Tuesday, 2 July 2013

When Will the Euro Collapse? An Update


In a blog dated November 2011 we have stated that the Euro will collapse around Q3 2013. Today, 15 months later, we have updated our forecast with the latest GDP data published by Eurostat and relative to Q2 2012 (Eurostat publishes such data with a lag of approximately two quarters). First of all, let us clarify that these forecasts are not to be seen as predictions of events that will "occur suddenly" on a given date - this cannot be done - but merely as extrapolations of trends in complexity which is a holistic KPI, reflecting the dynamics of an entire system, such as the Eurozone in this particular case. Because of the extremely turbulent character of the global economy, these analyses must be updated periodically.

In the mentioned period of 15 months, since the first forecast, Europe has not done much to improve the situation which continues to be extremely fragile. Quite the contrary. UK's Prime Minister Cameron has recently spoken of a referendum  on Britain's membership in the European Union. Surely, dissent within the ranks is not what the EU needs today. These are entropy-generation actions and it is precisely entropy (uncertainty) that we must get rid of, not generate more. A compact EU, with a clear and credible strategy may stand a chance. However, a strategy first needs a roadmap. But a roadmap needs a vision and vision means that there are visionaries. Today, there are no visionary leaders in the EU.

The Eurozone, when analyzed as a system of 27 interacting economies, each described via 24 macro-economic parameters, continues to exhibit  a poor one-star resilience rating, with a resilience of around 50%. This corresponds to very high fragility. In other words, the system is not capable of absorbing shocks. While in the mentioned 2011 blog we spoke of a "collapse" of the Euro around Q3 of 2013, today, based on the evolution of complexity we can say that:

the Eurozone is tending towards a state of long-term stagnation

This is apparent in the figure below, which shows how all complexity measures drop - indicating a shrinking economy - but tend towards a stable situation, and how the current measure of complexity continues to approach the critical value (indicated as Maxc. Complexity, blue curve).

What this means is that the robustness (resilience) of the system is slowly but constantly decreasing, see figure below.

Extrapolation based on last eight quarters shows how the economy continues to shrink, even though the situation is apparently converging to a hopefully momentary equilibrium (frustration?). First, the complexity measures.

and robustness, which shows a more pronounced tendency to drop even further. This means that, based on the currently available data, the situation will become globally even more fragile.

So, what we observe are two alarming trends:
1. Complexity is dropping. This means the system (the economy, as seen through the mentioned macro-economic parameters) is shrinking.
2. Complexity is approaching Critical Complexity. In other words, the system is becoming more fragile, hence less able to absorb shocks.

Both phenomena are not a good omen when it comes to the survivability of the Euro and of the European project. By the way, what is the European project?

What is needed, in order to reverse the tendency are two things:

1. Put in place measures of structural nature that will favour growth. Complexity shows that the crisis has taken the economy back to levels of 8-10 years back. If we can make the economy grow this will be reflected in increasing complexity. Evolving (growing) systems increase their complexity (think of our biosphere). However, one must always try to stay away from Critical Complexity as this inevitably implies fragility. In any event, structural measures must be implemented at European (system) level in order to be effective. Politicians must therefore work to consolidate the Eurozone as a single entity before any serious measures are put in place.

2. Make the system more resilient. This can be done by increasing the difference between the Critical Complexity (blue curve) and the current value of complexity (green curve). In order to accomplish this it is necessary to "dump ballast". What this equates to is essentially a reduction of entropy (amount of chaos within the system). This means:

  • reducing inefficiencies
  • increasing synergies
  • avoiding anything that increases uncertainty
  • limiting speculation
  • regulating extremely complex financial products
  • taking (certain) downgrades by rating agencies less seriously

Again, this should be done at system level, not at the level of each contry. Sure, in each Eurozone member state there are local and specific problems, but these are strongly linked to the dynamics of the system as a whole and cannot be addressed in isolation.

3. Make the system more governable. More on this soon.

In a short blog, such as this, it is evidently not possible to offer solutions to problems of this magnitude. However, one can say that it would help a lot if economists and politicians though more as engineers, who know very well how to treat systems (of systems).

Update (14/2/2013) from cnn: Eurozone recession deepens as exports suffer.

Click here to see Interactive Complexity Map.

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