Money has often been a cause of the delusion of multitude

“…Money has often been a cause of the delusion of multitude. Sovereign nations have all at once become desperate gamblers and risk almost their existence upon the turn of the piece of paper…””…Men it has been well said thinks in heards it will be seen that they go mad in herds while they only recover their senses slowly and one by one..”
The quotation comes from the book “Memoirs of Extraordinary Popular Delusions and the Madness of Crowds” written by Charles MacKay in 1852. (The complete version of the book you can download here). In volume one of the book author describes the Mississippi scheme, the South-Sea Bubble, the tulipomania among others market bubbles and crashes from the past. After reading all that stories I had strange feeling that those stories aren’t quite different from those which I’m reading nowadays in the newspapers. A striking feature of the crisis (then and now) is that the situation evolved rapidly and appeared to be driven by emotion. Now word “FEAR” appears in almost every news or article covering present market/economic events. Over/(lack of)confidence, fear, gloom, doom, crowding aren’t concepts closely related to good old-fashioned rationality but are related to the out of equilibrium processes . In contrast to that modern economics is based on equilibrium models, which assume the rationality of the economic agents and put emphasis on the importance of expectations. Don’t get me wrong. I’m not calling to get rid of the equilibrium models from economics (because they are useful) but I think that the current crisis shows the limitations of the mainstream paradigm.
The source of the crises was originally precipitated by the levels of the credit that are difficult to justify as rational. I’m not talking here just about UK,US homeowners who got a large amounts of loans with no money down. I’m also talking about whole nations (i.e. Iceland, Hungary, Ukraine, South and Eastern European Countries, Baltic countries) which were flown with almost free credit assuming that those countries will grow only faster and faster and will be able to payback its debt in the future.
Is the crisis a simple consequence of madness of the crowds, completely orthogonal to the equilibrium model? I don’t think so but it’s obvious to me that lenders were way too optimistic in their assumptions and maturation of this systemic instability led the system to the critical zone and to an inevitable crash
This blog is about non-equilibrium processes and especially about power laws in economics. Power law distributions imply that rare events (like October crash) are occurring with a finite non-negligible probability in the complex systems. Is therefore meaningful to ask the following question: How is the dynamics of a complex system affected when system undergoes to extreme event? In other words in the following posts I will focus on the market dynamics after the large crises trying to answer the question how long will take the transition phase to bull market.