Weak Coupling

One of the puzzles of the recent liquidity crisis is whether it was the result of a scam or just a bubble. It's not quite clear where the dividing line is, I suppose, but some of those who assembled the various exotic SIV's made a lot of money from the suckers that bought them. On the other hand, much the same crowd seems to contain many of the victims. Meanwhile, economists wander around muttering imprecations like "fat tails" and "opacity" - or maybe it's really "lack of transparency."

Opacity, of course, is friend of the highwayman, the swindler, and every other thief in the night. Still, I wonder if there might not be more to the whole question.

The kinds of problems we know how to solve in physics are mostly characterized by locality and weak coupling to the external domain. If the Twentieth Century had any economic lesson it was that the command economy is clumsy and inefficient. One reason, I think, is that it violates weak coupling and locality.

One effect of free markets is to move decisions down to a local level - when decisions are made by individuals and individual enterprises there are strong incentives not to overproduce or underproduce goods.

Economic development requires a supply of capital - capital that can be assembled by pooling mechanisms or accumulation in the hands of the few. Modern financial technology consists in large part in assembling pooling mechanisms of great sophistication and complexity. In an attempt to leverage or conversely, to insure against risk, many of these mechanisms have complicated feedback processes. The result is that weak coupling is violated, and a relatively small butterfly quake in California triggers a magmatic meltdown in London financial markets.