Extreme fragility, dead ahead.

Just prior to the Great Depression an American accountant, Ralph Elliot, has taken Charles Dow’s insight about economic cycles a step forward and came up with the ‘Wave Theory’.
I won’t enter into details here but I have to give you some broad outlines.
Charles Dow: In any market, prices evolve in trends – sustained moves towards the main direction fragmented by ‘reactions’ that run contrary to the trend. According to Dow there are three categories/levels of trends: major, intermediary and minor. The major trends cannot be manipulated and comprises three phases: ‘accumulation/distribution’, ‘public participation’ and ‘panic’. The names are self explanatory but if you want to read some more please click here.
Ralph Elliot: (If a certain asset is traded by a large enough number of traders so that market could be considered ‘free’) Price action is fractal in nature and hence can be broken down and analyzed as such. While Dow identified 3 levels of trending Elliot uses 9 but both ‘agree’ that each action in the direction of the analyzed trend is followed by a reaction contrary to that direction.

Robert Prechter, the brain behind ‘Elliot Wave International’, ” the largest independent financial analysis and market forecasting firm in the world” – the guys from whom I borrowed the picture above – has been using successfully the ‘Elliot Wave theory’ for some 40 years now.
And here comes the really interesting part. Besides building Elliot Wave International as a market analysis company Prechter also founded The Socionomics Institute, a think tank that starts from the assumption that the markets are driven by the prevalent social mood (sentiment) that dominates at any given moment and not all the way around as it is usually believed. Prechter posits that markets go down when/because ‘people are afraid’ and not ‘people start to panic after the market has begun to go down’.
For some people this whole process is a tug of war between greed and fear. It makes a lot of sense but we still lack an explanation about why at some points the bulls are stronger than the bears and at some-other points the situation is completely turned over. Reason was supposed to take care of business at all times, wasn’t it?
Now some of you will tell me that Daniel Kahneman and others have provided ample proof that the market is far from being rational... OK, I agree with that but still, we continue to need an explanation for why the market behaves for so long as if it were reasonable only to break down exactly when everybody was so happy – as it constantly did, from the Tulip Mania in the the XVII-th century Holland to the last financial melt down.

Now please remember two things that I already mentioned.
– One of Charles Dow’s assumptions was that ‘major trends cannot be manipulated while the lesser ones might
– (If a certain asset is traded by a sufficient number of traders so that market could be considered ‘free’). Here I was presumptuous enough to introduce my own experience into the equation. After I was introduced to the Elliot Wave theory I found out that it worked (meaning that I could use it successfully – statistically, of course) for indices or other frequently traded symbols while it is completely useless for illiquid ones.

I started to understand what’s going on only after reading Nassim Taleb’s Antifragile.
The gist of this book is that for a system to remain viable, to conserve it’s chances to survive, it has to keep open as many options as it possibly can.
Does it make any sense to you?
To be alive means being able to make decisions, as freely as possible. If you are forced to make one thing or another then you are not free anymore, right? If you have at least the slightest opportunity to choose among two or more possibilities then it means that you still have a sparkle of life in you! Stephen Hawkins, tied in his wheelchair for so many years, is alive just because he choose not to be overwhelmed by his condition while so many of us are (brain) dead because we indiscriminately follow fads, fashions, habits, you name it. The moment we give up our individual autonomy and enroll into a crowd (read ‘herd’) we might have the impression of becoming safe, or at least safer, but in reality we are already headed for the slaughterhouse.

It is somewhat true though that ‘there is safety in numbers’. And no, I’m not contradicting myself. The bigger the crowd the harder it is for someone to control it (take it to the slaughterhouse, by will or by error) and the greater the chances for an individual to escape an unforeseenĀ  predator. So you need a really big crowd if you want to have a survival situation, a reasonably viable system.

If we look back in history – no magical solution can be found there, only a long list of errors – we’ll see that empires never fail to crash, authoritarian regimes survive for considerable shorter periods than the more democratic ones and that the more powerful a fad was the least it survived. And all these situations fit perfectly Taleb’s theory: the less open options a system has the less able it is to survive. The emperor is but a single man, who inevitable ends up being ‘naked’, no matter how capable it is – and people notice it sooner or later. Also the more an authoritarian a regime the less are the ordinary people inclined to contribute to the welfare of the community.
And something else. When a fad becomes intense enough the people involved become blind to any other alternatives but those prescribed by those convinced that they have a lot to gain by keeping that fad alive. That’s why it is very hard for a social ‘vicious circle’ to be broken until enough people hit the rock bottom. No grown up will voluntarily shout ‘the emperor is naked’ because he thinks he has nothing to gain from this. As strange as it may seem it is rather hard for the regular Joe, who’s afraid of the emperor, to understand that the entire kingdom becomes a laughing stock for the rest of the world if the emperor is known to stroll naked through the public square.

Now please take a second glance at this picture.
Extreme fragility, dead ahead.

What does it suggest?
That there is a certain correlation between income being concentrated in fewer and fewer hands and the probability of a market crash?
But correlation is not causation!
No, it isn’t. Not unless we can find a reasonable story for what may ’cause’ that correlation! Explain it, that is!

By now I’m almost convinced that most of you have already ‘got’ it.
Concentration of revenue means concentration of decision power. As less and less people (proportionally) remain in ‘powerful’ positions they not only command a higher proportion of the aggregated revenue of the entire community but they also control in a greater measure the destiny of that community.

No, I don’t think that ‘they’ are ill intended. ‘They’ live here too. They are not idiots, otherwise they wouldn’t have reached/been able to retain those lofty positions. So no, I don’t think they are willingly leading us to disaster.

The problem is that they are too few! No individual human being is able to make a considerable number of decisions in a short period time. That’s the very reason why we have consultants and so on, right? The problem is that ‘consultants’ only give advice, they cannot/are not allowed to make actual decisions. And the fewer are the people wielding real power the more the rest of us become mere consultants…

And according to Taleb’s theory and to an immense number of historical occurrences the less people are involved in the decision making process the higher are the chances for a catastrophic error to ‘reset’ the entire system.

PS I. Funny for a conclusion like that to be drawn from a picture published by a company that caters for the needs of the kind of people that are working hard to get as rich as possible, isn’t it?
On the other side…if these people considered this so important as to write about it … maybe we give it a thought or two.

PS II Never say never!
I don’t think we are necessarily facing another economic melt down in the immediate future. It might happen, of course. It will happen – sooner or later, of course again, but there is no sure way of telling when.
What I’m trying to suggest here is that there is a very strong possibility that in the near future we’ll witness a considerable change in how we manage the economy and in the way we relate to the concept of ‘money’.