The feedback spiral.

I will start with an example about confidence and performance of a hard-working person.

Performance of person boosts his confidence. Confidence of person boosts his performance.
This can be taken as a classical example of a feedback loop. This is story of Uncle Sam.

He performs well in his job. He gets good results and great bonus. His confidence boosts up. More confidence leads to even better performance. His confidence becomes over-confidence. His performance gets even better. This is the feedback loop working in making a positive spiral. Both his performance and confidence reach very high levels. Now Uncle Sam is the best performer, everybody thinks he is intelligent and hardworking. This is a boom.

Now, for some reasons his performance remain subdued because of an illness for 5 day. He performs terribly in his job, confidence goes down. After this time the illness is over. He again starts performing better and confidence again reach good values. Performance and Confidence, just had a minor correction but reached new peaks again. This is similar to a market correction.

Now, consider a case when this illness continues for a little longer, say an year.
Performance is down because of illness. Confidence goes down a little. Performance suffers because of confidence. Confidence goes down even more. Performance suffers more. Confidence become under-confidence, performance literally crashes. Uncle Sam is not even confident, if he can work anymore ever. His performance and confidence both goes to subdued levels. He looks like an asshole to everybody else. Uncle Sam is depressed and stops working. This is a bust. This is called market crash.

This feedback loop exist everywhere. Human nature is like that. Everybody likes it when it works in making a positive spiral. But when things remain subdued for long period of time due to some reason there is a significant risk that positive spiral never begins again. And things unwind in a negative spiral and end terribly.

Some economic examples are here.
One bank declared bankruptcy because of subprime mortgages. This leads to a credit crunch, because everybody is worried which bank will go next, so nobody offers credit. This credit crunch makes it difficult for banks to borrow when they need money. Leading to further bankruptcy and a worse credit crunch. Such spiral will continue in the negative direction and credit crunch will even worse until and unless this negative feedback loop is broken by a government intervention.

Another example, is the housing market, if house price fall more than unusual, people default on their loans. At this time, banks should keep giving more loans, but banks will take a decision of going slow on housing loans. This hinders people to buy houses, leading to further fall in house prices. Further defaults. Further tightening in load dispersal. Further price fall. Further defaults.


Whole globe faced similar risk just some days before. If US would not have decided on bailout,
more banks will go insolvent, credit crunch get even deeper, credit availibility threatens housing loan, car loan, education loans and industry loans. Industries stops working, leading to unemployment. The whole economy slows down, if credit is not easily available.
US has done good to save their economy by a 700B$ bailout.

This bailout is nice because it will take down the US economy slowly. If US economy would have collapsed, it will take all the economies along with it. But the problem has not yet ended, economic policies have to manage the impossible trinity. US cannot just manage this impossible trinity, the interest rate, the currency and the inflation.

If US keeps interest rates low for a long period of time, people move away from dollar for higher interest rate in some other currency. If dollar depreciates, chinese goods and Oil become expensive in US, hurting there economy GDP and purchasing power of individuals. Leading to high inflation.

If US inturn raises interest rates, the growth of the economy already at a brink of collapse, slow down and risk of collapse increase again.

US has no choice but to keep interest rate low, so dollar will continue to depreciate in a long run.
In next 5 years, we will see lower acceptance of dollar as a safe currency. Which currency will people keep their forex reserves in ?

The problem which leads to fall because of formation of a negative spiral with US economy. This same problem also leads to formation of a positive spiral with Indian economy.

I will write about what made US, the greatest economy after all. What made Warren Buffet, look intelligent and make a lot of money living in a boom. What created a boom, called US.
What will lead to its relative fall to other economies and losing its superpower status.