Excerpt from

by James B. Berger

From the perspective 2023, the roots of the financial crisis provide a lesson that the government has yet to learn.

The Roots of a Financial Crisis

I wrote this piece shortly after the financial crises of 2008 I have left this article on this web page because I think it is worth reflection.

Summary & Conclusion

Understanding the roots of the financial crisis of 2008 is simple, but it is not easy. The manner in which we normally try to understand the behavior of complex systems—such as the U.S. economy—diverts our attention from the real roots of the systemic problem. We have also, like the drug addict, come to confuse the symptoms of recovery—the financial meltdown—with the symptoms of disease—the euphoria of boom times.

To begin to understand where to look for the roots of this crisis we must first understand what influences the performance of a complex system—such as the U.S. economy. Second, we must understand the nature of a sustainable economic system. To see why things do not work, we must first see how they should work. Third, with that background, we will have the knowledge to understand why our system collapsed. Using that understanding we can formulate a cure.

Understanding the Performance of Complex Systems

Complete understanding of complex systems requires that we examine them at three levels: events, patterns of behavior, and systemic structure. Onetime events may provide the first indication of a problem, but they provide little or no information about the cause. Patterns of behavior tell us whether we have experienced a onetime anomalous occurrence. If a pattern exists, it can give us a clue as to the composition of the root causes of all systemic behavior: systemic structure. Systemic structure holds the key to the behavior (or performance) of any system.

Economists and commentators have focused their current attempts to understand the "crisis" on events. They have failed to acknowledge that, although larger than most, this crisis amounts to an event that fits into a repeating pattern that recurs because of the structure of our economic system.

So, what would an ideal, sustainable system look like?

A Sustainable Economic System

Economic systems have all the characteristics of living systems: they self-reference, they self-organize, they self-transcend. In a phrase, they learn and adjust. As a result, those economic systems that sustain will demonstrate the following characteristics in their events, patterns of behavior, and systemic structure.

First, the events in a sustainable system will occur locally and involve single entities. Businesses succeed and fail. Prices go up and down. But, they don’t combine into single, system-wide dramatic events.

Second, these local events will combine to form patterns of behavior for businesses or industries. Individual businesses will have patterns of success that extend over short and long periods. They will have extended periods of decline or they will collapse suddenly. These ups and downs will offset each other in the overall economy.

Because the small and local nature of events in a large sustainable economy, few discernible patterns will appear. No need will exist to examine aggregate patterns of behavior[1], but if one did examine them, the generalized patterns would appear rather placid, with changes in one segment of the economy canceling out those in another segment.

Third, the systemic structure of a sustainable economic system will have one noteworthy characteristic: free exchange without violent intervention. The players in the system always act voluntarily. They have the ability to adjust their behavior without the interference of the state. Coercive forces—government or other—do not impede the natural ability of the actors to produce, consume, and exchange goods to satisfy their individual and collective needs. They rely on the sanctity of contracts to establish the rules that govern interactions within the system. As a result the system adjusts to changes in population, resources, and technology.

In addition, sustainable economic systems operate on the intuitive understanding that economic value flows from the preferences of individual actors in the market. Interference with the ability of individuals to act based on their individual preferences disrupts the self-organizing nature of the entire system. But, acting individually, market actors demonstrate the wisdom of crowds.

Like all living systems, economic systems contain reinforcing and balancing processes. Reinforcing processes accelerate the behavior of the system in a single direction. Balancing processes tend to counteract the reinforcing processes, either stopping the process at a predetermined level or slowing the acceleration to a sustainable rate. Sustainable systems exhibit an ebb and flow between reinforcing and balancing processes, which keep the system from going to extremes.

If you need an example, look at nature. Trees don’t grow too tall. Elephants don’t grow too big. Mice know the right size too.

Our Unsustainable System

At each of the three levels, unsustainable systems, have significantly different characteristics.

First, significant events tend to have a much wider impact, involving multiple businesses or multiple industries. Unlike the sustainable system, the unsustainable system frequently experiences large, system-wide events: booms and busts. Events tend to occur nationally or internationally, instead of just locally. This characteristic should lead us to ask questions about patterns of behavior and systemic structure.

Second, these events form patterns of behavior over time that display wide spread expansions and contractions in economic activity. From a distance in time, it appears as if everyone makes the same mistakes at the same time. Frequently these patterns contain very large fluctuations in specific market segments that transmit distortions to other parts of the market. This crisis and the boom that preceded it fit into long term patterns that we frequently refer to as business cycles. We can determine the inevitability of these cycles only by examining the structure of our economic system.

Third, the structures of unsustainable economic systems usually contain structural sources of violent intervention. The elements of intervention in our system take three basic forms: 1) regulation, 2) spending, and 3) an expansionary monetary system.

1) Regulation

Government regulation directly impedes free choice, preventing the actors in the market from making quick and effective adaptations to the changing market environment. Regulation distorts the results of their interactions.

2) Spending

Government "spending" reallocates economic resources based on political power and preferences rather than the efficient calculations of the market. Spending redistributes resources from more-productive uses to less-productive uses, retarding the effectiveness, efficiency and adaptability of the entire system. Taxation, the twin sister of spending, simply directs whose resources the government will confiscate.

3) Monetary Inflation

The perpetual artificial expansion of the supply of money represents the most important and insidious form of violent interventions used by the government. Monetary inflation has wide reaching influence and, by distorting the information carried by the price system, it causes market actors to act against their own best interest. Rising prices caused by monetary inflation sends signals of shortage to those segments of the economy into which money flows most readily. Acting rationally on those false signals entrepreneurs make what seem like sound investments.

They later learn that these apparently sound investments have become bad investments—malinvestments. The natural liquidation of malinvestments manifests as market collapses. These collapses—the healthy part of the cycle—clear out the disease of these malinvestments.

Finally, the unsustainable system contains the same reinforcing and balancing processes as do all living system. In the case of the unsustainable system, however, the triad of violent intervention—regulation, spending, inflation—upsets the natural balance of these processes.

The violent interventions of government tend to amplify the reinforcing processes, carrying them to extremes. These extremes build up excess tension in the system from the balancing processes. When the balancing processes finally overpower the reinforcing processes, the system makes a dramatic shift in direction. The distorted interaction of these processes lead to the booms and busts, like the event we just experienced.

The Cure—A New Structure

How then do we cure the disease that causes financial crises?

First, we need to understand that financial crises represent a symptom of the disease. Although the pain comes in what we refer to as a crisis, they occur as a result of the system’s natural tendency to compensate for the violent interventions in the system. The real disease occurs in the boom. To eliminate the busts requires eliminating the root causes of the booms.

We must transform—not just reform—the structure of our economic system.

The cycles of boom and bust have a staggeringly simple—but not easy—solution: eliminate the violent intervention of government. We don’t, however, have the political insight or courage to take this action for we like the addictive high of constantly rising prices and the artificial booms that go with them.

Instead of espousing free markets, then implementing more interventions, we need to release the system from these artificial burdens. We must stop picking the pockets of our neighbors—regardless of the merits of our cause. Stopping the violent intervention will allow a healthy system to emerge. People will work together, in cooperation, to build a stronger economy and better lives.


[1]Aggregate patterns of behavior, indeed the whole concept of “macro-economics,” have little validity because mathematical aggregates of non-homogeneous economic goods violate the laws of physics and sound math.


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