[ I’ve extracted about half of Korowicz’s paper, left out the references, math, charts, and tables, so you might want to read the original document yourself. This is a great explanation – one of the best – of the intertwined spheres of complexity (financial system, supply chains, oil production, electric grid, and so on) and how incredibly fragile this has made civilization, because if one breaks, it crashes the other systems. Then he describes the feedback loops. For example if oil prices rise, food prices and the cost of everything else rise since there isn’t anything in society that doesn’t depend on oil, social unrest rises, high oil prices drive businesses bankrupt, the financial system fails, belief in the monetary system and government fails, and so on. Oil prices then drop, exploration and drilling stop and projects are canceled, because the price of oil is so low it’s not economic anymore. When oil shortages begin, the price shoots up, and crashes the financial system again. Clearly at some point on this ever ratcheting downwards spiral trucks start being unable to find fuel and supply chains start to break. And we all know from “When Trucks Stop Running” what that means…



Above all, Korowicz explains why there is likely to be a very fast crash when one of these important hubs fails. Fossil-fueled civilization is not going to fade away over centuries like some of the civilizations ages ago (though it turns out the Mayans, the western Roman empire, and civilization in 1177 B.C., among others, fell rather rapidly, so I don’t know why so many people believe it takes centuries. Perhaps it’s because historians can find events that happen centuries before the collapse helping to trigger it.

Related posts:

Alice Friedemann www.energyskeptic.com author of “When Trucks Stop Running: Energy and the Future of Transportation”, 2015, Springer and “Crunch! Whole Grain Artisan Chips and Crackers”. Podcasts: Derrick Jensen, Practical Prepping, KunstlerCast 253, KunstlerCast278, Peak Prosperity , XX2 report ]

Korowicz, D. 2012. Financial System Supply-Chain Cross-Contagion: a study in global systemic collapse. Feasta Metis Risk Consulting www.feasta.org

This study considers the relationship between a global systemic banking, monetary and solvency crisis and its implications for the real-time flow of goods and services in the globalized economy. It outlines how contagion in the financial system could set off semi-autonomous contagion in supply-chains globally, even where buyers and sellers are linked by solvency, sound money and bank intermediation. The cross-contagion between the financial system and trade/production networks is mutually reinforcing.

The growing complexity (interconnectedness, interdependence and the speed of processes), the de-localization of production and concentration within key pillars of the globalized economy have magnified global vulnerability and opened up the possibility of a rapid and largescale collapse. Collapse in this sense means the irreversible loss of socio-economic complexity which fundamentally transforms the nature of the economy.

As the globalized economy has become more complex and ever faster (for example, Just-in-Time logistics), the ability of the real economy to pick up and globally transmit supply-chain failure, and then contagion, has become greater and potentially more devastating in its impacts. In a more complex and interdependent economy, fewer failures are required to transmit cascading failure through socio-economic systems.

The most powerful primary cause of such an event would be a large-scale financial shock initially centering on some of the most complex and trade central parts of the globalized economy. A large-scale and globalized financial-banking-monetary crisis is likely from the outcome and management of credit over-expansion and global imbalances and the growing stresses in the Eurozone and global banking system. Also from the manifest risk that we are at a peak in global oil production, and that affordable, real-time production will begin to decline in the next few years. In the latter case, the credit backing of fractional reserve banks, monetary systems and financial assets are fundamentally incompatible with energy constraints. It

This breakdown, however and whenever it comes, is likely to be fast and disorderly and could overwhelm society’s ability to respond. The longer the crisis, the greater the likelihood it can’t be reversed.

A networked society behaves like a multicellular organism…random damage is like lopping off a chunk of sheep. Whether or not the sheep survives depends upon which chunk is lost….When we do the analysis, almost any part is critical if you lose enough of it…. National economies can have local character and limited degrees of freedom, but they exist inter-dependently, just as a heart or lung cannot exist apart from the body and still retain its original identity.

Consider that a modern auto manufacturer has been estimated to put together 15,000 individual parts, from many hundreds of screw types to many tens of micro-processors. Imagine if each of their suppliers put together 1,500 parts in the manufacture of their input to the company (assuming they are less complex), and each of the suppliers to those inputs put together a further 1,500. That makes a total of nearly 34 billion supply-chain interactions (15,000 x 1,500 x 1,500),

Mobile devices, now ubiquitous, represent the culmination of 20th-century physics, chemistry and engineering. They signify thousands of direct and billions of indirect businesses and people who work to provide the parts for the phone, and the inputs needed for those parts, and the production lines that build them, the mining equipment for antimony in China, platinum from South Africa, and zinc from Peru, and the makers of that equipment. The mobile device encompasses the critical infrastructures that those businesses require just to operate and trade transport networks, electric grids and power-plants, refineries and pipelines, telecommunications and water networks across the world. It requires banks and stable money and the people and systems behind them. It requires a vast range of specialized skills and knowledge and the education systems behind them. And it requires people with income right across the world, not just as producers, but also as consumers who can afford to share the costs of the phones and associated networks there are economies of scale right through the diverse elements of the globalized economy.

Consumers can only afford the devices because work is done within the globalized economy.

The speed of interaction between all these parts of the globalized economy has been getting faster. Automatic trading occurs over milliseconds, and financial and credit shocks can propagate globally in seconds.

One of the major transformations in business is that lean inventories and tight scheduling means many businesses and industries hold hardly any stock. Automatic signals go from check-out counters, to warehouses, to suppliers who ramp production up or down to meet demand. That supplier too sends signals to their suppliers who also run Just-In-Time logistics (JIT).

In all the vast complexity of the globalized economy, there is no person or institution in control, or who knows how it all fits together, for it is far beyond our comprehension. Facebook, for example, does not need to know how to make an electric grid work, or how to process antimony, yet nevertheless they are all connected through diverse and unfathomable relationships. Each person, business, institution and community acts within their own niche; with their evolutionary heritage and their common and distinct histories; with their acquired skills and assets; and through physical and cultural networks.

What emerges at a large scale is the globalized economy. We are both contributors to, and dependent upon, the functioning of that economy.

Stepping back, what can be observed is that a new phase in global growth began to take off in the early 1800s. It was faster and more sustained than ever before1. Because the growth was exponential, each year’s 3% growth added more goods and services than the year before. Rising economic growth was in a reinforcing cycle with growing complexity. That stability provided the narrative arc that has taught us to assume economic growth will continue, technology will evolve in complexity, food will be in the supermarket tomorrow and the lights will remain on. We have adapted to its normalcy.

Maddison estimates that Gross World Product grew:

0.34% (1500-1820)

0.94% (1820-1870)

2.12% (1870-1993)

1.82% (1913-1950)

4.9% (1950-1973)

3.17% (1973-2003)

2.25% (1820-2003).

The complexity is attenuated in simple things: my mobile phone works, money is accepted for bread, and my train arrives. We notice the immediacy of things, not the living fabric of conditionality from which it emerges.

The general stability of the globalized economy and the operational fabric has provided the conditions for goods and services, socio-political structures, critical infrastructure, companies, global markets and a myriad other systems adaptive to that environment to evolve and maintain their local stability over time. This is just like an animal adapted to its ecological niche. The niche is dependent upon the wider ecosystem operating within the range of conditions (or stability domain) that maintain the niche and so keep in check the animal’s security (food, shelter, disease vectors, symbiotic relationships and predators).

A complex networked society can in many ways be remarkably resilient. If there is crop failure in one place, food can come from another region. If there is a break in a company’s supply-chain, a replacement part can come from elsewhere. Increased complexity and its twin, growth, have allowed the displacement and reduction of risk in space and time. Insurance, pensions, sewage systems, wealth, healthcare, and socio-political systems have all contributed to an era of huge reductions in the risk to an individual’s daily welfare, especially in the most advanced economies.

The individual risk can sometime be removed, or it sometimes is pooled or displaced over space and time. The green revolution of the 1950’s-70’s staved off the risk of major famine by a deep integration of food production into the innovating platform of the globalizing economy. That macro-system turned fossil fuels into increased production through fertilizers, pesticides and machinery. It drove efficiencies through interconnection and economies of scale, and de-localization through packaging, additives and transport. It also enabled the more than doubling of the human population, each individual on average consuming more year-on-year, and habituating to that. The cost of the revolution, in greenhouse gas emissions and degraded fertility could be displaced onto a future generation.

The green revolution could be said to have displaced and magnified risk into the future. That future is likely soon upon us.

In a more complex and tightly coupled economy, rather than absorbing shocks, the economy can amplify and transmit them: we saw this as the financial crisis has evolved. We are now dependent upon many more interactions to maintain our welfare. More complexity and connectivity means there are many more points where failure or breakdown can occur.

More interdependence between nodes means that the failure of one node can cause cascading failure across many nodes. De-localization means that there are many more places and events that can transmit failure, and major structural stresses can build at a global scale. There is less local resilience to failure, in that we cannot repair or replace many critical elements from local resources.

The rising speed of processes means that failure for even a short time can, for example, overwhelm tiny inventories, causing cascading failure along supply-chains. In addition, the high-speed spreading of such failure if it were to spread at the speed of financial markets or inventories could outrun our ability to bring it to a halt or even slow it down.

Rising complexity leads to increased systemic risk. While this has been recognized at the fringes of academic work for many years, it has only recently begun to come in to more mainstream thinking with reports addressing some of the issues from the World Economic Forum, including in its Global Risks 2012 report, and Chatham House7.

The financial and monetary keystone hub has virtually no system diversity. Whatever bank one cares to consider, whatever form of country financing, whatever monetary system they all share the same platform of fiat money and credit-money creation by fractional reserve banking. The whole of the financial and economic system is dependent upon credit dynamics and leverage. [ My comment: In an ecosystem, this would be a disaster, similar to having just a handful of species instead of millions ].

Such credit dynamics helped to entrench the imbalances that built up in the global economy between countries running trade surpluses and those absorbing ever-rising credit flows. Without the level of de-localization, complexity, and open connectivity, it is doubtful that such high levels of debt could have built across so many countries. Debt is now not just a feature of countries and banks – it is a system stress in the globalized economy as a whole.

The banking system has become less and less diverse too: there are many banks in the world, but banking activity has become more concentrated in only a tiny fraction of them; these are the ‘too-big-to-save, too-big-to-fail’ banks. The connectivity between retail banks, merchant banks and the shadow banking system has further removed system diversity and buffers to the spread of contagion.

Further, the response to the financial crisis has been to stave off a global banking collapse by releasing some of the tension onto sovereign states, where credit expansion could be maintained, at least for a while. This is particularly true of countries within the Eurozone which cannot print their own currency. This has reduced the system diversity of the financial system, and removed buffers to the spread of contagion, by coupling sovereign financing and the banking system ever more tightly. By enabling further credit expansion, which is part of why there was a problem in the first place, the risk of systemic failure has increased. The risk of systemic failure is further increased by the process of debt deflation, itself the direct result of credit over-expansion.

The shortening ‘relaxation time’ – the time markets remain confident between new crisis points in the Eurozone and political-economic reaction – suggests a growing inability of the interacting systems to absorb risk displacement in space and time. We are likely to be impelled to respond faster and faster as the socio-economic environment becomes riskier, more unpredictable and high speed.

The financial system, because it links almost everything in the economy, could be compared with the heart or lungs.

Consider the default of Argentina on its sovereign debt a decade ago. In the most general terms, the potential cascading effects on the global economy were dependent upon the size of the default relative to the global economy, the relative importance of Argentina’s economy and confidence within the globalized economy. The world economy easily absorbed the impact: indeed, this was not the first time that Argentina and countries of similar size had defaulted. With its newly devalued and competitive currency, it could re-equilibrate with the stable surround of a strong, confident, globalized economy, and soon returned to growth.

The stress within the globalized economy arose out of its internal dynamics. However, even if we were to restore and invigorate global growth, we would still be on the edge of an environmental constraint with profound implications. That constraint would expose in an even starker manner the inherent instability of the global financial system.

There is an acknowledged risk that we are now at the peak of global oil production . That is, the amount of affordable oil that can be brought on stream in real-time time is hitting constraints and will decline. Economic and complexity growth are predicated on rising and adaptive energy flows. Constraints on energy flows that cannot be substituted affordably, adaptively, and in real-time, are expressed through constraints on economic activity.

If the global economy cannot grow and starts to contract, feedback processes drive further contraction. A contracting economy is incompatible with the credit backing of the globalized economy and the value of all financial assets because it undermines the ability to service debt in real terms. Monetary stability, bank solvency, intermediation and credit are all dependent upon confidence in continuing credit expansion and rising economic activity. That is, the financial and monetary systems that we have come to take for granted were adaptive within a particular set of conditions.

When those conditions change, the financial and monetary system keystone-hub may slip out of its historical equilibrium.

Generally, we tend to assume that change is gradual; a dependent condition changes and the system responds proportionally. Our assumption of gradual change tends to imagine that the effects of economic contraction, debt deflation, climate change, energy depletion, or biodiversity loss will gradually grind us down, snipping away at our wealth and welfare over years or decades. This may be so.

However, all those changing conditions need to do is drive the globalized economy, or keystone-hubs within it, out of their stability domain, after which the system’s internal interdependencies come out of synch with what they have adapted to and the system can be at risk of collapse. The speed of that collapse is related to the levels of integration and complexity in the system.

One of the effects of massive credit over-expansion and/or the peaking of global oil production is the growing risk of a global systemic financial shock. The likelihood, as with so many financial crises of the past, is that the breakdown of the global financial system will be sudden and catastrophic, marked by complacency and hope turning to fear and panic. It would happen over hours and days.

Production Flow Keystone-hub

We have briefly outlined the risks of failure in the financial and monetary system keystone-hub. However, its most critical function is to enable the flow of goods and services in the globalized economy, that is, it maintains the production flow keystone-hub. Production flows are enabled by money, credit and bank intermediation. It is this which keeps food in the supermarkets, businesses and production running, and critical infrastructure serviced.

Production flows determine our dependencies and the ability to maintain any form of socio-economic complexity. As production flows have grown in complexity, de-localization, interdependence and speed, our vulnerability to any form of major financial shock has increased immensely.

The societies that would be impacted most extensively and rapidly are the most complex ones. Being the most complex, they have the greatest number of critical inputs into keeping systems (factories, supermarkets, critical infrastructure) running. They have the highest levels of interdependence and are adaptive to leaner, JIT logistics.

Consider briefly a ‘soft-to-mid-core’ (Spain, Italy…..Belguim, France?), disorderly default and contagion in the Eurozone, coupled, as would be likely, with a systemic global banking crisis. There would be bank runs, bank collapses and fear of bank collapses; uncertainty over the next countries to default and re-issue currency; plummeting bond markets; a global market collapse; and a global credit crunch. Counter-party risk would affect trade, just as it would affect the inter-bank market.

Within days there could be a food security crisis, health crisis, production stoppages and so on within the most directly impacted countries, and the number of such countries would rise.

Governments, emergency services, and the public would by and large be shell-shocked. Without serious preplanning, a government would be unable even to provide emergency feeding stations for weeks. There would be growing risk to critical infrastructure.

Imports and exports would collapse in the most exposed countries and fall for those as risk. It would also cut global trade as Letters of Credit dried up. The longer the crisis went on the more countries would be at risk. But once the contagion took hold, it would be very difficult for the ECB/ IMF or governments to stop; it would be a large-scale cascading failure at the heart of the global financial system.

The collapse in trade within some critical trade hubs would mean missing critical inputs for production processes across the world, stopping further production, which could cascade through production globally.

Factories from Germany to China and the US would shut down, helping to spread further financial and economic fears within those countries.

Supply-chain contagion would feedback into deepening and spreading financial system contagion, which would in turn feedback into further supply-chain contagion.

What largely unites the left, the right, and the green is the assumption that they could re-shape or re-order the economy and financial system (if only their respective bogeymen would get out of the way). This is probably an illusion. The concept of lock-in is used to explain why.

There is something that is implied in the outcome of the fuel blockades and in the McKinnon study: the impact of the crisis becomes non-linear in time. That is, the damage caused by the disruption does not rise in proportion to the length of time the disruption occurs: rather it starts to accelerate. Later, we shall argue that this is firstly because inventories and buffer stocks cushion the early impact of the crisis, but as time goes on, those inventories are exhausted. Secondly, the level and structure of interconnections mean that the more people, businesses, goods and services (nodes) that are affected, the greater the chance of infecting the remaining unaffected nodes. Further, the more nodes that are infected, the greater the chance that ‘hubs’ such as critical infrastructure will be infected. Their failure has a disproportional effect on the general economy. Finally, as the crisis evolves, more businesses terminally fail due to loss of cash-flow.

One outcome of the financial crisis of 2008 was the reintroduction of the concept of a systemic banking collapse, and its link to supply-chains. For a moment, following the collapse of Lehman Brothers, there was a brief freeze in the issuance of Letters of Credit, a pillar of international trade, as banks hoarded liquidity and worried about counter-party risk. As a result the Baltic Dry Shipping Index, measuring bulk shipping demand, dropped by more than 90%. Only action by monetary and government authorities ensured that this was a passing moment.

There is no pillar of the economy more all-encompassing than the financial and monetary system: it links almost every good and service in the world. The fabric underpinning the exchange of real goods and services is enabled by money, credit, and financial intermediation. Money and credit have no intrinsic value. We swap a piece of paper or entries in a computer for the real labors and skills of billions of strangers across the world. This works if they too believe that those digits can be exchanged elsewhere for real things or services at a later time. What is implicit in such trust is faith in monetary access, stability and bank intermediation.

Some inputs are critical; such that a good or service cannot occur without them. So if a factory (or piece of infrastructure, socio-economic system or service function) has n critical inputs required to produce its output, it only takes one failure to stop production.

This is a version of Liebig’s Law of the Minimum, a principle derived from 19th century agriculture in which plant growth is limited not by the total level of resources, but by the scarcest resource.

The failed output of one company can spread through supply-chains causing further failure in production, or even meaning a spare part of the grid was not available so shutting down a whole swathe of industry, petrol pumps, bank machines, and so on.

We can say that in a more complex society there are a greater number of failure paths for any system, and an increased likelihood that the loss of that system will cause cascading failure in wider integrated systems.

A local region is less resilient to the loss of a critical input as the resources required to fix or replace it is unlikely to be locally available.

Because we live in a Just-In-Time economy, interruption in any link for more than a few days may cause inventories to vanish, so propagating interruptions through supply chains/networks. That is, we are dependent on much more time sensitive interdependencies.

With such amazing potential for failure, the astounding thing is that there is so little failure. Supermarkets are full with their usual brands, factories hum away and critical infrastructure is re-supplied, not just here or there, but right across the globalized world. Mostly things work, most of the time. When there is a failure, the globalized economy is highly adaptive to repairing localized damage. High speed communication, transport and long-range financial and monetary stability means that any shortage of a critical input can be quickly substituted from a range of sources.

But there are limitations. Some things are far easier to substitute than others. There are many bakers of bread and shops in which to purchase it. There are fewer makers of computers or cars. For very complex and specialized goods, there may only be one or two bespoke suppliers with very limited ability to ramp-up production outside of ‘normal’ parameters; otherwise very complex production systems would have to remain idle but ready outside of ‘freakish’ situations. This is a cost companies may not be able to carry, even if the externalized risk to society might be very high.

There are also larger scale failures that can initiate a ‘rip’ in the fabric of the globalized economy – for example, state collapse (Somalia, USSR); monetary (Zimbabwean hyperinflation, Argentinean crisis, 1999-2002); financial (Trade Credit Collapse post-Lehman Bros.); infrastructure failure (US North-East grid failure in 2003, UK fuel blockades in 2000); or production flows (Icelandic volcano 2008, fuel blockades, & Thai flooding in 2011). The key systemic concerns are whether the rip can be repaired, how long it takes to do so, and the potential for a crisis spreading – in other words for the rip to become a tear or worse.

The time-to-repair issue is critically important; if the post-Lehman credit crunch had deepened and expanded, it could have caused cascading failure, quite possibly swamping the ability of central banks and governments to respond and repair/ re-stabilize. The general level of centrality, or ‘hubness’ of a rip clearly both affects the ease of repair and the potential for any crisis to spread. A hyper-inflating Zimbabwe could latch onto the US dollar, not vice-versa!

The ability of the ‘core’ to help stabilize part of a weakened periphery also depends upon the health of the core. If the core is already weakened, the damaged periphery might tip the core over the edge.

What we have seen to date is a remarkable 200-year period of global economic growth, centered on an expanding and ever more complex core integrating a wider periphery. Even through the Great Depression and World Wars, the globalized economy bounced back and continued to evolve.

The most important parameter for defining this transformation is energy flows through the globalized economy. Thus energy flow, in the form adaptive to any particular system (food, light, fossil fuels), is generally a determining condition of the systems’ stability.

Economic and complexity growth are mutually reinforcing. Growing economies of scale, innovation and specialization link them. Increasing complexity in a system takes it further from the equilibrium to which all things tend. Maintaining complexity is a battle against entropic decay, and growing complexity is a battle against the universal tendency towards disorder. If you do not keep putting energy into something, it decays, and by decaying approaches equilibrium with its environment.

Our society’s sensitivity to growth rates that move too far from their normal growth rate is expressed in a general increase in anxiety over unemployment, depression or inflation. It is also within this stability domain that the cycle of booms and recessions occur, with an assumption of reversion to the long-term trend.

At a certain point, a slight change in the conditions or a tiny perturbation can cause the system to pass a tipping point and the state to transform into something very different.

It is not uncommon for complex systems to undergo a rapid transition to an alternative state, a critical transition. It could be a heart attack and death, abrupt climate change, the collapse of the northern cod fishery, the Arab Spring, the major market crash, an electric grid collapse,

This can occur when the state of the system crosses a tipping point and undergoes a phase transition or regime shift. This is the point at which the system no longer undergoes negative feedback returning the system to its old equilibrium; instead positive feedback drives it away to a potentially alternative state. Positive feedback is a reinforcing cycle that amplifies a disturbance.

There is a intuition that the whole of our globalized economy, under the prospective effects of energy and resource depletion, climate change, biodiversity loss, or debt deflation (the current condition within much of the Eurozone and elsewhere) will undergo a gradual if grinding contraction. This may be so.

Our understanding of economies, of the discipline of economics and of economic models has developed within the context of a particular type of socio-economic change they have been created within – long-range economic and complexity growth and stability.

As the risk of major systemic change grows, those models will likely prove increasingly erroneous as the system moves out of its historical equilibrium.

A hub for me and my city might be the electric grid or the banking system. This is because if either one failed the city would grind to a halt, because almost all nodes (people, factories, goods and services, transport) are directly and indirectly linked to both. The banking system and grid are of course are very tightly coupled. If the grid went down, failure would be rapidly spread to accounts and payment systems and ATM machines. That is, there would be high-speed cascading failure between hubs. Looking at the inverse, if the banking system were to fail it might take longer for the grid to fail, as running our grid does not depend upon real time financial transactions.

Financial & Monetary System: At the heart of the financial and monetary system we have fiat money, credit and bank intermediation. Our ability to trade and invest requires faith that the money we receive for our real resources and labors is accessible and will be acceptable elsewhere in space and time for the real resources and labor of others. Because fiat money has no intrinsic value, it exists through collective confidence in relative monetary stability.

The interrelationships between money, credit and the banking system mean that the hub’s stability is dependent upon the ability to service credit expansion, or in general the debt/GDP ratio. Credit hyper-expansion can destabilize this and/ or GDP destruction.

Economies of Scale: People around the world share the costs of consuming what is produced in the world, which is affordable because people around the world are also producing what is being consumed. It is adaptive to levels of population, income and the evolving distribution between discretionary and non-discretionary expenditure. It is also related to the scale and structure of global aggregate demand.

Production Flows: This includes factories and supply-chains. It’s the chain of final and intermediate goods and services transactions and the combinations that produce things in the economy and move them through the economy. They comprise flows for final consumption, and flows to maintain and repair factories and infrastructure against the inexorable effect of entropic decay. As production has expanded (economic growth) and become more complex, more and more production tributaries are required to be maintained.

Behavior: This is the collective behavioral responses and expectations adaptive to economic and social conditionality. This includes the extent of those we cooperate with (social radius), social discount rates, habituation, herd behavior, and our willingness to maintain institutions of trust (local law, international law, IMF, EU), popular consensus and radical social change.

Critical Infrastructure: Generally the collectively shared infrastructure that provides critical services that support wider economic and social processes. It includes grids and power stations, IT networks, transport, the banking system, sewage & water systems, and emergency services. Generally the collectively shared infrastructure that provides critical services that support wider economic and social processes. It includes grids and power stations, IT networks, transport, the banking system, sewage & water systems, and emergency services.

Energy & Resource Infrastructure: This is all the things between an in situ resource and the user of that input in the production system. This includes oil rigs, refineries, pipelines, farm machinery, fertilizers and mining systems. It sends food and energy and other resources into the globalized economy.

All of the core keystone-hubs co-evolved together, and each supports the functionality of the others. Together they maintain the dynamic state of the globalized economy. It will be noted that these keystone-hubs are very high level critical inputs for the globalized economy, and subject to Liebig’s law of the minimum. If the financial and monetary system failed, so too would production flows and replacements for critical infrastructure while bank runs and food riots could bring down governments (behavior). If critical infrastructure were to fail so too would banking systems, production flows, energy & resource infrastructure and behavioral response.

A very important feature of these primary global hubs is that they tend to have little or no redundancy. That is, they have no substitutes at scale. For example, we are all dependent on fiat currency, fractional reserve banking, and credit. We have almost no resilience to a systemic failure of the financial system, as we hold little currency, no alternative delocalized trading systems, have little to barter (as our personal productivity is dependent upon the globalized financial system), and have little capacity to maintain ourselves at even subsistence level (low personal and community resilience).

Likewise, while we might have a choice of electricity providers, they share a common grid. If the grid were to fail there is no fallback system. Diesel generators are limited. Further if grid failure initiated banking and IT system failure, diesel may be unobtainable. A reason for the concentration on hubs and a lack of redundancy arises

One of the principal ways of gaining overall efficiency is by letting individual parts of the system share the costs of transactions by sharing common infrastructure platforms (information and transport networks, electric grid, water/sewage systems, financial systems), and integrating more. Thus there is a reinforcing trend of benefits for those who build the platform and the users of the platform, which grows as the number of users grows. In time, the scale of the system becomes a barrier to a diversity of alternative systems as the upfront cost and the embedded economies of scale become a greater barrier to new entrants, especially where there is a complex high-cost hub infrastructure.

A related feature of all of them is that they share path dependency. That is, their current form and structure is contingent upon historical conditions.

Understanding this is critical, for it helps define the extent of their stability domains and their susceptibility to change.

To frame some examples that will be drawn upon later, the keystone-hub is imagined to be forced into the condition of a contracting economy, that is, the very opposite of its path dependent evolution. What will be shown is that this moves it out of its stability domain, it crosses a tipping point, and positive feedback drives it towards some form of disintegration.

The normal negative feedbacks that maintain the systems stability fail and become swamped by the effects of positive feedback. Thus the normal stabilizers in an economy to reverse a recession (devaluation, efficiency gains, exports, deficit spending) become impossible, of not enough scale, or too slow to drive the system back into its historical equilibrium.

Credit is one of our economies’ principal ways to inter-temporalize risk. Money in the bank and borrowing on all scales from people through to governments allow us to manage risk in recessions. But if the recession or depression is too deep this tool becomes increasingly vulnerable due to debt deflation, say, and the system loses resilience.

Deflation, if it is deep enough, can induce systemic financial failure, a fast and powerful positive feedback of cascading collapse.

Reverse economies of scale in critical infrastructure: As the globalized economy expanded in scale, larger and more complex critical infrastructure had to expand to service that growth. As infrastructure such as water/ sewage systems, telecoms networks, and power and grid infrastructure expanded, the fixed costs of maintenance and repair rose also. This reflects our eternal battle against entropic decay. The income a utility earns must cover the fixed costs of the maintenance and repair of its network plus normal running costs. Because infrastructure has amongst the largest scale and most complex physical structures in the economy, its fixed costs are very high. In a constant or expanding economy this can be afforded. The scale of our infrastructure is adapted to the economies of scale of the economy we have now. However, in a contracting economy it sets off a positive feedback of reduced demand, deteriorating networks, and growing economic damage to the wider economy.

As the economy contracts, then the customers of the utility have less to spend. A decline in revenue would mean that the utility income relative to the fixed costs would fall. If they want to maintain the network, they may have to raise the price of their service; this would drive away some customers, and cause others to use less services. Thus the utility revenue would fall further, requiring further price rises, spending falls and so on. If the utility cannot afford to maintain the network, the service deteriorates making it less attractive for customers, who drop out, reducing income and so on.

The infrastructure does not decline linearly with economic contraction, rather there is a positive feedback of accelerating infrastructure decline until it is no longer viable, and fails. Overall, it will have undergone a phase transition from a scale adaptive state where it operated well into a new collapsed state.

Complex critical infrastructure is very interdependent. Thus failure of an integrated grid-power station- water- sewage- telecoms – transport network under economic contraction would be set by failure of the weakest link. Further, because critical infrastructure is a keystone-hub, its failure can have cause cascading failure across other keystone-hubs, thereby driving the whole of the economy out of its stability domain.

The ability of the contracting economy to maintain critical infrastructure by subsidizing it would be increasingly difficult as contraction undermined other keystone-hubs.

Debt deflation: Bank-issued interest-bearing credit is the source of almost all money in the economy. Because credit is charged at interest, credit expansion is required to service previously issued credit. In order for the issued credit-money to retain its value relative to goods and services in the economy, GDP must increase commensurate with credit-money expansion.

The amount of credit-money can fall in an economy because over-borrowed people and businesses cannot borrow any more while de-leveraging takes money out of the economy. In addition, people and businesses are more cautious, saving more and spending less, so the velocity of money falls also. Less credit-money in the economy flowing more slowly through the economy means less for businesses. Some businesses fail, leading to growing bad debts, rising unemployment, less taxation income, reduced confidence and investment. Asset prices fall, GDP declines, and the real cost of debt rises. Rising bad debts means bank capital is destroyed, risking bank’s solvency, and the general economic outlook worsens. Bank issued credit-money and its velocity in the economy declines further. The cycle continues, and GDP falls further. The cost of credit on international markets for the country and banks rises due to fears of default, which increases the vulnerability of both.

Let us imagine some of the debt is written off. The country and investors can again go to the market and decide to borrow for real production that will grow GDP and hopefully allow the loans to be serviced in future. But producing GDP requires energy. Let us imagine that the energy to grow GDP is not there, rather it starts to decline.

But what if we thought that energy constraints were to continue to contract growth for many years, how would that change things? Banks would see that the real economic activity required to service outstanding debt could not be repaid in real terms. They would understand that as almost all money and deposits were issued into circulation as loans, all the money and deposits in the economy could not repay outstanding principal + interest. They would stop issuing new credit. The public and businesses might notice that as the economy declines, more and more of its shrinking productive output would have to go on servicing debt.

We may not get far into this process. That is because banks have evolved in the expectation of continued growth. Their retained earnings and shareholder capital amount to only between 2-9% of their loan book. Only a small percentage of loans have to go bad before the bank is bust. So a contracting economy would mean, very soon into the process, that all banks failed. No amount of liquidity would change that. Bank intermediation required for economic life would stop. Because our monetary system is based upon bank issued credit-money, it too would come apart.

So rather than a continuing deflationary slide, a point would come when the banking system just collapsed, along with our monetary system. This tends to happen when reality finally shatters the delusions that supported the system up until that point. Then, in a wave of panic and fear, investors, depositors, bond holders and all the interlinked counterparties would run to exit the financial system. This would also be a phase transition.

Trust Radii in Expansion & Contraction: The evolutionary economist Paul Seabright argues that trust between unrelated strangers outside our own tribal grouping cannot be taken for granted. In an expanding economy, trade can be expected to increase into the future. To share in that future’s good fortune, we and those within our own identified group need to be regarded by the distant others with whom we might trade as trustworthy. If we are untrustworthy (don’t pay for goods received) we not only damage our own future benefit, but also our groups’, so they too have an interest in preventing a free-loader on the groups’ good name. From this has grown institutions of trust and deterrence (‘good standing’, international legal frameworks, the EU, IMF) to reinforce cooperation and deter free-loaders. Trust builds compliance, which brings benefits, which builds trust. This has been true in an era of global economic expansion.

In a contracting economy the situation might be expected to break down. If less and less is expected to be available in the future, the benefit of grabbing something now increases (because you are getting poorer), and the cost of breaking trust with a stranger across the world falls (because the benefits of future trade are going to fall anyway). Because it is with a far off stranger rather than someone within your tribal group, your reputation as a freeloader will be minimal. Trust takes a long time to build but can be lost rapidly. For Seabright, global trade hangs upon a thread as fine as trust.

A related issue is the contraction of trust radii, and a hardening of tribal feeling in times of stress and crisis. A suspicion of ‘outsiders’ and increasing nationalism are common features of an economic crisis.

The banking system: Prior to the beginning of the financial crisis, risk management by regulators was focused on individual banks. It was common to hear how increased interconnection and integration between banks reduced systemic risk by dispersing individual bank risk over the whole system.

The crisis prompted a wave of studies, drawing particularly upon ecology, emphasizing how the structure between banks could increase systemic risk. This included collective effects like herding, in which financial networks enabled imitative strategies in the search for yield, or transmitted collective euphoria or panic. They also showed how deregulation and connectivity had removed ‘circuit-breakers’ in financial systems such as the integration of retail banks into merchant banks trading on their own account.

Further the nature of the connections between banks was explored. Each bank was not connected at random to other banks, rather a very small number of large banks were highly connected with lots of other banks, who had few connections to each other. Big banks have greater economies of scale and bargaining power, so can attract more business than their smaller rivals with better deals or market crowd-out, thus generating. Big banks have greater economies of scale and bargaining power, so can attract more business than their smaller rivals with better deals or market crowd-out, thus generating even greater economies of scale.

When the Federal Reserve Bank of New York commissioned a study of the structure of the inter-bank payment flows within the US Fedwire system they found remarkable levels of concentration. Looking at 7,000 transfers between 5,000 banks on an average day, they found 75% of payment flows involved less than 0.1% of the banks and 0.3% of linkages.

The failure of a hub node has a disproportionate impact, especially if those hub nodes have high connectivity to each other. This concentration opened up the possibility of ‘too big to fail’ and ‘too big to save’ banks, that is, a small group of banks that were ‘hubs’ of the global banking system. Upon this small number of super-connected banks stand the operations of lots of small ones.

Production Flows

Some countries’ role in trade is far more important to the globalized economy than others.

Importance Index to rank their influence: For example Thailand was at the center of the 1997-1998 Asian financial crisis ranked 22nd in terms of global trade share, but 11th on their level of importance. That means its potential as a crisis spreader was higher than its trade volumes indicated. Their results are based upon 1998 data. We list them in terms of their Importance Index (Eurozone countries in blue): USA(1st), Germany, Japan, France, UK, Italy, Belgium-Lux, Spain, Russian Fed, Netherlands (10th).

Hidalgo & Hausmann used international trade data to look at two things – the diversity of products a country produces, and the exclusivity of what they produce. An exclusive product is something made by few other countries.

The most complex countries (such as those in the Eurozone) are diversified and make more exclusive products. More exclusive products have less substitutability.

What is Collapse?

The shock from a collapse depends upon the level of complexity lost. The Black Death which killed about one third of Europe’s population in the middle of fourteenth century did not fundamentally alter the socio-economic complexity of the time3. A dead producer represented a dead consumer. The same small number of social functions (farmer, mason, and cleric) remained before and after, there were just fewer people doing each role. This reflects low levels of complexity and interdependence within and across functions in society.

However, in modelling of pandemic influenza in modern societies, it was found that once more than about 10% of people are randomly removed from the workforce, the risks of large-scale societal dislocation increases significantly. This is because at this level of removal it is likely that key people with specialized knowledge will disappear from the workforce, meaning that key teams or functions cannot operate, which further cascades through other co-dependent functions throughout social and economic networks.

One analysis shows that the evolution of key manufacturing processes over the last century saw a six order of magnitude increase in the energy and resource intensiveness per unit mass of processed materials. This should be quite intuitive – as we put more and more elements and functionality onto a micro-chip, the energy and resource requirements rise.

A systemic collapse in the globalized economy implies there is connectedness and integration. It also requires contagion mechanisms.

It can be argued that collapse happens when a system crosses a tipping point and is driven by negative feedbacks into a new and structurally and qualitatively different state, one with a different arrangement between parts and a fall in complexity. The operational fabric could cease to operate and the systems that are adaptive to maintaining our welfare could cease or be severely degraded. As a society, we would have to do other things in other ways to establish our welfare.

The speed of collapse would be set by the speed of the fastest and most responsive systems coming out of their equilibrium, causing cascading failure across other systems. In particular we will consider that the monetary and financial keystone hub would spread contagion to the keystone hub of production flows, which would feed back into the financial and monetary system and other keystone hubs. The speed of contagion would be set by the operational speeds of these hubs. As the operational speeds have increased along with the growth of the globalized economy, and the functioning of more complex societies have become ever more dependent upon their moment-by-moment, day-by-day operation, the potential speed of collapse has risen.

Converging Crises in the Financial, Banking & Monetary System

In this section the context in which an unprecedented and catastrophic shock could occur sometime within this decade is presented. The first sub-section considers the implications of massive credit expansion and global imbalances over decades. At the heart of this is too much debt relative to GDP. This is particularly acute as credit, monetary systems and bank solvency are highly codependent and support the functionality of the globalized economy. Since 2007/8 when the crisis first broke, systemic risk has increased. Continued ‘kicking the can’ and reduced buffers and confidence in the global financial system have increased the risk of a catastrophic financial shock.

There is a growing risk that oil and food constraints will increasingly bear down on global economic growth in the near-to-medium term. If the amount of affordable oil available to the global economy declines in real-time, and cannot be substituted in real-time, then economic contraction becomes inevitable.

Economic contraction feeds back into further economic contraction. Sustained economic contraction is totally incompatible with the credit backing of the globalized economy as expressed through monetary systems, fractional reserve banking, fiat money, financial intermediation and all financial assets. The market ‘discovery’ of such an incompatibility could also be catastrophic.

However, we may not ‘see’ much of the effect of oil constraints because the effects of a breakdown of the financial system arising from the already present implications of credit expansion has already caused cascading failure through keystone-hubs, collapsing the globalized economy and energy demand. Or we may see oil (and food) constraints merely nudge that already increasingly unstable system tipping it into a collapsed state.

Credit over-expansion and imbalances: The response to the financial crisis in 2007/8 staved off a full banking crisis and avoided tipping the economy into a new great depression.

It did not solve the massive disparity between debt and income; it displaced immediate risks onto sovereigns via bank guarantees and unsustainable deficits. We responded to too much debt with more debt, yet our ability to service that debt is even more questionable than four years ago.

In many cases, through direct and indirect means, we are borrowing additional principal to service existing debt-the very definition of Ponzi borrowing. This situation was always untenable. But the displacement of immediate risk has further increased the potential for catastrophic systemic failure by removing potential buffers in the financial system and undermining further the confidence in the institutional and political actors that would be required to manage a crisis.

The Bank of International Settlements point out that the core issue is not just financial debt; government, corporate (non-financial) and household is far above levels that undermine growth in many of the most advanced economies. They concluded that if government debt is greater than 100% of national income growth is undermined, if household debt is above 85% of national income growth is undermined, and if corporate debt is above 90% growth is undermined.

In the Eurozone just prior to the crisis, even Germany and the Netherlands had levels of Total External Debt-to-Exports, and Total External Debt-to-GDP that exceed Reinhart and Rogoff’s criteria for countries tipped as likely to default. Out-side of the Eurozone, the United Kingdom has total debt (government +financial + non-financial +household) of over 900% of GDP, while Japan’s is over 600%. While the United States continue to benefit from their dollar reserve status, grave questions remain, even with the best global outlook, as to whether they will be forced to inflate their currency or default in the medium term.

What these debt figures do not take into account are contingent liabilities. They do not include state guaranteed bonds, bank guaranteed bonds, or the guarantees behind the complex ‘rescue’ mechanisms within the Eurozone. Mark Grant uses the example of Belgium, which at the end of 2011 had an official government Debt-to-GDP ratio of 98%. What are not included in the calculation are the guarantees for banks such as BNP Paribas and Fortis bank, as well as standing behind loans to the financial sector. It is also accountable for part of the balance sheets of the ECB, the Stabilization funds, and the Macro Financial Assistance Fund. So Belgium’s total debt and contingent liabilities-to-GDP are 203%.

There are also large liabilities distributed throughout the Eurozones’s internal payments settlement system (TARGET2). For example, Hans-Werner Sinn of the Bundesbank estimates German contingent liabilities of over half a trillion Euros could be revealed were the Eurozone to break-up41.

The concern about such contingent liabilities, which exist throughout the Eurozone, is that provided there is no deepening of the financial crisis, or especially if there is no major shock, one can pretend them away. But if a shock occurs and the country is called to pay guarantees it immediately imperils its own solvency. Further, as such a shock it likely to be part of a global banking crisis and a multi-country sovereign crisis in the Eurozone, there would be little credit available to cover liabilities in the market, even if it was affordable. Sovereigns and banks are hot-wired for rapid contagion in the event of a shock. This is part of what we have referred to as a loss of system diversity (putting the banking system and sovereigns on the same platform), that can increase the speed and scale of any major crisis.

Banks create deposits when they create loans. Their pumping of credit-money is what makes the world go around. When there is no further capacity for borrowing in an already over borrowed economy, and de-leveraging destroys money as loans are extinguished, the money-credit supply drops relative to the goods and services produced in the economy. Less credit-money in the economy means less for economic activity, resulting in business closures, defaults, falling asset prices, and rising unemployment. As the economic outlook worsens, people and businesses reduce spending due to fear of unemployment, say, and in anticipation of falling prices. This reduces the velocity of money, further reducing the effective money flowing through the economy. This further reduces economic activity in a reinforcing spiral. In all of this, assets and collateral are eaten away.

Austerity policies by governments cannot reverse this process – they exacerbate it. Hypothetically new money could enter the economy from foreign trade reversing the deflationary forces. But with much of the world’s biggest importers suffering from too much debt, where is this growth to come from? Canada, Australia and China seem to be on the edge of a collapsing property bubble and therefore contain vulnerable banking systems.

Sovereign risk can only increase. Eurobonds, further leverage of the European Financial Stability Facility (EFSF), and waves of European Central Bank liquidity add debt but do not address insolvency. Indeed, new waves of central bank liquidity seem to be suffering from declining marginal returns, and worse,

Fractional reserve banking system, core capital and shareholder equity is only a tiny fraction, 2%-9%, of assets. Thus leverage of 26 times core capital in the Eurozone banking system could mean an asset loss of just 4% would wipe out the banks. This would leave the banks unable to cover their liabilities to the public, businesses, and other financial institutions.

Leverage throughout the shadow financial system is far higher via complex securitization, and off-balance sheet liabilities. Financial assets are the leveraged collateral for further financial assets which have been further collateralized and leveraged. The use of repos, collateral re-hypothetication and an array of derivatives are the shadow banking system’s equivalent of fractional reserve credit expansion, but without the transparency that the ‘normal’ banking system is expected to pay some heed to. Because of this huge leverage, once a ‘run’ on such financial assets occurs, it can vaporize massive levels of virtual wealth. Because of the complexity and opacity of how and where such assets are held, in a crisis banks would be unsure whether counter-party banks or even their own balance sheet is safe from one moment to the next.

The Bank of International Settlements shows that over-the-counter derivatives outstanding rose by $100 Trillion to some $700 Trillion between 2010 and 2011, over ten times global GDP43. While these values are regarded as ‘notional’, they represent a web of obligations that may not be redeemable. For example, US treasury secretary Timothy Geithner’s refusal to support a ‘hair-cut’ of Irish bondholders was in the context of US banks holding Credit Default Swaps on Eurozone debt. The implication being that US banks may not be able to pay out if called upon to cover a ‘credit event’, with cascading implications.

Further intrinsic vulnerability is reliance upon short-term funding. Ninety banks in The European Banking Authority’s stress tests in mid-2011 have to re-finance €5,400 billion, equivalent to 45% of EU GDP in the following two years. If there is already far too much debt in the financial system and thus on bank balance sheets, and economic contraction due to debt deflation is likely, then the affordability of re-financing such sums would naturally decline further. Authorities can help systemically important banks ‘hide’ possible

Insolvency, but they can only play such games if their bluff is not called. For example, there is concern that the US banking system may be holding huge unacknowledged losses that are being obscured by the suspension of the ‘mark to market’ rule in 200846. The bluff calling can come from a run on banks, a collapse in bond values, a frozen inter-bank market, a margin call, or a forced asset sale.

The ECB, which alone has an infinite balance sheet (it can print indefinitely at any scale), is by its actions further destabilizing the financial system by pushing risk it can absorb onto parts of the system that cannot. It is also making itself indispensable to further refinancing operations as those risks spread and it crowds out private capital.

Peak Oil and its Economic Implications. But if the above pessimism turns out to be foolish, if the global economy maintains strong levels of growth, it is likely to hit new constraints, ones that are already being made apparent. The high quality and affordable oil that powered the growth of the globalized economy is being replaced by increasingly low grade and expensive oil. There are already good indications that we cannot maintain production at this level; rather, it will begin to fall. This is an issue of today. Conventional global oil production, 90% of our oil, has been essentially flat since 2005.

Oil contributes to about 40% of global energy production, but well over 90% of all transport fuel. It provides the physical linkages of goods and people across the globalized economy. It also is a raw material in a huge range of production from plastics to pesticides. Peak oil is the point in time when global oil production has reached a maximum and thereafter it enters a period of terminal decline.

The phenomenon of peaking, be it in oil, natural gas, minerals, or even fishing is an expression of the following dynamics. With a finite resource such as oil, we find in general that that which is easiest and cheapest to exploit is used first. As demand for oil increases, and knowledge and technology associated with exploration and exploitation progresses, production can be ramped up. New and cheap oil encourages new oil-based products, markets, and revenues, which in turn provide increasing revenue for investments in production. For a while this is a self-reinforcing process. Countervailing this trend, the energetic, material and financial cost of finding and exploiting new production starts to rise. This is because as time goes on new fields are found in smaller deposits, in deeper water, in more technically demanding geological conditions and require more advanced processing.

The oil produced from individual wells peak and then decline. So must production from fields, countries and the globe. Two-thirds of oil producing countries have already passed their local peak. The United States peaked in 1970 and the United Kingdom in 1999, and decline has continued. It should be noted that both countries contain the worlds’ best universities, most dynamic financial markets, most technologically able exploration and production companies, and stable pro-business political environments. Nevertheless, in neither case has decline been halted.

There are good grounds for arguing that we are at or near the peak of oil production now. The International Energy Agency argued that conventional oil production peaked in 2006. More than 60 countries have already passed their peak. To continue supplying oil commensurate with a growing economy in the light of the prospective decline in conventional production as more old fields deplete, will require huge production increases from unconventional oil such as tar sands, coal-to-liquids, polar and deep water oil. Further, oil producers are using more of their own production to feed their growing economies, meaning there is a declining volume of internationally traded oil.

The question then is can sufficient oil be brought on stream on time, at an affordable price, and at a sufficient energy return on energy invested (EROI). Or can the economy’s requirement for additional oil be substituted by efficiency measures, or with other energy sources such as renewable energy

Further, this requires massive investment from manufacturers and consumers, again, on time and at scale. This requires a strong confident economy, functioning credit markets, and customers who can afford a decline in transport asset resale value. Again there are analysts who argue that substitution and efficiency cannot substitute.

Peak oil is not primarily concerned with reserves, but flow rates . Promises of energies yet to be accessed, technologies not yet in production (never mind being rolled out at scale) are irrelevant if the constraint is pressing. Using an analogy, it is of little use knowing that there is an oasis a hundred miles away if a stumbling man is dying of thirst now.

Because the economy is path dependent, it is adaptive to particular forms of energy flows, as revealed in our fixed assets (cars, refineries and pipelines), settlement patterns, trade arbitrage and ultimately many of the structural and social characteristics of the economy. One cannot jump across energy carriers without time, effort and the working operational fabric of the globalized economy.

Thermodynamic-Economic. To anybody with a basic knowledge of physics it should seem natural and necessary that rising energy flows are required for economic growth. More particularly, it is the amount of that energy that can be converted into useful work.

Economic. The thermodynamic constraints are expressed through the changing internal dynamics of the global economy. Rising oil prices affect the economy in two principal ways. Firstly, they squeeze discretionary income. Rising prices have direct effects on the cost of transport, pesticides and so on. More broadly, the indirect effects are upon every element of GWP because energy prices represent a cost of producing GWP. The price of oil is embedded in every good and service produced. Hamilton and Deutsche Bank have argued that when energy share of total consumer expenditure becomes too large, recessions occur.

The second impact of high oil prices is that importers experience a weakening of their balance of payments. More money leaks from a potentially already deflating economy.

High oil prices feed back into the economy through reduced economic activity, increasing pressure on discretionary income and rising defaults. This is an accelerator of debt deflation dynamics.

One can have rising prices in a deflationary environment

Debt deflation, even without rising food and energy prices, leads to reduced discretionary spending. Food and energy prices, because they are at the heart of non-discretionary expenditure, lead to further squeezes on discretionary spending, credit issuance, and the ability to service debt. Thus economies are caught between vice-grips of debt deflation arising from credit over-expansion, and the rising costs of its primary needs. This reinforces a debt deflationary spiral.

This leads to reduced economic activity and thus a fall in energy demand. The result is an overhang of spare production capacity and a deteriorating investment climate for energy investment.

After the oil price collapse in 2008, when oil prices dropped below the marginal cost of production for new developments, projects were cancelled. Credit conditions put further strain on project finance. According to the International Energy Agency about $17o billion of new projects were cancelled or delayed. The result will be further reductions in available oil in the future when those projects were expected to come on stream.

This situation demonstrates that constrained oil production, even if necessary to the economy does not necessarily lead to ever-rising prices. Economies can only pay so much for oil before their economies become damaged. Damaged economies use less energy and cannot invest in future oil (or other energy) production. This then becomes a harbinger of even deeper economic constraints.

One might assume that falling oil (and food) prices might lead to renewed economic activity, initiating an economic recovery until oil production constraints are again felt. But the production constraints would be felt at a lower level of production not only because of the natural decline rates associated with standard peak oil models, but because of the reduced levels of investment.

Economies would still remain in a debt deflationary environment arising from credit over expansion, so it is doubtful that any growth would be forthcoming. Rather economic contraction would continue, even while oil and all energy prices dropped. If however, by whatever means, a relatively painless debt write-off allowed economic growth to take off, it would soon be hit by rising oil and food prices, again initiating a new debt deflationary cycle, causing further economic contraction and reduced energy investment.

Even if we had the ‘perfect’ monetary and financial system, sustained contraction would still affect the production flow hub, the critical infrastructure hub, the energy and resource infrastructure hub, and the economies of scale hub – all of which are adaptive to growth or economic maintenance of the status quo. The de-stabilization of any of these hubs would be likely to lead to destabilization of other hubs. The net effect would be to collapse the globalized economy, for it is maintained and dependent upon those hubs.

Food production

Global food production has been hitting constraints as rising populations and changing diets hit against flattening productivity, water and fertility constraints, and the likely early effects of climate change.

One of the main effects of the Green Revolution of the 1950’s, 60’s and 70’s was to put food production onto a fossil fuel platform. Modern food production relies on pesticides, fertilizers, machinery, drying systems, long-haul transport, packaging, freezing and so on, all fossil fuel dependent.

Modern seed varieties require more water, which requires more complex irrigation and aquifer pumping, again requiring more fossil fuel input, and putting more strain on already stressed water supplies. By various estimates, between six and ten fossil fuel calories are used to produce every calorie of food.

Food is now being converted into fuel, adding further pressure to already strained supplies. Today, 40% of the US corn crop is used to produce biofuels, and globally, biofuels consume 6.5% of grains and 8% of vegetable oil production.

Food is the most inelastic part of consumption. Like oil, rising prices drive out other consumption, which can lead to job losses, unemployment, and defaults. The most developed countries spend about 10% of their disposable income on food, however in many parts of the world it is over 50%.

The two rounds of QE were to support battered financial institutions. This injection helped drive a global commodity bubble, affecting an already stressed global food market. Pressure was displaced from the US onto the plates of citizens in the Middle-East and North Africa.

There is general agreement that one of the contributing factors to the rolling revolutions beginning at the end of 2010 was increasing food prices eating into already strained incomes. Food is, and always has been a mainstay of welfare and social peace.

A contracting economy

Proxy wealth can be created at virtually no cost and can expand in a wave of optimism. Real wealth is limited by available land, hard assets and GDP. GDP depends on the operation, stability and functionality of the globalized economy, which requires real energy and resource flows.

A terminally contracting global economy is incompatible with the credit backing of the global financial system, fractional reserve banking, and the monetary system, as we have seen in section III.3.1. This is simply because in an expanding economy credit (principal + interest) can be serviced in real terms; in a contracting economy not even the principal can be returned. So our problem of hyper-credit expansion is that debt expands beyond the GDP’s ability to service it, while debt deflation and peak oil causes GDP to contract undermining the ability of the economy to service debt.

The loss of faith, as is the way with markets and human behavior, will be waves of panic as holders of such proxy assets run for the exit, trying to convert a mountain of financial assets into a molehill of real assets. It would be a sellers-only market.

The conversion of financial to real assets would be further constrained as money is required for intermediation. But in such a crisis, people would cling to any cash they had, banks would be collapsing, there would be fears of currency re-issue, inflation, or even hyper-inflation.

Global financial markets and the assets they trade are, in their entirety, a Ponzi scheme, and like all Ponzi schemes, they live only as long as confidence is maintained before collapsing under the weight of lost illusions.

Something sets off an interrelated Eurozone crisis and banking crisis, a Spanish default say, which spreads panic and fear across other vulnerable Eurozone countries. This sets off a Minsky moment when overleveraged speculators in the banking and shadow banking system are forced to unwind positions into a one-sided (sellers only) market. The financial system contagion passes a tipping point where governments and central banks start to lose control and panic drives a (positive feedback) deepening and widening of the impact globally. In our tropic model of the globalized economy, the banking and monetary system keystone hub comes out of its equilibrium range, crosses a tipping point, and is driven away by positive feedbacks to some new state.

This directly links to another keystone-hub, production flows. Failing banks, fears of currency re-issue, fears of further default, collapse in Letters of Credit, and growing panic directly quickly shut down trade in the most affected countries. As the week progresses factories close, communications are impaired, social stress and government panic increases. After a week almost all businesses are closed, there is a rising risk to critical infrastructure.

Trade is impaired globally via a credit crunch. This undermines exports from some of the most trade-central countries, with some of the most efficient JIT dependencies in the world. This cuts inputs into the production and trade into countries that were initially weakly affected by direct financial contagion. Globally, the spread of trade contagion depends on complexity, centrality, and inventory times and once a critical threshold is passed spreads exponentially until the effect is damped by a large-scale global production collapse (implying another keystone-hub, economies of scale is driven out of equilibrium).

Trade contagion and its implications feed back into financial system contagion, helping drive further disintegration. The interacting and mutually destabilizing effects of keystone-hubs coming out of equilibrium destroy the equilibrium of the globalized economy initiating a systemic collapse.

Once the financial system contagion crosses a particular threshold the de-stabilization of the globalized economy will be exceedingly difficult to arrest; this point may be in as little as ten days.

As financial and monetary systems become more unstable, the risks associated with doing anything significant to change or alter the course increase (see also the discussion of lock-in in the final section). In addition, the diversity of national actors, public opinion, institutional players and perceptions works against a coherent consensus on action. Therefore the temptation is to displace immediate risk by taking the minimal action to avert an imminent crisis.

The actions taken to prevent a crisis, or preparations for dealing with the aftermath of a crisis, may help precipitate the crisis. Therefore to avoid precipitation, the preparation has to be low key and below the radar of the public and markets. This limits the extent and scope of preparation, increasing the risk of a chaotic and slow response.

Black swans & brittle systems — the growing stress in our very complex globalized economy means it is much less resilient.

Rumors of default cause a run on Country A’s banks. The government, without full preparation, defaults and new lending to the government stops. Bills cannot be paid and it becomes immediately clear that the economy will experience a shock. Bond values plummet. The domestic banking system faces a wipe-out. Cash machines close and transactions cannot be processed. Those with access to cash stockpile food and medicines, building a public and political sense of panic.

Money is needed to pay bills and support banks. Will the country a) get new loans and stay in the Euro, or b) restore its national currency and leave the Euro?

Defaults and stays in Euro: The country should in theory be better able to service new loans after defaulting on old ones. The requirements could be enormous, they would need debt to run the state and re-capitalize the banking system rapidly. But if country A receives market support, worried creditors of countries B, C and D are likely to see their bond values plummet, and public debt and banking re-financing costs spiking, and thus spreading systemic risk through the banking system and sovereign debt markets. Thus, financing is unlikely to be forthcoming (we may also be in the grip of a credit crunch), and for the country concerned, having a new national currency would have been a part of the reason they entered a default. Thus it is more probable that a country would default and re-issue.

Defaults and re-issues new currency: How prepared are the government and local central bank authorities, how long will it take to be implemented? Further, how does the complexity of modern financial and monetary architecture within the real economy hinder implementation and what is the chance it will be botched?

One can assume that there would be forced conversion of Euros into the new currency at one or more conversion rates. The banking system would have been made insolvent by a flight of Euros overseas or into cash. The government would intend to re-capitalize the bank in the new currency. There would be a bank holiday over which all deposits and liabilities would be converted into the new national currency. Euro notes would have to be stamped with some sign of its new status. As the government would have been bounced into it, the banks could be shut for a week or more before electronic payments systems were again able to process transactions.

There would be an imposition of capital controls, including trade controls, to prevent an outflow of deposits. Trade controls would be needed to prevent companies falsifying imports in order to get money out. The practicalities in real-time of facilitating trade while at the same time instituting trade controls would be immense.

If it intends to issue a new national currency, it will need to re-denominate all assets and liabilities in the new currency. This will immediately destroy the balance sheets of many companies that had Euro liabilities, but now hold a devalued new currency asset base. This would spread losses directly to companies across the world.

The value of the new currency would fall rapidly against the euro and other currencies. This would lead to an immediate soaring of prices of the most basic goods and the overnight destruction of savings. Let us say the government of an exiting country decides to set an exchange rate with the euro that can be defended with the help of the IMF, say. Ideally, one would want a carefully controlled money supply. However in the growing intensity of the crisis, the temptation would be to print more and more cash to maintain government services and temper major social unrest. The result could be a break-up of the defended exchange rate, major inflation, or even hyper-inflation.

Once one country defaults, it undermines the confidence that the next weakest countries, B, C, and D will not default. Bank runs and asset flights undermine bank balance sheets as television pictures of queues forming outside banks in major European capitals are beamed around the world. How long would it take to introduce capital controls or bank holidays? Would they undermine trade? Bond values plummet, re-financing costs jump across the bond markets causing further contagion. National banks collapse, but cannot be bailed out. The process of default contagion undermines prospects for global economic growth and thus prospects for continued solvency of what were previously though to be ‘good’ credit risk countries. Trouble comes to countries E, F and G, which may or may not be in the Eurozone. An inverted pyramid of debt is vaporised.

The second interrelated track is what is likely to be rapid contagion across the global banking and shadow banking system. The process of bank contagion, like sovereign default, is a fear driven process of cascading de-stabilization. As sovereign bonds are defaulted on, national banks shut their doors, and the prospect for whole economies rapidly turn dire, all classes of debt become at risk. The mood turns fearful and pessimistic. France (say) and the Netherlands have to publicly ‘stand behind their bank depositors’, but in the context of increasing fear and paranoia, rather than re-assuring, this causes panic and bank runs. In many cases state guarantees and national deposit insurance turn out to be, or are perceived to be worthless (see the case of Belgium, discussed earlier).

A Minsky moment occurs when massively overleveraged speculators are forced to unwind their positions to a one-sided (sellers only) market forcing a “discontinuous price discovery”. Falling asset values, margin calls, a general flight from risk assets to cash, counter-party risk, forced asset sales to cover obligations (collateral, CDS contracts, capital ratios), discovery of competing claims on collateral, a collapse in credit markets, and collapsing hub banks would re-enforce a rapid and deepening global spread of the crisis. Trade credit and working credit for businesses would vanish. Oil prices would collapse as positions are closed and a flight to liquidity at any price occurs. The global economic outlook would turn awful, raising fears for all credit assets around the world. Raw fear and counter-party risk would paralyze even the banks thought most secure.

There would be a major flight to the dollar, but huge currency volatility would remain as major US banks have to be rescued with unlimited liquidity even though they are clearly insolvent. The outlook for the US economy would turn dire. Its rapidly appreciating currency, the prospective massive drop in GWP, and the prospective massive debt to income levels would mean a deflationary shock with the growing risk of inflation. Investment would stop. US, UK, Japanese, Chinese, and Australian banks would have to be rescued.

Central Banks & Governments to the Rescue?

Within a day or two we would see global bank runs, bank and credit collapses and food security crises spreading from one default country to prospective defaulters. The banking system would be transmitting profound insolvency across the world. There would be a race between the disintegration process and government and central bank response.

But as the US authorities prevented severe contagion after the fall of Lehman brothers, and bailed out the insurer AIG to protect counter-parties to derivative contracts, why could governments and central banks not do so again? The first reason is that the global financial system is understood to be in a more precarious state now than three years ago, with the cracks apparent not just in Europe and the US, but in China, and elsewhere and with that there is less confidence, and more of its flip-side, fear. Secondly, this would now include a sovereign debt crisis and the break up of the Euro. Third, the tools that officials could wield in 2008 have become worn. Interest rates are already very low, and the crisis is likely to emerge as a consequence of a loss of faith in yet more ‘ big bazooka’ patches, and even more ECB liquidity.

In the end the only backstop a central bank has is the ability to print infinite money, and if it has to go that far, it has failed because it will have destroyed confidence in the money.

Trade Credit & Insurance. The broadest effect on trade is through the issuance of Letters of Credit; this would have world-wide significance. Letters of Credit are the method of payment for over 90% of international shipping. They are intermediated by banks over a period between when a buyer-seller agreement is made and when goods are delivered in exchange for a bill of landing. In 2008, following the collapse of Lehman Brothers and the subsequent credit crunch, banks withdrew from such financing. This was held to be responsible for a 93% drop in the Baltic Dry Shipping Index, which measures the cost of bulk dry shipping.

For Letters of Credit to operate, it requires that banks are willing and able to extend credit. Firstly, this requires that banks are solvent. Secondly, even if they are solvent, in a severe credit crunch and financial crisis they are likely to hoard cash on their own balance sheets. This is because they are at risk from closed inter-bank markets; a general collapse in asset values due to forced sales; opaque counter-party risks; and possible bank runs. Of all credit issuance, Letters of Credit are the easiest to pull so as to preserve core liquidity/ solvency.

A related issue is credit insurance. Most European exports are uninsured, though coverage rises as high as 25% for export focused Germany. Already Euler Hermes, Europe’s biggest trade credit insurer, has suspended cover on shipments to Greece. There are also indications that there is growing caution about coverage of exports to Spain and Italy. During the 2008 crisis, governments stepped in when private sector insurance was pulled. However, in the contagion scenario outlined in this section, many governments could not provide such coverage, or could not afford to risk open-ended contingent liabilities.

Almost all trade within the country would stop as banks would be rendered insolvent and be shut down in order to enable re-issue. People and businesses would be left with cash on hand. Supermarkets, pharmacies, and petrol stations would quickly run out of stock. Re-supply of businesses, factories, and hospitals would become increasingly difficult as inventories vanished. Within days there would be the beginnings of a food security crisis and a lack of medicines. Panic buying could be expected. Initially the most exposed would be those with little cash at hand, low home inventories, mobility restrictions, and weak family and community ties. The number of people affected would increase significantly as the days went on.

Businesses could not re-stock because they could not pay their suppliers. While it is sometimes mentioned that a currency re-issue could be completed over a weekend, this seems exceedingly optimistic for some of the reasons already mentioned (the uniqueness of the experience, the complexity of financial and monetary systems and infrastructure, the reflexivity trap). It could be days, or even weeks.

Even if the exchange rate of the new currency with the Euro was known, and had the new currency available to businesses and the public, re-pricing would highly problematic. For example, suppose Italian bank accounts underwent a one Euro to one new Lira re-issue. Further, assume there is a defended 50% devaluation of the new Lira against the Euro. One cannot assume that every price along the supply-chain would just be the same nominal value in the new currency. In broad terms, the more import dependent the good or service, the higher the new price would have to be.

This makes re-pricing highly opaque. Firstly because there are so many links in complex supply-chains, and the more links, the greater uncertainty in what the end price might be. Further, because of the dispersed delocalization of supply-chains, they would be subject to growing volatility across many exchange rates.

This brings us back to another facet of the stable surround idea. That is, large-scale stability can support new elements integrating with a system, or help a failed part re-equilibriate. So pricing a new good or service is possible because of the wide stability of prices along the supply-chain, the price stability of essential services, and the pricing of competitors. But if there is a systemic pricing fog (massive volatility) across a whole economy, there is no stable point of reference. This adds to the time over which transactions may not occur, even after a ‘successful’ re-issue.

Even if the re-issue was successful, speedy, and the effect of the pricing fog was minimal, there would remain many challenges. Many businesses would be bankrupt, having lost Euro assets. People and businesses would hoard any remaining Euros, but even the new currency would be spent guardedly. One would expect a massive and rapid reorientation away from discretionary consumption towards primary needs-food, essential energy, medicines and communication.

Certain businesses could argue that as ‘essential’ they should have access to larger currency transfers. Firstly, this may take time (days, weeks?) to organize and institute mechanisms to prevent capital flight. However, the ability of the business to produce is not its own gift, it exists interdependently in a complex society. Because of the number of conditions that are required for production of goods and services in complex societies, the failure of only one element can cause a general output failure- this we have linked with Liebig’s Law of the Minimum. Increasing complexity means the company may be unable to spot its vulnerabilities as they depend not just upon the direct but also indirect dependencies. Further, the more extensive the shut-down of wider economic activity the greater the chance that any of their critical inputs might be compromised. For example, remembering the discussion of pandemic planning, key employees, or inputs/ services may not be able to arrive due to lack of transport fuel, so shutting down production. So while some larger companies have been preparing for a break-up of the Eurozone, they can never guarantee production in a crisis.

Red Countries are the ones in the worst shape and fail first

Red countries’ imports would collapse as companies had no access to, or limited access to money and credit. Exporters to red countries would fear they would not get paid, or be paid in a devalued currency.

Even if a red company had money kept in the bank of an Amber or Green country its ability to utilize imports from elsewhere will be increasingly impaired due to other failures in its local supply-chain. Furthermore, it may be tempted to hold onto any deposits elsewhere even at the risk of shutting down its own production if it feared a major economic collapse.

Barter might work for simple exchanges, but not the diversity of goods and services in a complex economy. Red imports would collapse.

Red Exports. The value of earning potentially ‘hard’ currency which could be deposited in a green country bank would be immense. However, the ability to export would be undermined by an inability to produce (Liebig’s law of the minimum). Even if a good or service could be produced, the company would have increasing difficulty exporting it. This could be due to transport and shipping problems, getting and paying for insurance, or the availability of customs agents. If the product could be produced and shipped, there would be no demand from other red countries.

Green (better off than red nations) imports: There would be a severe drop in imports from red countries, and increasing drops from amber countries. Lack of trade credit would also affect imports from other green countries. Imports from amber countries could drop because of production/ supply-chain failures in those countries, fear over getting paid, and exchange rate volatility. Weak currency green countries would see drops in exports from rapidly appreciating US dollar/ sterling. Green imports would drop.

Green Exports Production would begin to be affected by lack of inputs from red and amber countries in particular, but even from some green countries. This could begin to ripple through wider supply-chain networks, affecting local production and goods and services available for export. Green exports would drop.

Supply-Chain Contagion

The second phase is the links, via supply-chains, to other nodes that are not affected by the primary cause. That is, the high complexity de-localization of dependencies means that supply-chain failure in one place can propagate elsewhere on the planet, causing further failures elsewhere. This is supply-chain contagion.

In our scenario, the impact is in some of the most high centrality countries in the world (section III.4); the Garas et. al. list of most central countries is: China, Russia, Japan, Spain, UK, Netherlands, Italy, Germany, Belgium, Luxembourg, USA, France. We would be expecting at least three of them to be in the red/ amber phase along with a number of other countries such as Greece, Portugal, and Ireland (which probably has high centrality even if not in the top 10).

Non-Eurozone countries would also be likely to see plummeting bond markets, bank-runs and bank collapses, and while they could print money in a crisis, exporters to those countries would no doubt fear rapid inflation and thus question real returns, thus hampering imports and exports. In addition, the Minsky moment impact would freeze credit worldwide, and see banks failing across the world. The UK would probably be in the midst of a major banking and shadow banking crisis as the City of London froze.

These countries produce some of the most complex and least easily substitutable goods and services in the world. So the loss of such outputs to the world economy would be of very high impact.

These countries would also have high levels of vulnerability as they are the most complex with high levels of interdependencies. This would also reflect a long term habituation to normalcy. Those many decades of stability will have embedded increasingly complex, high efficiency JIT logistics.

For a trade collapse or a wider system collapse, one does not need everything to fail, only certain things. The impact can then cascade across businesses, economies and society.

A supply-chain crisis becomes non-linear in time. That is, the damage caused by the disruption does not rise in proportion to the length of time the disruption occurs, rather it starts to accelerate. We can hypothesize that this is firstly because inventories and buffer stocks cushion the early impact of the crisis. If the crisis-causing event is shorter than inventory times, there should be minimal supply-chain problems. As inventories have fallen, tolerance for largescale and shorter-timed interruptions has fallen.

Secondly, the level and structure of interconnections mean that the more people, businesses, goods, and services (nodes) that are affected, the greater the chance of infecting any remaining unaffected nodes.

The number of infected nodes starts to rise exponentially. Later, the rate of supply-chain failure slows as the pool of unaffected nodes declines. Ultimately, all globally interconnected nodes fail. This is the localization limit, where the only transactions are gift, barter, or residual trading between closely linked people.

The contagion spreads fastest where the inventories are shortest, that is where JIT logistics are most efficient.

The connection between critical infrastructure elements is probably too complex to understand.

The functioning of core elements of critical infrastructure does not occur in a vacuum. Because of interdependencies between elements of critical infrastructure, and because of the general level of complexity (many critical dependencies, consumables, higher levels of low substitutability inputs), there is considerable scope for failure. Thus while a power and grid company might be confident that it has a vast inventory of all the things it needs, it can never be confident that its co-dependents have had such foresight. Water, telecommunications or transport companies might not be so well-prepared, and so pose a contagion risk.

The period of financial and supply-chain crisis would have changed societies. As the financial system resumed operation, many people may not have been paid and confidence would be shattered. Non-discretionary consumption would have fallen dramatically, leading to further economic contraction, rising unemployment, and a growing share of falling national income spent on necessities. Thus large parts of the globalized economy could lose significant productive output. Spare capacity that existed could be directed to deal with the devastation of the crisis, rather than restarting what existed before. Further, the operational fabric of countries and regions could be so impaired that complex planning and delivery of reconstruction could be impossible.

One cannot just shut down production lines and infrastructure for an extended period and expect them to work again on demand. Systems rust and decay, valves leak and chemicals go out of date, the longer systems remain idle, the harder they are to resume. This is particularly true for more complex systems. Even with a fully viable operational fabric, a shut-down in a semi-conductor or pharmaceutical plant can take weeks to resume.

We do not like to think of ourselves as potentially irrational herd animals. We seek narrative frameworks that purport to explain our good fortune, ideally in ways that flatter. Reinhardt and Rogoff called it the This Time It’s Different syndrome as each age sought to deflect warnings by arguing we’re smarter now, better organized, or living in a different world. Just as the sellers of an overpriced home will convince themselves that it was their interior decorating skills, not an inflating bubble that got them the good deal.

Of course warnings may keep coming, and almost by definition, from the fringes. When assessing risks that challenge consensus, people are more likely to defer to authority, which generally sees itself as the representative of the consensus. Furthermore, as a species with strong 