points" or phase transitions when the system suddenly and unpredictably switches from one stable…