13 Delli Gatti, Domenico, et al. (2008), "Financially Constrained Fluctuations in an Evolving Network Economy," NBER Working Paper No. W14112.
14 By "design principles" I am not implying there is a designer - these are emergent properties that have evolved in natural systems. See also: De Atauri, Pedro, et al. (2004), "Evolution of "design principles" in biology and engineering," IEE Syst. Biol., 1, 28-40.
15 Kubelec, C. and Sa, F. (2009), "The Geographical Composition of National External Balance Sheets: 1980-2005," Bank of England Working Paper (forthcoming). Available at Haldane, A.G. (2009), "Rethinking the Financial Network," speech delivered at the Financial Student a.s.sociation, Amsterdam, April 2009, available at: For a discussion of network connectivity, see Orrell, David (2008), The Other Side of the Coin: The Emerging Vision of Economics and Our Place in the World (Toronto: Key Porter), p. 96.
16 May, R.M., Levin, S.A., and Sugihara, G. (2008), "Ecology for bankers," Nature, 451, 891-93.
17 Csete, M. and Doyle, J. (2004), "Bow ties, metabolism and disease," Trends in Biotechnology, 22 (9), 446-50.
18 Bair, Sheila (2007), "Remarks," 2007 Risk Management and Allocation Conference (Paris), 25 June 2007.
19 Canada had the world"s soundest banking system in 2008, according to the World Economic Forum. Taylor, Rob (2008), "Canada rated world"s soundest bank system: survey," Reuters, 9 October 2008.
20 Martin, Eric and Tsang, Michael (2009), "Cash Best as Record Correlation Hints Herd Collapse," Bloomberg, 29 June 2009.
21 As an example, see: Lillo, Fabrizio, et al. (2008), "Specialization of strategies and herding behavior of trading firms in a financial market," New Journal of Physics, 10, 043019.
22 Giles, Chris and Parker, George (2009), "Transcript: Interview with Alistair Darling," Financial Times, 14 September 2009.
23 Kambhu, J., Weidman, S., and Krishnan, N. (2007), New Directions for Understanding Systemic Risk (Washington DC: National Academies Press).
24 House of Representatives, Committee on Oversight and Government Reform, "The Financial Crisis and the Role of Federal Regulators, Preliminary Transcript," 36-37, 23 October 2008, available at: 25 As Bank of England governor Mervyn King said in October 2009: "Anyone who proposed giving government guarantees to retail depositors and other creditors and then suggested that such funding could be used to finance highly risky and speculative activities would be thought rather unworldly. But that is where we are now." Vina, Gonzalo and Ryan, Jennifer (2009), "King Opens Rift With Brown on Whether to Split Banks," Bloomberg, 21 October 2009.
26 As mentioned in the introduction, network scientists were among the first to spot the possibility of cascading failures in the financial system. Barabasi, Albert-Laszlo (2003), Linked: How Everything is Connected to Everything Else and What it Means for Business, Science, and Everyday Life (Cambridge, MA: Plume), p. 211.
27 In the UK, at the height of the crisis, the sight of financiers "scrawling on pieces of paper" gave the treasury department "the feel of a particularly crowded kindergarten during art cla.s.s," according to the Observer newspaper. Treanor, Jill and Elliott, Larry (2009), "Dark days when banks reached brink of oblivion," Observer, 6 September 2009.
28 See: 29 Haldane, A.G. (2009), "Rethinking the Financial Network," speech delivered at the Financial Student a.s.sociation, Amsterdam, April 2009, available at:
Chapter 3.
1 Bouchaud, J.-P. (2008), "Economics needs a scientific revolution," Nature, 455, 1181.
2 These may take the form of probability laws, as in quantum theory.
3 The economist Alfred Marshall said that Jevons" work "will probably be found to have more constructive force than any, save that of Ricardo, that has been done during the last hundred years." Marshall, Alfred and Whitaker, John King (ed.), (2005), The Correspondence of Alfred Marshall, Economist: Climbing, 1868-1890 (Cambridge University Press), p. 164.
4 Anonymous (2008), "Leon Walras," The Concise Encyclopedia of Economics (Library of Economics and Liberty). Retrieved 17 July 2009 from: 5 Schumpeter, J.A. (1954), History of Economic a.n.a.lysis (London: Routledge), p. 827.
6 Powers, Charles H. (1987), Vilfredo Pareto, ed. Jonathan H. Turner (Masters of Social Theory, 5; Newbury Park, CA: Sage Publications), pp. 13-20.
7 Jevons, William Stanley (1909), "The Solar Period and the Price of Corn (1875)," in H.S. Foxwell (ed.), Investigations in Currency and Finance (London: Macmillan), pp. 194-205.
8 Image from: 9 Soros, George (2008), The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means (New York: PublicAffairs), p. 6.
10 Boyle, Catherine (2009), "Bank of China starts to offer mortgages in the UK," The Times, 25 July 2009.
11 Adrian, Tobias and Shin, Hyun Song (2008), "Financial Intermediary Leverage and Value-at-Risk," Staff Report No. 338 (Federal Reserve Bank of New York).
12 For example, MIT economist Andrew Lo described economists as suffering from a "peculiar psychological disorder known as "physics envy"." Anonymous (2002), "Bubble trouble," Economist, 16 May 2002.
13 Minsky, Hyman P. (1972), "Financial instability revisited: the economics of disaster," Reappraisal of the Federal Reserve Discount Mechanism (Washington, DC: Board of Governors of the Federal Reserve System), 95-136.
14 Mihm, Stephen (2009), "Why capitalism fails," Boston Globe, 13 September 2009.
15 As noted at "In the last decade, many have come to realize that nonlinearity [including feedback loops] is an inherent feature of economic and financial markets." Despite this, mainstream economics retains a conceptual framework that, as systems scientist Jay W. Forrester observed, "is narrow, is based on unrealistic a.s.sumptions, emphasizes equilibrium conditions, and is committed to mostly linear mathematical methods." Forrester, Jay W. (2003), "Economic Theory for the New Millennium," plenary address at the International System Dynamics Conference, New York, 21 July 2003.
16 John Sterman of the MIT System Dynamics Group, for example, has developed "management flight simulators" that allow business leaders to accustomise themselves to the effects of feedback. Sterman, J.D. (2000), Business Dynamics: Systems thinking and modeling for a complex world (New York: McGraw Hill).
17 Clement, Douglas (2007), "Interview with Eugene Fama," The Region, December 2007.
18 According to Arthur Levitt Jr. (former chairman of the Securities and Exchange Commission). Goodman, Peter S. (2008), "The Reckoning - Taking Hard New Look at a Greenspan Legacy," New York Times, 8 October 2008.
19 Kitano, H. (2004), "Cancer as a robust system: implications for anticancer therapy," Nature Reviews Cancer, 4, 227-35.
20 As an example of how removing regulatory control loops can disrupt a biological system, see: Orrell, David, et al. (2006), "Feedback control of stochastic noise in the yeast galactose utilization pathway," Physica D, 217, 64-76.
21 As George Soros notes, central banks can "take a step and then they get a feedback from the market and so the feedback will tell them whether they"ve done enough or whether they have to do more. So this feedback helps to correct and get close to maintaining balance." Soros, George and Freeland, Chrystia (2009), "George Soros interview," Financial Times, 23 October 2009. Another proposed stabilising mechanism, known as regulatory hybrid securities, is a kind of debt, to be issued by banks, that can be converted into equity during a crisis. See: Shiller, Robert (2009), "Engineering financial stability," World Finance, 16 February 2010.
Chapter 4.
1 Galton, Francis (1889), Natural Inheritance (London: Macmillan).
2 Clever, but not completely original or reliable, according to Haug, Espen Gaarder and Taleb, Na.s.sim Nicholas (2009), "Why We Have Never Used the Black-Scholes-Merton Option Pricing Formula (fifth version)." Available at SSRN: 3 As Pablo Triana wrote: "all the n.o.bels awarded to financial economics are heavily grounded on the Normal a.s.sumption; remove such tenet, and the prized theories crumble and crash." Triana, Pablo (2009), Lecturing Birds on Flying: Can Mathematical Theories Destroy the Financial Markets? (New York: Wiley).
4 Overbye, Dennis (2009), "They Tried to Outsmart Wall Street," New York Times, 9 March 2009.
5 Taleb, Na.s.sim Nicholas (2007), The Black Swan: The Impact of the Highly Improbable (New York: Random House), p. 127.
6 Barford, Vanessa (2008), ""It"s like a ma.s.sive earthquake" ," BBC News, 15 September 2008.
7 Lux, T. (1996), "The Stable Paretian Hypothesis and the Frequency of Large Returns: An Examination of Major German Stocks," Applied Financial Economics, 6, 463-75; Gopikrishnan, P., et al. (1998), "Inverse cubic law for the distribution of stock price variations," European Physical Journal B, 3, 139-40; Gopikrishnan, P., et al. (1999), "Scaling of the distribution of fluctuations of financial market indices," Physical Review E, 60, 5305-16; Plerou, V., et al. (1999), "Scaling of the distribution of price fluctuations of individual companies," Physical Review E, 60, 6519-29.
8 Seismograph (vertical acceleration, nm/sq. sec) of the Kobe earthquake. Recorded at Tasmania University, Hobart, Australia on 16 January 1995 beginning at 20:56:51 (GMT). Source: Data management centre, Washington University. Downloaded from: 9 Mandelbrot, Benoit and Hudson, Richard L. (2004), The Misbehavior of Markets: A Fractal View of Financial Turbulence (New York: Basic Books).
10 Bak, Per (1996), How Nature Works: The science of self-organized criticality (New York: Springer-Verlag).
11 One person who uses fractal methods to make predictions is econophysicist Didier Sornette, who foresees a "singularity around 2050, signaling a fundamental change of regime of the world economy and population." Of course this a.s.sumes we survive 2012, predicted by the Mayans to be an equally eventful year. Sornette, Didier (2002), Why Stock Markets Crash: Critical Events in Complex Financial Systems (Princeton University Press), p. xvii.
12 As Na.s.sim Taleb points out: "Parametrizing a power law lends itself to extremely large estimation errors." Taleb, Na.s.sim Nicholas (2009), "Errors, robustness, and the fourth quadrant," International Journal of Forecasting, 25, 744-59.
13 As geophysicist Susan Hough wrote: "Scientists have been chasing earthquake prediction - the holy grail of earthquake science - for decades ... Yet we have little to no real progress to show for our efforts." Hough, Susan (2009), "Confusing Patterns With Coincidences," New York Times, 11 April 2009.
14 Quoted in Triana, Pablo (2009), Lecturing Birds on Flying: Can Mathematical Theories Destroy the Financial Markets? (New York: Wiley), p. 137.
15 An example is so-called "frailty factors." See Duffie, Darrell, et al. (2006), "Frailty Correlated Default," Swiss Finance Inst.i.tute Research Paper.
16 Nocera, Joe (2009), "Risk Mismanagement," New York Times, 2 January 2009.
17 According to Hiroaki Kitano, this is similar to the law of conservation of energy in physics. See for example: Csete, Marie E. and Doyle, John C. (2002), "Reverse Engineering of Biological Complexity," Science, 295, 1664-69.
18 See: 19 Birchall, Jonathan (2009), "Ionic shampoo and photon genies offer phantom cures for swine flu," Financial Times, 8 August 2009.
20 Tett, Gillian (2009a), "Could "Tobin tax" reshape financial sector DNA?" Financial Times, 27 August 2009.
21 Sunderland, Ruth (2009a), "We can put a stop to huge, undeserved bank bonuses," Guardian, 25 October 2009. As an ill.u.s.tration, here"s a quote from the chief executive of the Royal Bank of Scotland, in his 2009 letter to shareholders: "We are in the limelight - understandably but uncomfortably so ... we especially, but all banks too, have become regrettably high profile. We sometimes feel as if commentators variously want us to go back to over-lending, to operate on a "not-for-profit" basis, to never entertain a client and to offer employment conditions that deter the best and brightest. Oh yes, and at the same time to pull off a recovery enabling taxpayers to recoup the support given." The tone seems a little self-pitying, from a person on a 9.6m salary package, at a company that is majority owned by the UK government. The argument that banks need to pay enormous salaries to pay the "best and brightest" is also disingenuous - if they"re so smart, why are they on government support?
22 Taleb, Na.s.sim Nicholas and Spitznagel, Mark (2009), "Time to tackle the real evil: too much debt," Financial Times, 13 July 2009.
23 For my take on this topic, see: Orrell, David (2007), Apollo"s Arrow: The Science of Prediction and the Future of Everything (Toronto: HarperCollins).
Chapter 5.
1 Kearns, Jeff and Tsang, Michael (2009), "VIX Signals S&P 500 Swoon as September Approaches," Bloomberg, 10 August 2009.
2 Seymour, Ben, et al. (2007), "Differential Encoding of Losses and Gains in the Human Striatum," Journal of Neuroscience, 27, 4826-31.
3 Poincare, Henri (1908), "L" Avenir des mathematiques," in Atti del IV Congresso Intern.a.z.ionale dei Matematici, Rome, 1908 (Rome: Accademia dei Lincei), 1909, pp. 167-82, esp. p. 182; Leopold Kronecker as quoted in Schoenflies, A. (1927), "Die Krisis in Cantor"s mathematischem Schaffen," Acta Mathematica, 50, pp. 1-23, esp. p. 2.
4 Bentham quoted in Jevons, William Stanley (1879), Theory of Political Economy (2nd edn; London: Macmillan), p. 24.
5 Mill, John Stuart (2002), "Utilitarianism" and "On Liberty": Including "Essay on Bentham" and Selections from the Writings of Jeremy Bentham and John Austin (introd. Mary Warnock), (2nd edn; Oxford: Blackwell).
6 Bernstein, Peter L. (1996), Against the G.o.ds: The remarkable story of risk (New York: Wiley), pp. 159-60.
7 Arrow, Kenneth J. and Debreu, Gerard (1954), "Existence of a Compet.i.tive Equilibrium for a Compet.i.tive Economy," Econometrica, 22, 65-90.
8 Radner, Roy (1968), "Compet.i.tive equilibrium under uncertainty," Econometrica, 36, 31-58. Quoted in Ormerod, Paul (1994), The Death of Economics (London: Faber and Faber), p. 90.
9 Blaug, Mark (1998), "Disturbing currents in modern economics," Challenge, 41 (3), 11-34.
10 Friedman, Milton (1953), Essays in Positive Economics (University of Chicago Press).
11 n.o.ble, Holcomb B. (2006), "Milton Friedman, 94, Free-Market Theorist, Dies," New York Times, 17 November 2006.
12 The Open Mind: Milton Friedman interview (WNBC, 1975), Heffner, Richard (dir.). For opinions on drug regulation, see: Friedman, Milton and Friedman, Rose (1990), Free to Choose: A Personal Statement (New York: Harvest Books), pp. 207-10.
13 Keynes, John Maynard (1936), The General Theory of Employment, Interest and Money (London: Macmillan), pp. 161-2.
14 Klein, Naomi (2008), The Shock Doctrine: The Rise of Disaster Capitalism (London: Penguin).
15 The Economist noted in 2006 that governments rarely make big decisions without "turning to CGE models to forewarn them of the consequences." Anonymous (2006), "Big questions and big numbers," Economist, 13 July 2006.
16 In the 1990s, for example, CGE models were used to a.s.sess the economic impact of the North American Free Trade Agreement (NAFTA). A 2005 study by Timothy Kehoe of the University of Minnesota showed that: "The models drastically underestimated the impact of NAFTA on North American trade." Kehoe, Timothy J. (2005), "An Evaluation of the Performance of Applied General Equilibrium Models of the Impact of NAFTA," in Timothy J. Kehoe, T.N. Srinivasan and John Whalley (eds), Frontiers in Applied General Equilibrium Modeling: Essays in Honor of Herbert Scarf (Cambridge University Press), pp. 341-77.
17 Quoted in Beinhocker, Eric D. (2006), Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics (Boston, MA: Harvard Business School Press), p. 59.
18 Quoted in Blanchflower, David (2009), "It"s good to go walkabout," New Statesman, 16 November 2009.
19 Anonymous (2009), "What went wrong with economics," Economist, 16 July 2009.
20 Blanchflower, David (2009), "It"s good to go walkabout," New Statesman, 16 November 2009.
21 Anonymous (2009), "The other-worldly philosophers," Economist, 16 July 2009.
22 As even he admitted: "The use of quant.i.ty of money as a target has not been a success." London, Simon (2003), "Lunch with the FT: Milton Friedman," Financial Times, 7 June 2003.
23 Knight, Frank H. (1932), "The Newer Economics and the Control of Economic Activity," Journal of Political Economy, 50, 455.
24 A good example of this is the popularity of string theory in physics, despite the fact that it enjoys no experimental support. See Woit, Peter (2006), Not Even Wrong: The Failure of String Theory and the Continuing Challenge to Unify the Laws of Physics (New York: Basic Books). Also: Smolin, Lee (2006), The Trouble With Physics: The Rise of String Theory, the Fall of a Science, and What Comes Next (Boston, MA: Houghton Mifflin).
25 Anonymous (2009), "Efficiency and beyond," Economist, 16 July 2009.
26 Schrage, Michael (2003), "Daniel Kahneman: The Thought Leader Interview," Strategy+Business, Winter 2003.
27 Schrage, Michael (2003), "Daniel Kahneman: The Thought Leader Interview," Strategy+Business, Winter 2003.
28 McClure, Samuel M., et al. (2004), "Separate Neural Systems Value Immediate and Delayed Monetary Rewards," Science, 306, 503-07.
29 Bechara, A. (2004), "The role of emotion in decision-making: Evidence from neurological patients with orbitofrontal damage," Brain and Cognition, 55, 30-40.
30 Cutler, D.M., Poterba, J.M., and Summers, L.H. (1989), "What moves stock prices?" Journal of Portfolio Management, 15, 4-12.
31 Clement, Douglas (2007), "Interview with Eugene Fama," The Region, December 2007.