Financial System Supply-Chain Cross-Contagion:
a study in global systemic collapse.
30th June (revised) , 2012
Metis Risk Consulting & Feasta
Metis Risk Consulting
Understanding, communicating and managing large-scale systemic risk
With support from:
The Foundation for the Economics of Sustainability
"Designing systems for a changing world"
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
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.
Financial System Supply-Chain Cross-Contagion: a study in global systemic collapse.
I. Introduction 4
I.1 The living fabric of exchange
I.2 Complexity & risk
I.3 This study in context
II. Supply-Chain Failure and Repair 14
II.1 The connectedness of things: natural disasters and blockading truckers.
II.2 Rips & Repair
III. The Ecology of the Globalised Economy 21
III.1 The dynamical state of the globalised economy, stability & critical transitions
III.2 A trophic web model of the globalised economy
III.3 Path dependence, and economic contraction as a critical transition
III.3.1 Reverse economies of scale in critical infrastructure
III.3.2 Debt deflation
III.3.3 Trust radii in expansion & contraction
III.4 Secondary keystones & scale-free networks
III.4.1 The global banking system
III.4.2 Trade networks
III.5 What is collapse?
IV. Converging Crises in the Financial & Monetary System 40
IV.1 Credit over-expansion & imbalances
IV.2Peak oil and its economic implications
IV.3Real wealth, proxy wealth & the end of credit
V. Financial System Supply-chain Cross Contagion:
A Eurozone Collapse Scenario 55
V.1 The bubble bursts
V.2 Central banks & governments to the rescue?
V.3 Financial system supply-chain contagion
V.4 Supply-chain contagion
V.5 Supply-chain financial system feedback
V.6 Time & irreversibility
VI. Risk, Constraints and a Conclusion 72
VI.1 Some thoughts about risk
A networked society behaves like a multicellular organism...random damage is like lopping off a
chunk of sheep. Whether or not the sheep survives depends upon which chunk is lost....When we
do the analysis, almost any part is critical if you lose enough of it.... Now that we can ask
questions of such systems in more sophisticated ways, we are discovering that they can be very
vulnerable. That means civilisation is very vulnerable.
New England Complex Systems Institute
I.1 The Living Fabric of Exchange
The Irish economy, the German economy and the UK, US and Chinese economies do not
exist, except by virtue of their integration in the globalised economy. Conversely, each is a
localised expression of a global system. At any moment a myriad of final and intermediate
goods, commodities, information and people is moving back and forth across borders.
Without those flows, which maintain socio-economic function and complexity, economies
would quickly collapse.
Here we make a distinction between our imagined communities, in particular the nation
state and the psycho-drama within and across nations, and our real dependencies, which
are globalised. National economies can have local character and limited degrees of
freedom, but they exist inter-dependently, just as a heart or lung cannot exist apart from
the body and still retain its original identity.
The nature of this integration has been evolving in ways that are reflected in common
conversations about the world becoming so much more complicated, globalisation, `the
world being flat', and the speed of change in the world. Broadly, we can say that the
globalised economy has been growing in complexity. This can be associated with growing
connectedness, interdependence and speed. There are many definitions of socio-economic
complexity and quite a bit of debate as to its nature. At the most general we could start
with the following:
Complexity is generally understood to refer to such things as the size of a society, the
number and distinctiveness of its parts, the variety of specialised roles that it
incorporates, the number of distinct social personalities present, and the variety of
mechanisms for organising these into a coherent, functioning whole. Augmenting any of
these dimensions increases the complexity of a society.
We can catch a fragmentary glimpse of this via Eric Beinhocker who compared the number
of distinct culturally produced artefacts produced by the Yanomamo tribe on the Orinoco
River and by modern New Yorkers. The former have a few hundred, the latter, tens of
billions3. John Gantz notes the massive increase in the "internet of things" such as cars,
ovens, payment and ordering systems, electric grids and water systems, rather than people.
The number of connected devices has risen from 2 billion in 2005, to 6 billion in 2010, and
is projected to be (conditions allowing) 16 billion by 20154.
Consider that a modern auto manufacturer has been estimated to put together 15,000
individual parts, from many hundreds of screw types to many tens of micro-processors.
Imagine if each of their suppliers put together 1,500 parts in the manufacture of their input
to the company (assuming they are less complex), and each of the suppliers to those inputs
put together a further 1,500. That makes a total of nearly 34 billion supply-chain
interactions (15,000 x 1,500 x 1,500), five times the number of people on the planet. This is
a highly imperfect example but it signals the vast conditionality upon which modern
The globalised economy is a singular recursive network or fabric of relationships between
people and things. Let us take a more discursive example. Mobile devices, now ubiquitous,
represent the culmination of 20th-century physics, chemistry and engineering. They signify
thousands of direct - and billions of indirect - businesses and people who work to provide
the parts for the phone, and the inputs needed for those parts, and the production lines
that build them, the mining equipment for antimony in China, platinum from South Africa,
and zinc from Peru, and the makers of that equipment. The mobile device encompasses the
critical infrastructures that those businesses require just to operate and trade - transport
networks, electric grids and power-plants, refineries and pipelines, telecommunications
and water networks - across the world. It requires banks and stable money and the people
and systems behind them. It requires a vast range of specialist skills and knowledge and
the education systems behind them. And it requires people with income right across the
world, not just as producers, but also as consumers who can afford to share the costs of the
phones and associated networks - there are economies of scale right through the diverse
elements of the globalised economy. Those consumers can only afford the devices because
they ply their trade through integration in the globalised economy.
The mobile device feeds back into the globalised economy, re-shaping and transforming it.
It is the building block for new levels of complexity when it combines with other things to
form new businesses and new economies of scale. It co-adapts with societies and
economies, intertwining, shaping how we live in and understand the world. The mobile
device is not a thing in the globalised economy, but a dependent expression of it.
The speed of interaction between all these parts of the globalised economy has been getting
faster. Automatic trading occurs over milliseconds, and financial and credit shocks can
propagate globally in seconds. Within a minute of deciding to talk to a friend on the other
side of the world, our conversation can begin. One of the major transformations in
business is that lean inventories and tight scheduling means many businesses and
industries hold hardly any stock. Automatic signals go from check-out counters, to
warehouses, to suppliers who ramp production up or down to meet demand. That supplier
too sends signals to their suppliers who also run Just-In-Time logistics (JIT).
It has been estimated that a modern industrial city only has about three days of food for its
inhabitants in situ. Later we will consider in more detail the blockade of fuel depots in the
UK in 2000, when the UK Home secretary Jack Straw accused the blockading truckers of
"threatening the lives of others and trying to put the whole of our economy and society at
risk". This was not hyperbole. As the protest evolved over about ten days, the UK's Just-in-
Time fuel distribution system started to break down. Supermarkets, which had also
adapted to Just-in-Time re-supply, began to empty. Supplies and staff could not reach
hospitals, forcing emergency-only admission. If it had gone on for only a few days longer,
large parts of UK industry would have shut down as the normal operation of re-supply
ground to a halt. One of the most advanced and complex societies on the planet was within
days of a food security crisis. In section II, various examples will be used to demonstrate
how growing complexity, interdependencies within socio-economic systems and the
increased speed of processes can cause widespread and rapid contagion if the `right' critical
In all the vast complexity of the globalised economy, there is no person or institution in
control, or who knows how it all fits together, for it is far beyond our comprehension.
Facebook, for example, does not need to know how to make an electric grid work, or how
to process antimony, yet nevertheless they are all connected through diverse and
unfathomable relationships. Each person, business, institution and community acts within
their own niche; with their evolutionary heritage and their common and distinct histories;
with their acquired skills and assets; and through physical and cultural networks. What
emerges at a large scale is the globalised economy. We are both contributors to, and
dependent upon, the functioning of that economy.
This is just Adam Smith's invisible hand at work, or in modern scientific parlance, an
example of self-organisation in a complex non-equilibrium system. In particular, the
globalised economy is an example of a complex adaptive system (CAS). A non-equilibrium
system is one prone to change and transformation. It is a system, because there is a level of
overall integration and identity, and co-dependence between parts. They are complex and
adaptive because they are composed of dynamically (not static) interacting parts
(sometimes called nodes) that change their individual and collective behaviour over time.
A person is a CAS, so too is a collection of them (at a sporting event, as part of traffic or as
a nation), so is a company, and so is an electric grid. An ant colony is a CAS, as is the
evolution of the earth's biosphere. They exist interdependently, mixing chance and
necessity over a universe of scales. What maintains a CAS is its internal stability and the
transformation of energy and resources.
Despite the ostensible change over our own lives - indeed, we live in a culture that prizes,
and an economy that delivers continual novelty - what is remarkable is how stable that
evolution has been. How can we talk of stability when there has been so much change: new
technologies, the rise of China and evolving social mores? But we would not make such on-
trend assumptions (technological evolution, economic growth), nor invest as though we
expect them to continue (how society educates its children, new infrastructure, pensions),
unless we felt comfortable that there was some form of macro-system stability. Within that
intuition of stability, we can have booms and busts, break-out technologies and bloody
wars, but over the medium to long term we can assume there is reversion to the trends
embodied in the macro-system evolution. Without such stability the high complexity de-
localised JIT integration could not have occurred: try crocheting on a roller-coaster.
Stepping back, what can be observed is that a new phase in global growth began to take off
in the early 1800s. It was faster and more sustained than ever before1. Because the growth
was exponential, each year's 3% growth added more goods and services than the year
1 Maddison estimates that Gross World Product grew 0.34% between 1500 and 1820, 0.94% (1820-1870), 2.12%
(1870-1993), 1.82% (1913-1950), 4.9% (1950-1973), 3.17% (1973-2003), and 2.25% (1820-2003).
before. Rising economic growth was in a reinforcing cycle with growing complexity. That
stability provided the narrative arc that has taught us to assume economic growth will
continue, technology will evolve in complexity, food will be in the supermarket tomorrow
and the lights will remain on. We have adapted to its normalcy.
Mostly we do not notice these high-speed de-localised complexities that underpin the
normal functioning of our lives, businesses and societies. Our understanding of the world
is captured in its constituent parts, by what is novel, and by what gains our attention,
framed by intra-human dramas. The complexity is attenuated in simple things: my mobile
phone works, money is accepted for bread, and my train arrives. We notice the immediacy
of things, not the living fabric of conditionality from which it emerges. We can generally
take for granted the operational fabric of our society. These are the given conditions in
time and space that maintain system-wide functionality, such as functioning markets,
monetary stability, supply-chain replenishment, critical infrastructure, trust and socio-
political stability. What we do not see so clearly are constraints, because mostly we have
become habituated to them.
The general stability of the globalised economy and the operational fabric has provided the
conditions for goods and services, socio-political structures, critical infrastructure,
companies, global markets and a myriad other systems adaptive to that environment to
evolve and maintain their local stability over time.
This is just like an animal adapted to its ecological niche. The niche is dependent upon the
wider ecosystem operating within the range of conditions (or stability domain) that
maintain the niche and so keep in check the animal's security (food, shelter, disease
vectors, symbiotic relationships and predators).
As a society we have largely ignored the implications of rising complexity because we are
adaptive to it. At its core, furthermore, grasping the vast conditional complexities of our
dependencies is an intuitive exercise, which strives for a picture of the whole when we can
see only the parts. This is an anathema to the analytic culture that prizes computable
I.2 Complexity & Risk
A complex networked society can in many ways be remarkably resilient. If there is crop
failure in one place, food can come from another region. If there is a break in a company's
supply-chain, a replacement part can come from elsewhere. Increased complexity and its
twin, growth, have allowed the displacement and reduction of risk in space and time.
Insurance, pensions, sewage systems, wealth, healthcare, and socio-political systems have
all contributed to an era of huge reductions in the risk to an individual's daily welfare,
especially in the most advanced economies.
The individual risk can sometime be removed, or it sometimes is pooled or displaced over
space and time. The green revolution of the 1950's-70's staved off the risk of major famine
by a deep integration of food production into the innovating platform of the globalising
economy. That macro-system turned fossil fuels into increased production through
fertilisers, pesticides and machinery. It drove efficiencies through interconnection and
economies of scale, and de-localisation through packaging, additives and transport. It also
enabled the more than doubling of the human population, each individual on average
consuming more year-on-year, and habituating to that. The cost of the revolution, in
greenhouse gas emissions and degraded fertility could be displaced onto a future
However, now there are now more people dependent upon a less diverse and more
ecologically vulnerable resource base. Further the globalised economy, which mediates
between our welfare and in-situ resources is more and more unstable. It is that which
enables food production, distribution and affordability. Thus the green revolution could be
said to have displaced and magnified risk into the future. That future is likely soon upon
In a more complex and tightly coupled economy, rather than absorbing shocks, the
economy can amplify and transmit them: we have seen this as the financial crisis has
evolved. We are now dependent upon many more interactions to maintain our welfare.
More complexity and connectivity means there are many more points where failure or
breakdown can occur. More interdependence between nodes means that the failure of one
node can cause cascading failure across many nodes. De-localisation means that there are
many more places and events that can transmit failure, and major structural stresses can
build at a global scale. There is less local resilience to failure, in that we cannot repair or
replace many critical elements from local resources. The rising speed of processes means
that failure for even a short time can, for example, overwhelm tiny inventories, causing
cascading failure along supply-chains. In addition, the high-speed spreading of such failure
if it were to spread at the speed of financial markets or inventories could outrun our ability
to bring it to a halt or even slow it down. So at first glance, rising complexity should lead to
increased systemic risk. While this has been recognised at the fringes of academic work for
many years, it has only recently begun to come in to more mainstream thinking with
reports addressing some of the issues from the World Economic Forum5 including in its
Global Risks 2012 report6, and Chatham House7.
There is another factor that has increased systemic risk. In many ecosystems there are
keystone species - a generalist pollinator for example - whose removal could collapse the
whole ecosystem. Likewise, the operation and integration of the globalised economy is
dependent upon a small number of interdependent keystone-hubs, where a significant
failure of any one of them could cause rapid catastrophic socio-economic failure to spread
globally. These keystone-hubs are themselves becoming more vulnerable. Just two will be
considered in this section: the financial and monetary system keystone-hub, and the
production flows keystone hub.
i) The financial and monetary keystone-hub: The financial and monetary keystone-
hub has virtually no general system diversity, which is always a danger in an ecosystem.
Whatever bank one cares to consider, whatever form of country financing, whatever
monetary system - they all share the same platform of fiat money and credit-money
creation by fractional reserve banking. The whole of the financial and economic system is
dependent upon credit dynamics and leverage.
Such credit dynamics helped to entrench the imbalances that built up in the global
economy between countries running trade surpluses and those absorbing ever-rising credit
flows. Without the level of de-localisation, complexity, and open connectivity, it is doubtful
that such high levels of debt could have built across so many countries. Debt is now not
just a feature of countries and banks - it is a system stress in the globalised economy as a
The banking system has become less and less diverse too: there are many banks in the
world, but banking activity has become more concentrated in only a tiny fraction of them;
these are the `too-big-to-save, too-big-to-fail' banks. The connectivity between retail banks,
merchant banks and the shadow banking system has further removed system diversity and
buffers to the spread of contagion.
Further, the response to the financial crisis has been to stave off a global banking collapse
by releasing some of the tension onto sovereign states, where credit expansion could be
maintained, at least for a while. This is particularly true of countries within the Eurozone
which cannot print their own currency. This has reduced the system diversity of the
financial system, and removed buffers to the spread of contagion, by coupling sovereign
financing and the banking system ever more tightly. By enabling further credit expansion,
which is part of why there was a problem in the first place, the risk of systemic failure has
increased. The risk of systemic failure is further increased by the process of debt deflation,
itself the direct result of credit over-expansion.
The shortening `relaxation time' - the time markets remain confident between new crisis
points in the Eurozone and political-economic reaction - suggests a growing inability of
the interacting systems to absorb risk displacement in space and time. We are likely to be
impelled to respond faster and faster as the socio-economic environment becomes riskier,
more unpredictable and high speed.
Referring to Bar-Yam's quote at the top of this section, the survival of the sheep depends
upon which part and how much of the animal is damaged. The financial system, because it
links almost everything in the economy, could be compared with the heart or lungs. We
also need to consider the potential scale of damage, and the ability of the animal to absorb
that damage. Thus, a healthy sheep could survive a shock that a weakened animal might
Consider the default of Argentina on its sovereign debt a decade ago. In the most general
terms, the potential cascading effects on the global economy were dependent upon the size
of the default relative to the global economy, the relative importance of Argentina's
economy and confidence within the globalised economy. The world economy easily
absorbed the impact: indeed, this was not the first time that Argentina and countries of
similar size had defaulted. With its newly devalued and competitive currency, it could re-
equilibrate with the stable surround of a strong, confident, globalised economy, and soon
returned to growth.
What if Ireland followed Argentina's example and defaulted, as some commentators have
suggested it should? First there is the huge complexity and uncertainty of being in the
Euro, but for the moment however, let us assume a new punt is introduced without a hitch
(this is an imaginative exercise), with the hope that the devalued punt would allow
renewed growth and exports. However, now there is much reduced resilience within the
globalised economy. There is more debt in the system than four years ago, and confidence
in central banks and governments' ability to handle the situation is almost gone. That is,