Put it probability distribution terms, the distribution of all possible outcomes is becoming more bimodal (tails are "fatter", as shown in the graph below). It appears that reality is abandoning the familiar Normal probability distribution shape, depriving us of the standard tools we used to rely on to estimate the future. The comfort of saying that there is a 95% probability that an event will be within 2 standard deviations from its mean is gone, leaving analysts and futurologists clueless.
|Sornette (2011): Scaled Distribution of Runs of Gains (Right) / Losses (Losses) for 30 major US stocks. |
Notice the fat tails of the distribution
Notice the importance of the meeting of the reinforcing elements. Without the interconnection of these elements, amplification doesn't occur. In human systems, interconnection amongst people allows imitative (herding) behavior that helps reinforce an event. We have all been witnesses of the effect of interconnectedness on social causes, like The Arab Revolutions. Here, potentially reinforcing elements (people willing to do something about a common problem) are interconnected thanks to a platform (the social networks) that exacerbate an event (social discontent) to create a "Dragon King" (simultaneous revolutions that have overthrown decades-old regimes). Once social discontent reaches a tipping point, all it takes is a trigger (Mohamed Bouazizi setting himself on fire) and interconnectedness fuels the fire.
Are we headed for a Dragon King in the global financial markets?
If we are looking for the orographic winds or the critical mass of snow in the global economy, by now it should be clear (thanks to the hyper-coverage in the media) that they are in the banks' high levels of leverage. Specifically, in the assets denominated in USD held by foreign banks (see graph below). Yes, those at the very center of the European debt crisis [gasp]. The critical mass for the snow avalanche or the orographic conditions for a Venezuelan flood are silently setting in.
|Shin (2011). Global Banking Glut & Risk Premium.|
|with world Bank Figures|
Our sky is filled with butterflies, and they are flapping their wings. Hard. Which one will create the next big hurricane? Who knows. No wonder people are nervous.