Globalisation introduces volatility spikes

(Excerpt from “The Interesting Times” email 21 Mar 2020 by Taylor Pearson)

As a thought experiment, imagine 100 ladders lined up against a long wall. Each has a 10% probability of falling over.

If the ladders are spaced out and independent from one another, each being used in a different spot, the probability that all of them fall is astronomically low.

There is about a 1020x higher chance of randomly selecting a particular atom out of all of the atoms in the known universe than all the ladders falling down at the same time.

However, if we line all the ladders up next to each other and tie them together, the dynamic is different.

We have made them “safer” in the sense that the likelihood of any individual ladder falling will be much smaller. If one ladder starts to tilt, the weight of all the others will support it.

However, we will have also massively increased the chance that all of the ladders might fall down together.

If one ladder starts to tip, it causes another ladder to tip. That causes the next one then at some point there is a “phase shift” where enough of the ladders have started falling that they will bring down all the others.

In the first scenario, we have lots of moderate volatility. The chance of one ladder falling is pretty high, but we’re unlikely to see all of them fall.

In the second scenario with all the ladders tied together, we will see alternating periods of very low volatility and very high volatility. Either none of the ladders fall or all of them do.

This is a metaphor for a vast amount of the world we live in and we are seeing it play out in real-time right now.

The interconnectedness of travel routes increases the probability of pandemics such as the Spanish flu and coronavirus and increases the speed at which they spread. Volatility goes from very low to very high.

The interconnectedness of our financial systems results in long periods of stability but then the possibility of massive and violent global market crashes.

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