The Ecology of Markets
How Mother Nature Protects Ecosystems
To paraphrase Nassim Taleb, author of Antifragile and world-renowned probability and risk expert,
Over a period of billions of years, Mother Nature has succeeded without command-and-control instruction from an Ivy League-educated director nominated by a search committee.[1]
Nature instills us with endless fascinations due in part to its remarkable ability to maintain life without any direction of a central plan and despite unfathomable complexity.
The word nature is derived from the Greek word “natura” which relates specifically to the attributes of self-development of plants and animals with an implied lack of intervention.[2]
Perhaps nowhere is Mother Nature’s aptitude for self-development in the face of complexity more apparent than within the Amazon Rainforest, where unbridled ecology exists in one of its purest forms.
The Rain Forest is quickly becoming an anomaly on earth, as it is one of the ever-diminishing environments free of human intervention. Even without human intervention however, the system endures a whole host of apparent calamities occurring in ceaseless fashion. Organisms constantly kill each other in a fierce competition for scarce resources while fires, floods and all variety of natural disaster, plague the inhabitants unabated.
Under the constant and enduring influence of apparent chaos, the Amazon is the most bio-diverse swathe of land in the world, supporting nearly 400 billion trees, 40,000 plant species, 2.5 million insect species, and over 2,000 bird and mammalian species. The total number of living organisms at any given time are vast and incalculable.[3]
Yet evidence suggests that the ecosystem does not thrive in spite of environmental adversity. To the contrary, the natural disruptions and volatility are integral to the health and robustness of the ecosystem.
Nassim Taleb, observes these characteristics of nature in his best-seller Anti-Fragile.
Consider that Mother Nature is not just “safe.” It is aggressive in destroying and replacing, in selecting and reshuffling.[5]
Taleb explains that over millions of years of withstanding constant volatility, the ecosystem becomes antifragile and adept at enduring all variety of hardship. Antifragile simply describes something that gains from volatility, whereas something that is fragile loses from volatility. Mother Nature falls quite clearly into the antifragile domain.
Volatility is precisely what fosters a strong ecosystem, capable of dealing with all manner of natural disaster and fierce competition for resources. Strength in the ecosystem is specifically derived from the extent to which it has endured volatility over time and as Taleb points out, time itself is volatility.
In short, the aptitude to endure future volatility is relative to experience in dealing with past volatility.
As the rainforest has been around for approximately 55 million years, Mother Nature has had quite some time to develop a hardy resilience to all manner of natural disruption.[6]
Yet Mother Nature is not the only chaotic natural system benefiting from volatility and disruption.
An underappreciated feature of human social ecology is the proclivity to operate much like other natural systems, becoming stronger over time when exposed to natural volatility and enduring natural disruptions unabated.
Suppression of nature’s volatility produces unintended consequences which manifest in socionomic systems, just as they do in forest ecosystems, both of which operate optimally without a caretaker or micromanaging bureaucrats.
Fire Prevention
In perhaps no way is the correlation between human social ecology and natural ecosystems more apparent than through the lens of a natural disaster.
One of the oldest and most important natural disasters is the wildfire, which occurs with imprecise regularity much like an economic recession. Wildfires have existed for as long as forests, and much longer than any trace of human civilization. Yet in very recent history, human imperception lead to attempts to manage this process, exerting outside influence on what Mother Nature had already perfected.
As Mark Spitznagel reveals in his book The Dao of Capital, the wildfire may be one of the most important ecological events serving to strengthen the forest ecosystem.
It is not the large-scale forest fires that burn for days on end that forests need, but the frequent yet moderate low-intensity burns that clear the system of dry and dead brush and enable the revitalizing process of new growth. Through these fires, lower performing elements of the forest are removed and resources are reallocated for new growth.
In contrast, large-scale fires inflict lasting systemic change to the forest ecosystem.
“While small natural wildfires destroy with precision (by definition), great unnatural forest fires destroy indiscriminately” says Spitznagel.
In the early 20th century in the United States, Mother Nature’s design was deemed inadequate by forest administrators and an experiment in forest management was conducted that lasted for decades.
Due to the increasing importance of wood for construction, forest fires were considered an aberration, and were to be halted immediately. In 1935, by decree of the parks service, all fires were to be contained by 10:00 AM the day following. [7]
For decades, this policy was met with measurable success, as annual acreage burned plummeted from the 1930’s through the 1960’s. Yet, the unintended consequences, though not immediate in their manifestation, would come in due time.
Although the Forest Service backtracked on some of the stricter policies, the groundwork had been laid for a larger disaster as the ecosystem had undergone a 30-year departure from its natural state.
It is by no coincidence that the brunt of the unintended consequences of forest management policy manifested in the very place where forest management had the strictest control.
In 1988, Yellowstone National Park was devastated by an aggregation of aggressive fires which burned nearly 800,000 acres. It was the largest forest fire to devastate a national park in history.
More from Spitznagel,
…by the early 1900s forests became viewed as resources that needed to be protected — in other words, burning was no longer allowed.
And so smaller fires were put out, but in the end could not be controlled and converged into the largest conflagration in the history of Yellowstone. Not only did the fire wipe out more than 30 times the acreage of any previously recorded fire, it also destroyed summer and winter grazing grounds for elk and bison herds, further altering the ecosystem. [9]
After the devastating Yellowstone fire, the effects of which can still be seen in satellite images today, the forest service learned the valuable lesson that small burns were in fact positively impactful to the ecosystem and forest management was changed forever as formally recognized in a 1995 federal report.[10]
If only economic disaster endowed such a valuable learning experience.
The fallacies in economic management are in shocking parallel with those of the Forest Service in the 20th century.
The economy, like the forest, needs the constant grooming of small fires in the form of bankruptcies and occasional deflations, in order to avoid much larger disasters i.e. systemic depressions. Small and frequent mini-recessions, like those of the late 19th century and early 20th century stave off the grave economic disasters that cripple entire economies.
Yet politicians and economists alike believe in “too big to fail” and the prevention bankruptcies through bailouts as was reaffirmed in spades during the 2008 crisis. Furthermore, central bankers tinker incessantly by lowering interest rates at any sign that prices may be dropping as it is their maniacal goal to maintain inflation and exert control over the system.
The consequences brought forth by central planners, both those in Washington and most certainly those at the Federal Reserve (the most prolific fire-fighters of them all), is much larger catastrophic economic events resulting from a fragilized socionomic system.
A History of Suppression
The prognosticators at the helm of global central banks continuously fail to learn the lessons of history which parallel those learned by the Forest Service in the 80’s. Central bankers claim victory after each intervention, just as the forest service did for much of the 20th century, attributing their actions to the end of recessions. At a cursory glance, this appears to be a justifiable narrative.
Central Bank interest rate policy is the mechanism by which central banks exact influence on the price of money. Lowering interest rates is an effort to cheapen money and induce inflation. But if the economy is examined under the pretense of a natural ecology, lowering rates would be analogous to economic fire suppression as the policy aims to prevent natural forces.
Central banks lower interest rates to facilitate higher asset prices through spending at times when spending and prices are naturally declining.
The unintended consequences of these policies are not immediately visible, but rather exude intertemporal properties and manifest years or decades after the interventions. This allows interventionists and managing bureaucrats to maintain a false narrative of providing a safer economic environment, as our collective memory is short.
Differentiating between the natural and the unnatural allows the postulation of what is desirable and what is undesirable in a natural system. While deflation seems undesirable in the near-term, the policies of central banks to facilitate inflation are devastating in the long-term. It is precisely the short-term time preference of policy makers which is their folly.
The Fed in essence is the fire-fighter saving us from a small fire with the unseen and unintended consequence of susceptibility to a systemic disaster.
Each attempt to suppress natural corrections by lowering interest rates rather than letting prices (and wages) drop from time to time, only postpones the natural corrective forces.
Over the last 30 years, the policy responses of the Fed have confirmed their misconception that natural market forces must be thwarted. When a natural market induced correction occurs, the Fed suppresses interest rates.
Over time, the effect is to make the system more fragile and therefore more susceptible to future recessions and depressions. Rather than precise, revitalizing and frequent recession, corrections are becoming increasingly systemic and destructive.
The unintended consequences of Federal Reserve policies have been slowly manifesting over the last 30 years.
Alan Greenspan lowered rates dramatically to stave off the 1991 recession giving us the much larger bubble crash of 2001. Ben Bernanke lowered rates further in the 2000’s in response to the ’01 crisis, giving us the worst disaster since the great depression in 2008.
Now chairman Yellen has maintained rates at essentially 0% while orchestrating all varieties of never-before-seen stimulus to counter natural market forces.
With each policy response, the Fed provides the same narrative of saving us from the latest disaster. Central bankers’ exceptionally short time preference has developed into a dangerous tunnel vision.
Add to this the now accepted role of government to bailout “too big to fail” corporations to save the system, whether big banks or car-makers, and you have recipe for disaster. These dynamics of bailouts and interest rate suppression have combined to make a historically fragile system flush with dry tender for an unprecedented conflagration.
The Market without the Firefighters
For just about anybody alive today, there has never been a market recession that has not been met by the interventionists supposed saving graces.
With recent history filled with examples of interventionist policy, where does one turn to find a working system that deals with the direct brunt of calamity largely without outside influence?
The recession of 1921 is perhaps the best example of how a robust natural market system handles apparent calamity. In his seminal work The Anatomy of the Bear, financial historian Russell Napier describes in detail the dire conditions of 1921.
“This was very probably the sharpest decline in prices in US history. Labour was not immune — the price of unskilled labour fell from 60¢ an hour at its peak to as low as 25¢ by the summer of 1921.”[12]
A nearly 60% decline in the wages of unskilled labor coupled with price declines exceeding 70% is beyond anything imageable in today’s fragilized market landscape.
Despite what today would be a horrific economic disaster, the sharp declines of 1921 were swift and were subsequently followed with one of the biggest bull markets in US history with US equities bringing investors a 5X return on capital invested at the bottom in 1921.
Conclusions
What goes up, must come down, and what comes down, will go up again in the future. Markets are not a malfunctioning engine in need of mechanic tinkering. Rather, they are natural systems which self-repair and bounce back from volatility and disaster with ever-greater resilience.
Markets proclivity for volatility is something we should come to appreciate, just as we now recognize the importance of small forest fires.
Recessions and the associated volatility contain important restorative qualities just as wildfires serve to strengthen forest ecosystems over time. Both events are naturally occurring and to thwart these disruptions brings far worse and systemically dangerous unintended consequences.
To intervene in these natural processes is heretical to the laws of Mother Nature and compromises her greatest endowment which is a robust and antifragile system capable of enduring volatility over time.
References:
[1] Nicholas Taleb, Nassim Antifragile. New York: Randomhouse, 2012
[2] https://en.wikipedia.org/wiki/Nature
[3] https://en.wikipedia.org/wiki/Amazon_rainforest
[4] https://en.wikipedia.org/wiki/Amazon_rainforest#/media/File:Campo12Foto_2.JPG
[5] Nicholas Taleb, Nassim Antifragile. New York: Randomhouse, 2012
[6] https://en.wikipedia.org/wiki/Eocene
[7] EVOLUTION OF FEDERAL WILDLAND FIRE MANAGEMENT POLICY — https://web.archive.org/web/20061223095855/http://www.nifc.gov/fire_policy/docs/chp1.pdf
[8] https://en.wikipedia.org/wiki/Yellowstone_fires_of_1988#/media/File:Crown_fire_Old_Faithful.jpg
[9] Spitznagel, Mark The Dao of Capital. Hoboken: John Wiley & Sons, 2013 (bolding mine)
[10] EVOLUTION OF FEDERAL WILDLAND FIRE MANAGEMENT POLICY — https://web.archive.org/web/20061223095855/http://www.nifc.gov/fire_policy/docs/chp1.pdf
[11] https://en.wikipedia.org/wiki/Yellowstone_fires_of_1988
[12]Napier, Russell The Anatomy of the Bear. Petersfield Hampshire Great Britain: Harriman House Ltd, 2005
