Trade Off: Financial system supply-chain cross contagion – a study in global systemic collapse

This new study by David Korowicz explores the implications of a major financial crisis for the supply-chains that feed us, keep production running and maintain our critical infrastructure. He uses a scenario involving the collapse of the Eurozone to show that increasing socio-economic complexity could rapidly spread irretrievable supply-chain failure across the world.

Read the paper (PDF, 1 MB)


This study considers the relationship between a global systemic banking, monetary and solvency crisis and its implications for the real-time flow of goods and services in the globalised economy. It outlines how contagion in the financial system could set off semi-autonomous contagion in supply-chains globally, even where buyers and sellers are linked by solvency, sound money and bank intermediation. The cross-contagion between the financial system and trade/production networks is mutually reinforcing.

It is argued that in order to understand systemic risk in the globalised economy, account must be taken of how growing complexity (interconnectedness, interdependence and the speed of processes), the de-localisation of production and concentration within key pillars of the globalised economy have magnified global vulnerability and opened up the possibility of a rapid and large-scale collapse. ‘Collapse’ in this sense means the irreversible loss of socio-economic complexity which fundamentally transforms the nature of the economy. These crucial issues have not been recognised by policy-makers nor are they reflected in economic thinking or modelling.

As the globalised economy has become more complex and ever faster (for example, Just-in-Time logistics), the ability of the real economy to pick up and globally transmit supply-chain failure, and then contagion, has become greater and potentially more devastating in its impacts. In a more complex and interdependent economy, fewer failures are required to transmit cascading failure through socio-economic systems. In addition, we have normalised massive increases in the complex conditionality that underpins modern societies and our welfare. Thus we have problems seeing, never mind planning for such eventualities, while the risk of them occurring has increased significantly. The most powerful primary cause of such an event would be a large-scale financial shock initially centring on some of the most complex and trade central parts of the globalised economy.

The argument that a large-scale and globalised financial-banking-monetary crisis is likely arises from two sources. Firstly, from the outcome and management of credit over-expansion and global imbalances and the growing stresses in the Eurozone and global banking system. Secondly, from the manifest risk that we are at a peak in global oil production, and that affordable, real-time production will begin to decline in the next few years. In the latter case, the credit backing of fractional reserve banks, monetary systems and financial assets are fundamentally incompatible with energy constraints. It is argued that in the coming years there are multiple routes to a large-scale breakdown in the global financial system, comprising systemic banking collapses, monetary system failure, credit and financial asset vaporization. This breakdown, however and whenever it comes, is likely to be fast and disorderly and could overwhelm society’s ability to respond.

We consider one scenario to give a practical dimension to understanding supply-chain contagion- a break-up of the Euro and an intertwined systemic banking crisis. Simple argument and modelling will point to the likelihood of a food security crisis within days in the directly affected countries and an initially exponential spread of production failures across the world beginning within a week. This will reinforce and spread financial system contagion. It is also argued that the longer the crisis goes on, the greater the likelihood of its irreversibility. This could be in as little as three weeks.

This study draws upon simple ideas drawn from ecology, systems dynamics, and the study of complex networks to frame the discussion of the globalised economy. Real-life events such as United Kingdom fuel blockades (2000) and the Japanese Tsunami (2011) are used to shed light on modern trade vulnerability.

Read the paper (PDF, 1 MB)

Featured image: Torn paper. Author: Billy Alexander. Source:

Note: Feasta is a forum for exchanging ideas. By posting on its site Feasta agrees that the ideas expressed by authors are worthy of consideration. However, there is no one ‘Feasta line’. The views of the article do not necessarily represent the views of all Feasta members. 

12 Replies to “Trade Off: Financial system supply-chain cross contagion – a study in global systemic collapse”

  1. Thank you for this report, which helps in many ways with understanding the complexities (barely touched on in mass media outlet articles) which make our current circumstances dysfunctional, undesirable, and unworkable—both in the long run, sooner than we would like to think, and as we speak.

    Notes from the “Supply-Chain Cross Contagion” report

    I looked carefully at the “Overview”

    “…account must be taken of how growing complexity (interconnectedness, interdependence and the speed of processes), the de-localisation of production and concentration within key pillars of the globalised economy have magnified global vulnerability and opened up the possibility of a rapid and largescale collapse.”

    and Section VI Risk Management, Constraints and a Conclusion

    “Lock-in can be broadly defined as an inability to deal with one problem by changing a sub-system in the economy without negatively modifying others upon which we depend. Further, doing complex surgery on a part of our economy or financial system, because they are so intertwined within the very operation of the globalised economy, can have unexpected and intrinsically unpredictable consequences.”

    “The point here is that we are locked into a vast and unimaginably complex fabric of conditions that we barely understand.”

    A Critical Challenges Assessment from The IPCR Initiative

    I have made a contribution to an assessment of the critical challenges ahead, and ways of generating a “constellations of initiatives” kind of solution-oriented activity, in the IPCR document “Calling ‘the better angels of our nature’: A Multi-Angle View of the Debt Crises” (Jan. 2012, 398 pages)[accessible for free from the homepage of The Interfaith Peacebuilding and Community Revitalization (IPCR) Initiative website (at )].

    The detailed Table of Contents provides a quick access to a “big picture” view of both challenges and solutions, and includes the following sections:

    IV. Cultures of Violence, Greed, Corruption, and Overindulgence
    V. Other Challenges Which Are Part of This Writer’s Ten Point List (see Appendix A) and Which Need to be Resolved as Part of a Sustainable Solution to the Current Debt Crises
    VI. Four Summaries of Critical Challenges Ahead

    In Section V., in the subsection on peak oil, I quote from the report “Armed Forces, Capabilities and Technologies in the 21st Century Environmental Dimensions of Security: Sub-study 1 Peak Oil–Security Policy Implications of Scarce Resources” (112 pages) [The study was produced by the Future Analysis department of the Bundeswehr Transformation Center, a branch of the German military, and an English translation was made accessible at the Energy Bulletin website by Rick Munroe].

    Two of those quotes are relevant here (both from page 65 in the “Multi-Angle” document):

    “…it is not possible to rule out considerable frictions on the labour market. New economic sectors, jobs and market opportunities can indeed develop in the wake of post-fossil transformation. This economic upheaval could, however, initially result in significant transformation unemployment. It is regarded as a special form of structural unemployment that can evolve as a result of profound changes in
    transformation countries. Most importantly, a devaluation of employees’ human capital may occur because the change in structure causes thus far fully adequate qualifications to be replaced by other qualification requirements. Depending on its scope and duration, transformation unemployment could develop into a major economic problem.”

    “On the other hand, it cannot be ruled out that the people’s confidence in state institutions as well as politics would be considerably shaken. This confidence is likely to dwindle even more in societies in which it is already weak – in particular if it is becoming obvious in crisis regions that governments have in the past failed to develop suitable solution strategies and provide orientation for society during this period of transition.”

    The “Multi-Angle” document is a mid-way point summary of “IPCR Critical Challenges Assessment 2011-2012” (at ), which is an in-depth assessment of ten critical challenges. In the context of responding here to the report “Trade Off: Financial system supply-chain cross contagion – a study in global systemic collapse”, it is worth noting critical challenge #9, which is worded as follows:

    “Community building associated with responding to the above eight challenges may or may not be accompanied by an exponential increase in compassion for our fellow human beings.

    “In such circumstances, shortages of goodwill in times of unprecedented transition could tilt already precarious systems into further disarray, and thus erode established systems in even the most stable communities and regions. “

    “IPCR Outreach 2012” and the need for an exponential increase in compassion for our fellow human beings

    The current IPCR Initiative project is “IPCR Outreach 2012”, which is making accessible through outreach brief introductory documents discussing challenges and solutions. At the IPCR webpage ( ), all documents being used in “IPCR Outreach 2012” are made accessible for free in pdf format. These documents include:

    “A List of Ten Critical Challenges”
    “A Three Page Introduction to the ‘Multi-Angle’ Document”
    “The Potential of Community Visioning Initiatives (in 500 words)”
    “Much Unrealized Potential for Community Service”
    “A Brief Introduction to The IPCR Initiative”

    The 1 page document “A Brief Introduction to The IPCR Initiative includes the following excerpts:

    “The beliefs that there is a critical need for an exponential increase in compassion for our fellow human beings—and that at no other time in history has there been more potential for such an increase—have urged and inspired The Interfaith Peacebuilding and Community Revitalization (IPCR) Initiative ( ) to explore how such potential might be realized.”

    “We are in uncharted territory, for there is no culture or association of societies that ever existed on planet Earth which has had to resolve the kind of challenges the next few generations of people will have to resolve. In many ways, all of us are Stakeholders, and People Needing Assistance, and most of us are going to need to become Experienced Practitioners of some kind. There can be some consolation in the fact that if most of us become Experienced Practitioners in the art of being compassionate towards our fellow human beings, we will all have a better chance of accomplishing what no civilization has accomplished before.”

    Concluding Comments

    I believe what I have included in this response is relevant to the discussion of your report “Trade Off: Financial system supply-chain cross contagion – a study in global systemic collapse”. I hope these comments are helpful in some way to people who are trying to facilitate solution-oriented activity at this critical time.

  2. Eventually, the system of interdependent supply chains crashes as oil prices get too high to support it. At first, decay should be gradual, but it’s unlikely to proceed in a linear fashion. The more near term threat, however, is economic disruption, but we may at least recover from this.

  3. there is one slightly hopeful aspect to globalised cpmplexity – it is that unleashing a war against an industrialised opponent would be counter productive – rather like an aircraft carrier launching its planes to bomb the other end of the ship.

  4. there is also a very negative aspect to financial complexity. in ‘casino capitalist’ markets the last act of the gamblers will be to see the threat of system failure coming, and place bets against success. they will be ‘shorting civilization.’ it is in their nature to do that. people in whose nature it is not to think that way, will already be gone from the markets and trying to survive some other way.

    it was long threatened that the chinese had it in their power to collapse the u s bond market. you will not need the chinese.

    charles ponzi should get a posthumous nobel prize for economics. the world has been run on economic principles devised by him for many decades now. he is far and away the most influential economic thinker.

  5. David, interesting paper, good in many respects, but the analysis has a few important blind spots or missing factors. First, the response of governments to nationalize individual companies or entire sectors, perhaps starting with the banking sector. That can make solvency, profits, and balance sheets become less relevant compared to day-to-day continued operations. (Although, counter-party risk might have to be wiped out in one swoop across an entire industry.) And second, as global supply chains disintegrate, the response of companies will be to localize production and inputs, adapting to what is available locally. This potential “de-globalization’ and local adaption process should not be underestimated for its power and scope — I think that will become one of the most visible and key aspects of the processes you analyze. Maybe you can include these two factors in a subsequent analysis.

    You also might look back at the history in Russia 1992-1997, the so-called “non-payments problem” when a large share of the economy continued to operate despite the fact that many people were not paying for things and suppliers were not getting paid–somehow things kept operating in the face of widespread non-payments (although GDP collapsed by 20% or more).

  6. Very informative report. I find such studies more important than papers trying to predict volatility of volatility.

  7. Have you considered that our leaders have already seen this coming, and are already doing something to control what is bound to happen next?

    The first thing is not to admit it publicly – confidence is essential to the success of a Ponzi scheme, so they must avoid a loss of confidence at all costs.

    Next they are going to have to “temporarily” take control of the banking sector and manage money in a totally anti-free-market way. They are going to have to “temporarily” control the people, who will be unemployed and hungry, and very very angry. This will require sweeping new police powers, suspension of democratic rights, censorship of dissenters, and so on – Homeland Security on steroids.

    To get those vital oil imports flowing again (that they can’t pay for except with funny money), they are going to have to take it by force. It doesn’t take a giant leap of imagination to think of where they will start. This explains why the Iranian nuclear situation (which is a fake problem) has been simmering since 2005, but without it going anywhere. So much demonisation of the Iranians has occurred, that it will seem patriotic to finally get on with it.

    It is also clear that an attack on Iran will quickly become WW3, when our leaders will be forced to declare a “war economy”, with all the austerity and patriotic censorship of dissent that that entails. The need for troops will help find patriotic jobs for the unemployed.

    So I predict the moment a sovereign default occurs, there will be a false flag event in the Straits of Hormuz, and neo-fascist control of former democracies will ensue.

    Your analysis is spot on if there is no WW3, but all the signs are that WW3 is being readied to meet the crisis you describe. Of course that is the last thing we need to solve the problem, but at least “they” will still be in control.

  8. Very informative paper. However, a few important issues are overlooked. Firstly, the flexibility of companies is a component of redundancy, which in turn makes system more resistant to a collapse. Please analyse how Greece adapts to crisis (i.e. more food from local sources). Secondly, it is not clear how supply chains are infected by financial system contagion . “The broadest affect on trade is through the letters of credit” Really ? Finally, reasons behind inertia and the tolerance for raising instability will be very interesting issues to discuss. The higher complexity will be a consequence of the current crisis since technology is not static.

  9. Blogger joebhed said…

    I have two suggestions for either preventing or rebuilding from the global financial crisis.

    Both involve understanding.

    1. Cartesian Economics: The Bearing of Physical Science Upon State Stewardship

    2. The Role of Money

    It’s all about the relationship between real physical science and our debt-based monetary systems.

    As Nobelist Soddy said in conclusion of studying the money system: “”It’s not a system; it’s a confidence trick.””

    It’s about the paper that is about to destroy the planet as we know it. But, it’s only paper.

    For the Money System Common.

  10. First of all, an opening statement. When studying economics with hard-won intellectual capital, we sometimes forget that economics concerns the behaviour of our fellow humans. There’s nothing wrong with anthropomorphizing human beings. [The fact that I have to bring in a tautology, a tautology that would be actively resisted in certain circles, speaks to that “forgettery.”]

    Looking at the matter while keeping in mind that the subject is the ecosystem (or “econo-system”) of our fellow humans, there are three intello-behavioral trends that make the system less robust than it used to be. All of them can be reversed to make the system more stable. These three are:

    1. A decline in prudence with a corresponding attitude that common prudence is inefficient, old-fashioned or unsophisticated. Roughly, “prudence” can be defined as sacrificing a maximal rate of complexity and productivity growth for the sake of widening the stability domain. In the abstract sense, while keeping in mind that the ideal amount of prudence is vague because the very practice assumes uncertainty in the future, the right amount of common prudence exchanges maximal growth for optimal growth over the foreseen and unforeseen future. Examples of common prudence include tying up some funds into a month’s supply of food or into a nearby warehouse with spare parts. The first restricts consumption possibilities; the second ties up working capital that could otherwise earn a return [barring speculative opportunities, which are unlikely.] The compensatory gain for both is greater robustness. Note that the new wave of financial-services regulation, as exemplified by Basel, is an attempt to both formalize and increase common prudence.

    It hasn’t happened yet, but a bigger shock will bring common prudence back into fashion. Once it becomes fashionable again, the restoration of prudence will slow down growth but provide greater shock absorption. Granted that this declension-to-ascension revival is in fact muffled by the new policy option of too-big-to-fail bailouts, as (most pointedly) illustrated by the U.S. government’s bail-outs of General Motors and Chrysler, but the resources of the world’s governments are limited too; so is the public’s patience. People can change their ways before instability turns into the Apocolypse.

    [As a reminder, I hope I need offer no apologies for anthropomorphizing my fellow human beings!]

    2. Overregulation – yes, overregulation. This second point does clash with the above note about regulated prudence, but the finance sector is only one industry. Moreover, most derivatives [specifically, OTC derivatives] were never regulated at all. What’s somewhat misleadingly called “deregulation” is more accurately described as the increase of complexity in financial engineering outstripping the regulators’ ability to respond to it. I can assure you that finance as a whole is quite regulated: if you don’t believe me, try opening up a brokerage shop with your Uncle Jack and see how far you get before legal sanctions shut you down [and get you and U.J. into legal hot water.] In an industry where regulations are truly minimal, like affiliate-sales Websites, you and Uncle Jack can try your luck without being brought to heel in any way provided you follow the basic law prohibiting fraud and a few disclosive add-ons for consumer protection. That freedom of entry is very much not the case in financial services.

    To get back to my general point: except for the special case of adversarial regulations (which I’m tempted to call “pugnacious regulations”), regulations tend to codify best practices in the industry being regulated. It’s assumed, common-sensically, that falling well below best practices is what should be actionable. Just as only a small minority of people are crooks, so it is that only a small minority of firms are crooks.

    The trouble is, regulations enshrine best practices at a certain point in time. As I noted above with respect to financial services, regulators are slow to adapt to change; that’s the downside of throughness and common-sensical caution. It’s common sense to suspect that cost-cutting means corner-cutting. It’s also common sense to assume that a genuinely unorthodox new idea has something wrong with it: after all, extraordinary claims require extraordinary evidence to back them up. Regulators are human beings too, so their motives and decision-making algorithms are not at all strange to the rest of us humans. The strangeness lies in the details, not the overall conceptuals.

    Unfortunately, the downside of common sense is that it sometime takes the form of “the common sense of ignorance and prejudice.” Genuinely unorthodox innovations – the products of non-glamourous non-conformity – are more likely to be stifled in regulated industries than in unregulated. Ironically, given point #1, this stifling is done for reasons of common prudence.

    A firm in a regulated industry is actually easier to manage, provided that the firm can compete while observing the constraints that the regulations put upon it. [It’s easiest for untainted market-leader firms at the time the regulations are promulgated, as those firms have already implemented best practices.] The trouble is, such firms are also rigid and less flexible in responding to changing conditions. Ironically, given point #1, common prudence in legal form has led to a decrease in robustness. That’s an unavoidable cost of safety.

    With regard to this component, firms can “set sail on the high seas” (as it were) as the financial institutions have done most successfully. Or, regulations can be overhauled to a) update best practices, and/or b) lessen the prior-restraint component and increase the after-the-fact punitive component. That is, give the regulated firms more latitude but apply greater punishments to firms (and those firms’ top exectives) that cause disasters. This adjustment can increase the robustness of the system before it collapses. [I should add: so can fleeing to the high seas, but only if said fredom-seeking is matched with an increase in internal restraints – i.e., common prudence.]

    3. Too narrow a definition of creativity; an overemphasis on innovation at the expense of resourcefulness. The spirit of innovation introduces new products and practices. The spirit of resourcefulness finds new methods for accomplishing present goals.

    Examples of resourcefulness would be: the invention of scrip in the event of a monetary collapse, launching an “eBay of barter” Website that uses computational power and a large database to get around the double coincidence of wants without money, buying farmland gone to seed – abandoned because the growing season is too short in its region – and reclaiming it as a bet on global warming, setting up a fish farm in the garage, finding a way for ordinary folks to refuel natural-gas cars in their homes safely (this one would be hard, but it would be a compelling application for cars fueled by plentiful natural gas), or the simple (if challenging) cultivation of the habit of staying calms when eveyone else is emotional so as to be a pillar of reasonableness when disaster strikes. All of these examples are far less glamourous than the new iPhone 5, but the underlying skills they exhibit are precisely the ones needed to contain a disaster. As long as there are reservoirs of resourcefulness in the human mind – and previous disasters show that this is indeed the case – the counteractions necessary to prevent a disaster from turning into an all-out collapse can be brought to bear.

    To sum up: The width of the staibility domain for today’s econo-system can be increased by:

    1. Firms that presently maximize complexity by living on the edge of collapse changing their ways by shifting to common prudence, particularly in the areas of storage and savings.
    2. The regulatory mix can be altered to permit greater freedom of action at the cost of more punitiveness in cases of damage due to negligence or malice.
    3. Innovative creativity can be de-emphasized for the benefit of resourceful creativity.

    Thankfully, we humans have a knack for showing our fellow humans that we’ve been underestimated – particularly, during a crisis. The above list of three is far from exhaustive.

    So, despite the unprecedented fragility of the current human econo-system, total collapse is far from inevitable. We’ll show ’em!

Comments are closed.