Australia’s Economy: Complex, Fragile or Centralised?

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Complex things are more fragile, says Nassim Taleb, author of the books The Black Swan and Antifragile. Your computer and its misbehaviours are daily proof. You can click on the same button as yesterday only to get completely different results. And encoded error messages are absolutely no help.

But there are many different kinds of complexity. For example, a complex economy can be less fragile than a simple one. You’re much more likely to survive a potato famine if you also grow turnips and squash.

The difference between good and bad complexity comes down to centralisation. If you’re reliant on a central linchpin and you add complexity, you’re playing with fire. That’s because, in a complex system, it’s difficult to see how things interrelate. You don’t know what relies on what.

The US housing bubble makes all this easy to understand. The linchpin was rising house prices. As long as house prices rose, all would be well. Anyone struggling to repay their mortgage could sell out and keep the profits. So under rising house prices, it paid to lend to anyone. And anyone could borrow and get rich. Once rich, you could spend money. And that’s how the economy grew.

But the mortgage market began to get complex. In an attempt to keep growing, it came up with interest-only mortgages, sub-prime loans, SPVs, CDOs, synthetic CDOs, leveraged synthetic CDOs and all the rest of the acronyms that began to flourish. Very few seemed to realise that this development began to drive house prices to unsustainable levels. The complexity of the mortgage market hid the fact that the entire economy relied on rising house prices, which in turn relied on more and more debt. Eventually, the linchpin began to carry too much weight.

As soon as people stopped borrowing, the linchpin snapped. Once house prices stopped going up in the US (around 2006), the crash in the rest of the economy was assured. Suddenly, all that complexity became a problem because it all relied on the one factor — rising house prices.

But back in 2007, hardly anyone expected flat house prices in the US to cause a global financial crisis, even triggering a sovereign debt crisis in Europe. Heck, much of Australia’s mining boom can be put down to China’s stimulus package, which was put in place to deal with the GFC. It’s odd how things can be interrelated in a complex system.

But what if you take away the central linchpin from the beginning? What if all that complexity hadn’t been built up on top of the belief that house prices always go up? What if you have a decentralised economy that is diverse?

You’d have a situation where it doesn’t pay to lend to people who can’t repay their debt. We know that sounds like a novel idea, but it’s true. And without the economy being built on a debt binge, the crisis would not have happened. At least not in the way it did.

How does all this apply to Australia? Well, we’ve got an economy reliant on resources and financial services. Our mining boom serves China, a centrally planned economy, and our financial industry is controlled by the rate rigging Reserve Bank of Australia. In other words, there is plenty of centralisation.

As for fragility, financial systems have a habit of collapsing, which is why central banks were invented. And the resources curse isn’t called a curse for nothing. Mining is a boom and bust industry.

As for complexity, Australia isn’t really a bastion of financial innovation. And mining isn’t the most complicated industry.

It’s difficult to know just how reliant the rest of our economy is on the two boom industries. Perhaps manufacturing, agriculture and whatever else Australia does would flourish without banks and miners sucking up all the capital. It’s more likely that our economy is reliant on the prosperity of the mining and financial industry.

Australia’s economy is fragile, centralised and complex.

Regards,

Nick Hubble+
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

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Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
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7 Comments on "Australia’s Economy: Complex, Fragile or Centralised?"

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RickW
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I am taking a stab that Nick Hubble has never worked at a mine in a technical role:
“And mining isn’t the most complicated industry”

Name another industry that is more complex. But to do that he would need to know something about the technical challenges of mining.

ram
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Real mining (where you find mineral resources, take them out of the ground, and sell them) is one of the most challenging technical tasks in the world. Unfortunately, most of Australia’s “mining sector” is not doing that, they are just selling securities. They make their money from blue sky and paper shuffling, not selling minerals. The real minerals industry crashed somewhat before 2006 and still has not returned. Some inquiries here and there, but no real funding for real projects.

RickW
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The big earners for Australia, iron ore and coal continued to make investment after 2007. Anyone who believes these business are not “real” with complex operations has not worked in them.

Dion
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Mining isnt complicated? You gotta be joking Nick. I am a Metallurgist at a base metals operation and you are welcome to visit and have your eyes opened. You could also read some of the technical papers available from the AusIMM and then reconsider your statement.

Scoop
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Guys, hold on a second here, I think your getting carried away with Nicks Comment, from what I understand of Nicks statement on the mining industry, is that holistically mining is not a complex industry by saying holistically I’m referring to the mining workforce skill base. There are many technical roles however the unskilled or low skill ratio of workers is the majority (i.e. Truck operators, diesel mechanics, auto electrician). These trades are nothing special or complex in relation to the Australian workforce, however the technical roles (i.e. Managers, Geo-technical Engineers, Planners, Financial Teams & Metallurgists) are highly skilled roles… Read more »
Jason
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The real fun starts for everyone when the price of oil goes up past $147…again.

Damian
Guest

Sure all ya need is a sick of dynamite, a shovel
and a pick.

wpDiscuz
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