"All great deeds and all great thoughts have ridiculous beginnings" Albert Camus.
Wall Street predicts the equity bull run will continue. Some investors worry the market already reflects high levels of optimism. The markets may be subject to "adjustment".
So what can sand pile theory tell us about the behaviour of markets? Imagine, the world is modeled on a simple template, like a steep pile of sand, it is poised on the brink of instability. Avalanches, in events, ideas or markets, follow a universal pattern of change.
At any time markets can achieve the Minsky Moment, the "brink of instability". The moment when speculative activity reaches a critical point that further expansion is unsustainable. Any further move or falling grain of sand, leads to rapid price adjustment and market collapse.
So how can we spot the Minsky Moment, that critical point when over speculation in markets will lead to collapse? It is time to count those red dots in the sand, As Mark Buchanan in his 2000 book "Ubiquity" explains.
The story begins with three physicists playing with sand in America. In 1987, three physicists at Brookhaven National Laboratory in New York State began to play a strange game
Per Bak, Chao Tang and Kurt Weisenfeld were trying to imagine what would happen if someone were to sprinkle grains of sand one at a time onto a table top. As grains pile up it seems clear that a broad mountain of sand should edge slowly skywards. Yet things obviously cannot continue in this way indefinitely.
As the pile grows the sides become steeper. It becomes more probable the next falling grain could trigger an avalanche. Sand would then slide downhill to some flatter region below making the mountain smaller not bigger.
In the process the mountain would ultimately grow and then shrink. A jagged silhouette forever fluctuating in dimension and shape.
What is the typical rhythm of the growing and shrinking sandpile ...
Bak, Tang and Weisenfeld wanted to understand those fluctuations. What is the typical rhythm of the growing and sinking sandpile?
Dropping sand one grain at a time is a delicate and laborious business. So in seeking some answers Bak and his colleagues constructed a computer model which would drop imaginary grains of sand onto an imaginary work top. Using the model, a pile would grow in seconds rather than days.
I was so easy to play, the three physicists soon became glued to their screens, obsessed with the falling grains and watching the results. They were to ask several basic questions. What is the typical size of an avalanche? How big should you expect the next avalanche to be? What determines the trigger point for an avalanche event?
The researchers ran a huge number of tests, counting the grains in millions of avalanches, in thousands of sand piles. looking for the typical number involved.
The result? There was no "typical" avalanche. Some involved a single grain, others, ten, a hundred or even thousands. Others were pile high "disasters" involving millions, which nearly brought the whole sand mountain tumbling down. At any time, anything, literally anything could be about to happen. The pile was completely chaotic in its unpredictability.
To try to understand why this was the case, Bak and his colleagues amended the model to colour the sand pile according to its steepness. Where it is relatively flat and stable, the pile was coloured green, Where it was steep and "ready to go" it was coloured red.
At the outset, the pile was mostly green. As the mountain grew, the green became interspersed with more and more red. With more grains, the scattering red dots grew until a dense skeleton of potential instability ran through the pile.
They discovered a grain falling on a red spot, can by a domino effect, cause sliding at other near by red spots. If the red network was sparse, and all trouble spots were well isolated from each other, then a single grain would have limited repercussions.
When red spots, riddled the pile, the next grain to fall would become "fiendishly unpredictable". It might trigger only a few tumblings, or it might instead, set off a cataclysmic chain reaction involving millions.
The sandpile configures itself into a hypersensitive and unstable condition in which the next falling grain could trigger a response of any size whatsoever. This hypersensitive state is known as the "critical state. This applies to markets, just as it does to piles of sand.
Every Avalanche Starts Out the Same Way ...
The surprising conclusion is that even the greatest of events have no special or exceptional causes. Every avalanche starts out the same way. A single grain falls and makes the pile just slightly too steep at one point.
'What makes one avalanche much larger than another has nothing to do with its original cause, and nothing to do with some special situation in the pile just before it starts. Rather, it has to do with the perpetually unstable organization of the critical state, which makes it always possible for the next grain to trigger an avalanche of any size." Mauldin
The Hyman Minsky Financial Instability Hypothesis is a model of a capitalist economy which does not rely upon exogenous shocks to generate business cycles of varying severity. The Minsky Moment defines the tipping point when speculative activity reaches a critical point that is unsustainable, leading to rapid price deflation and market collapse.
The Minsky Moment is the critical moment identified in the model of the sand piles. More grains of sand are added. Momentum will lead to a growing pile until the critical point is reached. Many red dots in the sand will lead to a cataclysmic collapse affecting millions. Every avalanche starts out the same way. A single grain falls and makes the pile just slightly too steep at one point triggering a cataclysmic reaction. We can never know exactly when and where the critical grain of sand will fall ... but fall it will ... eventually ...
Ubiquity, Why the world is simpler than we think; Mark Buchanan 2000
Thoughts from the front line ; John Mauldin August 2021
The Financial Instability Hypothesis; Hyman P Minsky 1992
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