Circuit Systems & our Financial Crisis I

March 18, 2009
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On the Nature & Philosophy of Financial Instability and Application to the Current Financial Crisis Part I

By Julian Sanchez, PhD

Abstract:

Very large systems operating in their normal range exhibit quasi-linear relationships between input and output that can be used to predict output behavior. However, when the system becomes destabilized, the dynamics change so that the relationship between output and input is non-linear. Making matters worse is the fact that these non-linear relationships between output and input become a function of time. The time varying non-linear nature of the system implies that injections into the system cannot be predicted and can produce large perturbations resulting in unintended consequences which are even more difficult to control. These perturbations are even more troubling since the entire system becomes unstable and not well understood. Altering the system in an effort to fix the problem usually results in new perturbations of the system. The probability increases that these quasi-random perturbations will synchronize triggering a cataclysmic failure resulting in system collapse or that outside disturbances such as environmental disaster, weather related tragedies, war, etc. will cause a weakened system to fail. Therefore, when dealing with a very large out of control multi-dimensional system, the best approach is to preserve the entire system (irrespective of moral hazard). In this paper we will discuss a comprehensive solution to stabilizing and preserving the system along with the philosophies that motivate them.

Can circuit systems teach us how to solve our financial crisis?

Introduction:

The purpose of financial systems is such that a gain is produced for each dollar invested into a given instrument. This gain in nature is similar to gain produced by a circuit that amplifies. However, any circuit that produces gain suffers from instability. The solution to eliminate such instability is to couple the output to input with negative feedback. Without automated negative feedback, the circuit will require excessive manual controls and high quality low tolerance components which are expensive and require constant maintenance to implement the negative feedback. The constant maintenance and excessive manual controls cannot be maintained without human error entering the process and occasionally inducing the collapse of the design. Therefore to produce a more robust design able to operate under a variety of conditions while still maintaining the desired operating conditions with lower quality components, control systems and circuit designers use negative feedback loops to create self correcting circuits able to produce the desired result under a variety of conditions. In this paper we review the overall philosophy of stability in financial systems. This paper provides an overview into guidelines and principles for a comprehensive solution to the current financial crisis. We will discuss the impact of shorting stock, morale hazard and other financial topics that can result in instability of the financial system. Our purpose is to provide a philosophical view with guiding principles for the current financial crisis.

Part II

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