Don't just do something, stand there! Reflections on the counterintuitive behavior of complex systems, seen through the eyes of System Dynamics, Systems Thinking and simulation.
San Joaquin Valley water managers were surprised and baffled by water releases initiated by executive order, and the president’s bizarre claims about them.
It was no game on Thursday when area water managers were given about an hour’s notice that the Army Corps planned to release water up to “channel capacity,” the top amount rivers can handle, immediately.
This policy is dumb in several ways, so it’s hard to know where to start, but I think two pictures tell a pretty good story.
The first key point is that the reservoirs involved are in a different watershed and almost 200 miles from LA, and therefore unlikely to contribute to LA’s water situation. The only connection between the two regions is a massive pumping station that’s expensive to run. Even if it had the capacity, you can’t simply take water from one basin to another, because every drop is spoken for. These water rights are private property, not a policy plaything.
Even if you could magically transport this water to LA, it wouldn’t prevent fires. That’s because fires occur due to fuel and weather conditions. There’s simply no way for imported water to run uphill into Pacific Palisades, moisten the soil, and humidify the air.
In short, no one with even the crudest understanding of SoCal water thinks this is a good idea.
“A decision to take summer water from local farmers and dump it out of these reservoirs shows a complete lack of understanding of how the system works and sets a very dangerous precedent,” said Dan Vink, a longtime Tulare County water manager and principal partner at Six-33 Solutions, a water and natural resource firm in Visalia.
“This decision was clearly made by someone with no understanding of the system or the impacts that come from knee-jerk political actions.”
Markets collapse when they’re in a vulnerable state. Coronavirus might be the straw that broke the camel’s back – this time – but there’s no clear pandemic to stock price causality.
The predominant explanation for this week’s steep decline in the stock market is coronavirus. I take this as evidence that the pandemic of open-loop, event-based thinking is as strong as ever.
First, let’s look at some data. Here’s interest in coronavirus:
It was already pretty high at the end of January. Why didn’t the market collapse then? (In fact, it rose a little over February). Is there a magic threshold of disease, beyond which markets collapse?
How about other pandemics? Interest in pandemics was apparently higher in 2009, with the H1N1 outbreak:
Did the market collapse then? No. In fact, that was the start of the long climb out of the 2007 financial crisis. The same was true for SARS, in spring 2003, in the aftermath of the dotcom bust.
There are also lots of examples of market crashes, like 1987, that aren’t associated with pandemic fears at all. Corrections of this magnitude are actually fairly common (especially if you consider the percentage drop, not the inflated absolute drop):
Wilshire Associates, Wilshire 5000 Full Cap Price Index [WILL5000PRFC], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WILL5000PRFC, February 28, 2020.So clearly a pandemic is neither necessary nor sufficient for a market correction to occur.
I submit that the current attribution of the decline to coronavirus is primarily superstitious, and that the market is doing what it always does.
It’s hard to do it justice briefly, but the stock market is basically an overlay of a complicated allocation mechanism on top of the real economy. In the real economy (green positive loop) capital and technology accumulation increase output (thinking strictly of on-market effects). Growth in that loop proceeds steadily in the long run, but with bumps from business cycles. The stock market is sending signals to the real economy about how to invest, but that’s complicated, hence the dashed line.
In the stock market, prices reflect expectations about the future flow of dividends from the economy (blue negative loop). If that were the whole story, coronavirus (orange) would have to have induced fears of a drop in the NPV of future profits of about 10%. Hopefully that’s way outside any plausible scenario. So why the big drop? It’s due to the other half of the story. Expectations are formed partly on fundamentals, and partly on the expectation that the market will go up, because it’s been going up (red positive loop).
There are actually a number of mechanisms behind this: naive extrapolation, sophisticated exploitation of the greater fool, redirection of media attention to prognosticators of growth when they’re right, and so on. The specifics aren’t important; what matters is that they create a destabilizing reinforcing feedback loop that inflates bubbles. Then, when some shock sufficient to overcome the expectations of appreciation arrives, the red loop runs the other way, as a vicious cycle. Diminished expected returns spark selling, lowering prices, and further diminishing expectations of appreciation. If things get bad enough, liquidity problems and feedback to the real economy accentuate the problem, as in 1929.
Importantly, this structure makes the response of the market to bad news nonlinear and state-dependent. When SARS and H1N1 arrived, the market was already bottomed out. At such a point, the red loop is weak, because there’s not much speculative activity or enthusiasm. The fact that this pandemic is having a large impact, even while it’s still hypothetical, suggests that market expectations were already in a fragile state. If SARS-Cov-2 hadn’t come along to pop the bubble, some other sharp object would have done it soon: a bank bust, a crop failure, or maybe just a bad hot dog for an influential trader.
Coronavirus may indeed be the proximate cause of this week’s decline, in the same sense as the straw that broke the camel’s back. However, the magnitude of the decline is indicative of the fragility of the market state when the shock came along, and not necessarily of the magnitude of the shock itself. The root cause of the decline is that the structure of markets is prone to abrupt losses.
538 had this cool visualization of the Russia investigation in the context of Watergate, Whitewater, and other historic investigations.
The original is fun to watch, but I found it hard to understand the time dynamics from the animation. For its maturity (660 days and counting), has the Russia investigation yielded more or fewer indictments than Watergate (1492 days total)? Are the indictments petering out, or accelerating?
So, the interesting question is whether we can – from partway through the history of the system – estimate the ultimate number of indictments and convictions it will yield. This is fraught with danger, especially when you have no independent information about the “physics” of the system, especially the population of potential crooks to be caught. Continue reading “Modeling Investigations”
I’ve only begun to think about the ways Jay influenced my life, but digging through the archives here I ran across a nice short video clip on Jay’s hope for the future. Jay sounds as prescient as ever, given recent events:
“The coming century, I think, will be dominated by major social, political turmoil. And it will result primarily because people are doing what they think they should do, but do not realize that what they’re doing are causing these problems. So, I think the hope for this coming century is to develop a sufficiently large percentage of the population that have true insight into the nature of the complex systems within which they live.”
Compared to the UN’s previous assessment of world p opulation trends, the new projected total population is higher, particularly after 2075. Part of the reason is that current fertility levels have been adjusted upward in a number of countries as new information has become available. In 15 high-fertil ity countries of sub-Saharan Africa, the estimated average number of children pe r woman has been adjusted upwards by more than 5 per cent.
The projections are essentially open loop with respect to major environmental or other driving forces, so the scenario range doesn’t reflect full uncertainty. Interestingly, the UN varies fertility but not mortality in projections. Small differences in fertility make big differences in population:
The “high-variant” projection, for example, which assumes an extra half of a child per woman (on average) than the medium variant, implies a world population of 10.9 billion in 2050. The “low-variant” projection, where women, on average, have half a child less than under the medium variant, would produce a population of 8.3 billion in 2050. Thus, a constant difference of only half a child above or below the medium variant would result in a global population of around 1.3 billion more or less in 2050 compared to the medium-variant forecast.
There’s a nice backgrounder on population projections, by Brian O’Neil et al., in Demographic Research. See Fig. 6 for a comparison of projections.
But of course the (amplified) message, Debt/GDP>90%=doom, was taken causally in the policy world; see the multiple clips in the intro to the Colbert video. Politicians are nuts to accord one paper in a sea of macroeconomic thought so much weight, but I guess this was the one they liked.
Ever get in a hotel shower and turn the faucet the wrong way, getting scalded or frozen as a result? It doesn’t help when the faucet is unmarked or backwards. If a new account is correct, that’s what happened to the Titanic.
(Reuters) – The Titanic hit an iceberg in 1912 because of a basic steering error, and only sank as fast as it did because an official persuaded the captain to continue sailing, an author said in an interview published on Wednesday.
…
“They could easily have avoided the iceberg if it wasn’t for the blunder,” Patten told the Daily Telegraph.
“Instead of steering Titanic safely round to the left of the iceberg, once it had been spotted dead ahead, the steersman, Robert Hitchins, had panicked and turned it the wrong way.”
Patten, who made the revelations to coincide with the publication of her new novel “Good as Gold” into which her account of events are woven, said that the conversion from sail ships to steam meant there were two different steering systems.
Crucially, one system meant turning the wheel one way and the other in completely the opposite direction.
Once the mistake had been made, Patten added, “they only had four minutes to change course and by the time (first officer William) Murdoch spotted Hitchins’ mistake and then tried to rectify it, it was too late.”
The WSJ has an article on the Chinese electric power sector that’s anecdotally interesting. It notes that increasing electricity prices would spur investment, creating a win-win for energy intensity and system reliability. Maybe so, but the supporting graph is an interesting example of statistics that are uninformative because they fail to account for bathtub dynamics. Here it is:
It seems plausible to compare investment and consumption, until you look at the system structure:
This indicates four problems with drawing conclusions from the plot:
Investment is not necessarily the same thing as installation of capacity, unless you assume constant price.
Consumption is essentially a direct function of stocks of consuming equipment and generating capacity, while investment is a flow. While there’s reason to expect growth rates of stocks and flows to match along a steady state growth path, this only applies in the very long term; in the short run, noise and disequilibrium will destroy any correspondence.
The thing we do care about is the match between generating capacity and consuming equipment, but that depends on outflows (retirements of capacity) as well as inflows, so again the stock-flow comparison tells us nothing.
There’s an additional level of indirection because we don’t see investment and consumption directly; the graph shows year-on-year changes. But that means that we’re seeing the slopes of investment and consumption, which tell us nothing about their absolute levels. So, it’s possible that investment growth is falling because it was much too high, and that consumption is growing because there’s excess generating capacity.
The best you can say about this graph is that it doesn’t contradict the article; otherwise it’s almost completely uninformative about the true state of the Chinese power system. It would be far better to have a direct comparison of generating and consuming capacity, or perhaps the growth rate of consumption (which is the net flow of consuming equipment) vs. investment in absolute terms.
It seems plausible to compare investment and consumption, until you look at the system structure:
