The Unexamined Game

Considered in the abstract, there are striking similarities between the near collapse of the global financial sector in 2008 and the series of events that precipitated the First World War. The kind of reasoning we use in connection with human institutions often transcends the specific purposes of the institutions themselves, applying as well to major banks as to national governments. Let us first consider, briefly, the events that lead to war in 1914.

In the minor nation of Serbia there was much bad feeling toward the neighboring Austrian empire. Gavrilo Princip, a Serbian patriot, assassinated Archduke Franz Ferdinand of Austria. Austria demanded that Serbia redress the matter in a way that would effectively nullify Serbia’s sovereignty. Serbia only partially complied. Austria used this less than complete submission as a pretext to declare war. Russia, bound by treaty to protect Serbia, mobilized its army. Germany, allied with Austria, declared war on Russia. France, allied with Russia, declared war on German and Austria. Germany invaded Belgium as a militarily favorable route to France. Britain, bound by treaty to defend Belgium, declared war on Germany. Four years of carnage and bloodshed were required to break the ensuing military deadlock.

What is notable here is the nature of the alliance game. Every government that was pulled into the war had sought to manipulate the political system of Europe to enhance its own influence and security. None had formed alliances with the immediate intention of going to war. They had all either hedged their political adventures by allying with a major power, or, in the case of the Russo-Serbian and Anglo-Belgian agreements, had attempted to protect weak friends from the ambitions of powerful enemies. The general conflagration that followed was the result of no one’s explicit intention. Rather, it was the collective result of each participant’s pursuit of advantage and risk mitigation.

Consider the events that led up to the crash of 2008. Prior to the crash, there was a huge proliferation of risk mitigation through the use of hedge funds. In essence, the large banks formed a network of interlocking alliances and agreements that gave them sense of security that was not really merited. While each individual risky derivative investment was mitigated by some carefully crafted bet, few people were paying any attention to the dynamics of the system as a whole. As in the First World War, when the first domino fell the rest followed inevitably.

It is a weakness of human beings that they tend to take the stability of the environment their institutions operate in for granted. While they recognize that their institutions themselves can have ups and downs (advancing one’s country or one’s business is the whole point of any political or economic game) there seems to be an innate assumption that game itself is more-or-less immutable. Thus, in Europe before the First World War statesmen jockeyed for position within the European balance of power, but never fully grasp that their own actions would collapse the European political system as a whole. Likewise, banks finding ways to leverage thin air into unprecedented levels of nominal wealth never really grasped that they were undermining the very basis of real wealth – the forces of industrial production.

Clearly, neither Serbia’s nor Austria’s national pride were worth the sixteen million deaths attributed to the First World War. Similarly, it is difficult to image the extraordinary expansion of paper wealth for a few in any way compensates for either the loss of real wealth for the many, or the wholesale damage to global economic stability which is still playing itself out. Neither event, however, appear to be the result of malice in any pure sense. In truth, humanity is simply ill-equipped, at least at this point in our evolution, to cope with nations and business institutions of the current gargantuan scale. To paraphrase the popular aphorism – we act globally, but think locally.