When I was going to school as a little boy, I had a clear understanding that school teachers were smart. That the physics teacher knows what gravity is and what the universe is composed of, that the biology teacher knows how life developed and how the first DNA molecule formed, that the psychology teacher knows what human psychology and consciousness are. Only later did I begin to understand that we are only given this impression. In reality, teachers and even scientists that are smarter than them, have difficulties with these problems.
Today, we have been left with the impression that economists know how the economy works. Predictions are made regarding by what percentage inflation will increase during the next year, when it will meet European monetary union terms and conditions and how long the real estate crisis will last. But for some reason, I have the same feeling I did after school, when I discovered that perhaps the world is perhaps a bit more complicated than we believe it to be.
Looking at the economy, it is clear that an attempt is being made to predict individual processes: inflation, economic growth, unemployment. The big picture and the whole topic should be viewed a bit more broadly. Viewing the way in which development occurs, what are the forces pushing it along, in what way do crises develop and how the successful resolution of crises brings the system to a higher level of development.
It is possible to take a much broader view of everything through chaos theory. It is they type of theory which observes processes, not individual elements. If we look at a waterfall, there is no point in trying to track every drop of water, but instead the waterfall should be viewed as a structure, the elements of which are changing. Each moment new drops of water are passing over the waterfall, but the waterfall itself is stable. An attempt should be made to view the economy in the same way. To try to not understand what a specific financial number is in the short term, but focus instead on the general process.
Chaos theory deals with these types of processes. In order to understand the relationship between chaos and order, to understand economic development and the crisis currently taking place or before us (based on whether the assessor views the world realistically or optimistically), I will now write about some principle truths and ask the reader to forgive me in advance for the complicated terminology governing the movement of the world and their simplified use.
The second law of thermodynamics exists in the world. The international variation of the law states that the world is itself heading in the direction of increasingly greater chaos and disarray. The fact that a car that leaves a factory new and in order will at some point be rusting and in a junkyard, that civilisations and cultures have, in the long term perspective, all been destroyed, that a room at home, for some reason, repeatedly becomes messy. Wherever we look in the universe - beginning with the stars which should someday burn out - to molecules which are travelling around the universe ever more chaotically, it is clear that the law applies absolutely everywhere.
The entire universe falls under and moves in the direction of growing entropy or chaos. The term entropy must be explained here – it is the disorganised measurement of a system. The larger the entropy, the more chaotic the system is. A new car has very little entropy, but the level of entropy in a car taken to the junkyard is high. A recently completed and beautifully furnished residence has low entropy, but an abandoned and rundown house has high entropy. This is a somewhat unsuccessful definition, because it does not show development and movement forward - but just the opposite - movement backwards.
Therefore, an increase in entropy means the devolution of a system. And it is clear, when viewing the universe, that all processes, objects and systems are moving in the direction of increasing chaos.
All of this was already known in the 19th century, when in 1865, during the course of the investigation of thermodynamics, the corresponding formula was developed. Scientists were then faced with the so-called million dollar question. How is it possible that in a universe which continues to move towards increasing chaos, we are seeing, at the same time, the development and the creation of increasingly complex systems?
We see that the initial Big Bang did not result in the formation of an amorphous mass of elementary particles, but they were instead gathered in stars and galaxies. The fact that atoms have formed complex molecules and that macro molecules have formed from molecules. After this, molecules have joined to form amino acids, which are the cornerstone of life, and they in turn have formed simpler single celled organisms.
The total development of life from simple to complex, from multi-cellular organisms to human beings, testifies against the universal constant. Although the development of humans has not brought an end to development in biological creatures. Humans have become self aware, a society has formed together with all its benefits and nonsense, economics has developed. Everything is increasingly complicated, with systems of complex levels. How is this possible? Our everyday view does not confirm in the least the operation of the second law of thermodynamics.
This problem troubled scientists until Ilja Prigogine received the Nobel Prize in 1974 for his discovery of the solution to this problem. Up to that point, scientists had been examining closed systems. A closed system is a situation where the system does not exchange energy, information or matter with the environment. A closed system is, for example, a brick or newspaper. Absolutely no development takes place in their case, they correspond completely with the second law of thermodynamics; they are subject to a continuous increase in entropy until one succumbs to decay and the other rot. Prigogine studied the open system, which is in interaction or counteraction with the environment, those that exchange material, energy and information with the environment. It became clear that development occurs in the open system through the process of disorder. The creation of order requires chaos. However, one more unexpected matter arose – in the case of the open system, the level of disorder within the system itself increased, but each open system increased the entropy outside of itself. Or in other words: during the development of the system, the level of chaos outside of the system increased.
At the level of society, when we look at our increasingly disorganised material world, with its mobile telephones, iPods, and skyscrapers, and when comparing it with 16th century Europe or some jungle tribe living in the Amazon, we see that modern society is accompanied by giant garbage dumps. When looking at a factory and its large smoke stack, it is clear that some type of product is created in the factory and that entropy exits via the smoke stack, not the other way around.
In a word – an unavoidable condition of each open system is that it must send entropy into the environment outside of itself. Growth inside the system is accompanied by an increase in the level of chaos outside of the system.
In investigating open systems further, it became clear that each system has its own limit threshold of how much entropy it is capable of releasing into the environment. If the system reaches the point where it is no longer able to digest all received energy, information and matter, and expel the residue, the moment of truth has arrived, or in scientific language, the bifurcation point, which in Estonian means the point of dividing into two.
This is the moment where the entire system becomes chaotic and a choice must be made between two directions: whether the system continues developing and is able to cope with such fluctuations, which it was unable to cope with earlier, or the system collapses and falls apart.
Let's take a look at society. When the Roman State reached its breaking point, either continued development or the destruction of the state was possible. Unfortunately, the latter occurred. In turn, the end of the feudal age did not come to an end with a return to the Stone Age, but instead with the Renaissance and capitalism. The mess in Zimbabwe ended sometime ago with revolution, the seizing of land from whites and a clear movement towards collapse and dictatorship.
The bifurcation point is thus the moment where events can begin to develop in either one direction or the other and in the case of which the end results are completely different. At the moment, one small push is sufficient and the unravelling process begins with one or another sequence of events, the end results of which are as far from each other as the moon and a cube.
Let’s take a look at a ball that is perched exactly on the tip of a mountain. A small push is enough to start the ball rolling down hill, in either one direction or another, along the north or south side of the mountain. The result is cardinally different in the case of each instance, but was caused by the tiniest of nudges. And it is just this moment of nudging during a period of instability in the system that is the bifurcation point.
Viewing the development of the economic and political system, the manner in which chaos is reached is clear, and from there, via revolutions or economic crisis, the jumps in development. It seems that one should be happy about the crisis and confusion, but unfortunately things are not that simple.
With the increase in confusion, it is never known in which direction the system will develop. Both Belarus and Estonia arose from the same socialistic void of empty darkness, but the results are completely different. In one state there is a dictator, in the other democracy. The Dominican Republic and Haiti are located next to each other on the same island, yet differ from each other like night and day.
Since it is not known what will happen with the increase in chaos, each system exerts a great deal of resistance to its capital reformation. The leaders of North Korea may even understand that their system is a mess, but until the system reaches total chaos, there is no change to be expected there. It would have been similarly unrealistic during the 1980 Olympic Games for the central committee of the Communist Part of the Soviet Union, under the direction of Brezhnev, to begin the transition from a socialist economy to a free market one. There was not enough chaos in the system yet.
The examples I have given so far have been primarily political. But the same principle also applies on all levels, from the formation of the simplest molecule and organism to the formation of galaxies. Prigogine received the Nobel Prize for his research on Zabolotsky reactions, where he showed how four substances, when mixed together, go on to form increasingly complex colours, patterns and relationships.
A good example of the development of a system is the network of roads in a country, for example, such as the United States. If the number of automobiles there is constantly increasing, then at some point traffic jams will occur. At first, the traffic jams will dissipate by noon or by evening and during the majority of the time moment takes place in a stable manner. However, with the subsequent addition of automobiles, the moment arrives when the roads are no longer able to support the passage of the number of desired automobiles (for example, Los Angeles today), and then the system has a choice to make, whether to end moment or to organise at a higher level.
Organisation at a higher level is helped along in this case by designers and builders, who add additional lanes to the roads and construct exits and entrances. Now the system is capable of administering the number of automobiles, which it was unable to do earlier.
I believe that a comparison with America was more fitting here than a comparison with the city centre of Tallinn and the roads leading there, where it can also be seen that the system is no longer able to cope with the flow of automobiles. For some reason, additional lanes are not being added in Tallinn, and in some places there are actually fewer lanes.
Taking a look at the economic and especially the financial world right now, it is clear how the system is no longer able to cope with the situation. Futures transactions are being performed at a previously unheard of level. For each citizen of the country there are currently more of them one million kroons worth of them up at every moment. Including for each infant, Papua and pygmy. All parties to a transaction are convinced that the system operates without interruptions, and if a problem occurs there is a court that will order payment of the money and assets belonging to him and return them to him.
Currently, the system is operating effectively, but if one is to remember their history, there was a period in the 17th century, during Holland's period of tulip mania, when previously unheard of futures transactions were being concluded for the purchasing and sale of tulip bulbs. However, when the prices dropped and seller wanted the agreed upon million dollars from the buyer, the buyers interestingly enough refused to pay the sum.
Naturally the matter was taken to court and the judicial power began to honourably resolve the problem. It is likely that it would have been able to resolve a few isolated cases, if the number of cases had not exceeded the working capacity of the court.
The processing of all non-performed transactions would have taken the courts hundreds of years. Therefore, the court turned to the state parliament with the problem, where nothing was decided, and the ball was rolled back to the courts. In this manner the ball was rolled back and forth a few times, until a Solomon like decision was reached: all futures transactions were declared invalid.
Since that time, the financial system has developed a great deal. Currently, thousands of transactions can be performed every second, all of which are precisely filled. Hopefully the same sort of mess will not happen again, but I have a hard time believing that the current legal system would be capable, in the case of a more serious problem, of cutting their way through and ensuring the fulfilment of all financial obligations. Reputedly, the current financial system is, above all, byte and computer based, without a carrier of material value.
Our society has yet to live through the greatest act of terrorism in the 21st century, the detonation of a nuclear bomb in a large city. In the case of the explosion of a nuclear bomb in the atmosphere, the electromagnetic pulse would knock out all functioning computer chips. It is safe to think here that all data has been saved in duplicate, and everything will go on in the same way as before. But will it? Is the restoration of all information possible? I have my doubts.
The world’s monetary system is subservient, like all other open systems, to chaos theory. And a jump in development requires chaos, from which order arises. It seems that chaos is approaching, since inputs into the system are beginning to push it to the brink, where it will no longer be able to emit sufficient entropy into the environment.
Entropy in this case can be read as losses, which at the current moment are increasing. Excessive transactions and risks or extremely large inputs into the system are not balanced with the timely acceptance of losses and write offs and these are now beginning to pile up.
As is known, it is natural in the case of a normal economy that incorrect decisions are made or poor quality goods are manufactured. But different from construction or transport, where junk is immediately visible and requires repair, in banking it is possible to hide incorrect decisions and losses creatively in balance sheet indicators, not to say in a criminal manner. Transactions resulting in losses are reflected at the acquisition cost, assessed value or following some other formula, the contents of which are unknown. This is how skeletons have appeared in the closets of banks today, the emergence of which no one wants, and attempts are being made to patch up the system as much as possible.
But there is no escape from chaos in the world’s monetary and banking systems. In all likelihood, the chaos will wipe away nearly all electronic money and the world will have the opportunity to build a new and better financial system. The current electronic monetary test is, after all, only the first. When looking at the history of money, there have been a great many unsuccessful attempts to make money from nothing. This group includes alchemists, who tried to make gold, as well as governments who melted the coins in circulation, placed less silver in them and then released them back into circulation, believing that they were now twice as rich.
All paper currency, without a single exception, has in the long-term perspective become waste. The Euro, Yuan and Kroon are no exceptions. Soon, no one will doubt the dollar chaos. The crash of an electronic money market has not been experienced by people before, and most likely it will be world wide in its scope and more destructive than any previous monetary crises in history. At the moment, nearly 96% of the money in the world's banks is in electronic form, without an actual carrier of its value.
The current system remains in place only thanks to trust, and if at one moment all bank account holders would want to withdraw their paper money simultaneously, it would be impossible. The system is constructed in such a way that all people never come at the same time to demand their money. However, this is incorrect. The coordinated action of only 5% of the people would be enough to get the masses moving, and the remaining 95% would follow suit.
Leaving aside the pictures of people in Europe and the United States from the 1930s, where thousands of people demanded their money back from the banks, one could think of the Northern Rock bank in England, where kilometre long lines of people formed in order to get their money.
Fortunately, the crisis did not spread across the world this time, but would have happened if similar lines were to form at dozens of banks in dozens of countries? The police would need to be placed on the streets to restore order, banks would be closed in the interests of society, but this would not give people their money back.
The main mistake that people make is that they fail to differentiate between actual wealth and virtual wealth. Actual wealth is objects: cars, houses, food, etc. That which we consume. Then there is virtual wealth: cash, shares and securities in bank accounts. The nature of virtual wealth is that during certain periods, which may be quite long, it is possible to exchange it for actual wealth. You go to the store and buy food and automobiles in exchange for money
Virtual wealth has one other interesting characteristic - it seems to appear out of nowhere. By owning shares, it seems like their value is increasing, they can be exchanged for money, which in turn can be used to buy real things. This property entices people to believe that virtual wealth is greater than actual wealth. They even say that actual wealth doesn’t grow, but cash in the bank brings in more money.
However, people don’t ask the question of where the money that is added to their accounts comes from and whether the actual wealth in the world is increased by that amount. The answer is, of course, no. If the price of shares increases by two fold, the holder of one million kroons in shares is able to buy two million kroons worth of goods from the store, but in actuality this comes from a decrease in the purchasing power of the remaining people. That this loss is divided between millions of people goes unnoticed at first.
The current system brings an advantage for a so-called clever person, but is detrimental in the long-term for everyone. Even those who initially achieve large growth must, in the end, suffer under a decrease in the standard of living.
The first time I thought of this was in relation to the currency exchange rate, when I observed the changes taking place on the currency market. My question was simple: if the rate increases and I earn a profit, who is the recipient of the loss? It isn’t possible that something is created from nothing, that wealth is spontaneously generated. It was then that I understood that when the euro rises against the dollar, the winners are all of the holders of the euro in the world, and the losers and those holding dollars, because they are able to purchase less with their money. When I thought about this for the first time, the world was a good bit more stable than it currently is and the dollar was the most stable currency.
Today, an incredible amount of dollars have been placed into circulation, which has resulted in the dollar continuing to lose its value. And in my opinion, there is no way to stop this process. The dollar will inevitably collapse, total chaos will occur, together with the destruction of holdings and savings. In the best case, a new order, better and higher than the current one, will arise out of the chaos.
One of the properties of chaos and organisation theory is that we never know what the new system of the new, higher level is. It is frequently in direct contradiction to the previous one. Hegel, in the case of development, was already discussing the denial of previous stages and the spiral development which followed, where denial is denied.
One stage does not want anything to do with the previous stage; at the same time the following stage is able to completely resolve the problems of the previous stage. Then at some point the system once again reaches a crisis, and the previous is denied and externally it is the same as the stage before last, but now at a new and higher level.
Therefore, the collapse of the dollar will most likely be followed by a newer and better system. According to Hegel’s denial law, it could be gold standard based money, since the gold standard has been sufficiently denied since 1971.
Alar Tamming, Master of Psychology