Sunday, 7 July 2013

When Will the Euro Collapse? Around Q3 2013

Blog written in November 2011, reported here verbatim.

It seems the Euro, and the European Union along with it, is doomed. If politicians don't move, and fast, it may already be too late. But is it already too late? Hoping that this is not a self-fulfilling prophecy, let's look at the science behind the forecast we have made.

When a system grows and evolves, its complexity increases. Take a look at evolution in our biosphere to realize that this is true. If you want to  accomplish more you must become more complex. This means two things: structure and entropy. Structure is what defines functionality, entropy is what allows a system to react in a creative and novel way to a changing and possibly harsh environment. In biology this is adaptation. When you get too much of either structure or entropy you're in trouble - you reach to so-called critical complexity and your fragility increases. You become exposed and vulnerable. Your ability to absorb more uncertainty (and still function) diminishes, just as your capacity to face extreme events. This last property is called resilience.

Using publicly available data at the Eurostat website, we have been tracking the complexity and resilience of the 27 EU member states for the past two years, publishing reports like the one you may find here.

Because of the recent buildup of the sovereign debt crisis in the EU, we have attempted to forecast when, if at all, the Euro will collapse, dissolving, de facto, the European Union.

Let's take a look at how the resilience of the system of the 27 member economies has evolved over the past few years (26 quarters are reported).

Since Q1 2008 resilience has been in a state of free fall, decelerating mildly in Q2 2010. However, the slope is still very steep, with no signs of imminent deceleration. The reason resilience has been falling is to be found in the fact that the complexity of the shrinking economy (this is reflected by the drop in complexity) has been approaching critical complexity. This is illustrated in the plot below.

The two upper curves (complexity and critical complexity) are in fact converging (the shape of the above curves resembles closely a biological system which reaches a peak of development and efficiency as it ages). A rough estimate - see dotted lines - points to Q3 2013 as the time when the two curves will get really close. Of course, the underlying assumption is that nothing will happen in the meantime and that politics will not be able to fix the situation. A more precise estimate dates the collapse one year later, as shown in the plot below, where exponential interpolation has been used to identify the intersection point.

However, it is not necessary for the curves to actually cross in order to declare collapse. The point is not to do any digital hairsplitting but to provide an estimate which, given the high degree of turbulence of the economy, cannot be but rough.

Let's be clear. The situation already today is quite critical. The resilience of the EU as a system is "VERY LOW" and this is a bad omen. Low resilience, in fact, is an overture to fast contagion. But it's not that in Q3 2013 you will hear a speaker in television announce that the Euro is no longer. All this means is that if we do nothing, we have  about a couple of years until the system dissolves on its own.

The analysis has been updated based on new data (Q2 2012). Read about it here.

The analysis has been performed using the on-line resilience rating system available here.