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Thoughts from the Frontline

How Change Happens

August 18, 2012

Choose your language

"To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none… The cause-creating drive is thus conditioned and excited by the feeling of fear …"

– Friedrich Nietzsche

"Any explanation is better than none." And the simpler, it seems, in the investment game, the better. "The markets went up because oil went down," we are told. Then the next day the opposite relationship occurs, and there is another reason for the movement of the markets. But we all intuitively know that things are far more complicated than that. As Nietzsche noted, dealing with the unknown can be disturbing, so we look for the simple explanation.

"Ah," we tell ourselves, "I know why that happened." With an explanation firmly in mind, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brain that make us feel good. We literally become addicted to the simple explanation. The fact that what we "know" (the explanation for the unknowable) is irrelevant or even wrong is not important for the chemical release. And thus we look eagerly for reasons.

And that is also why some people get so angry when you challenge their beliefs. You are literally taking away the source of their good feeling, like drugs from a junkie or a boyfriend from a teenage girl.

Thus we reason that the NASDAQ bubble happened because of Greenspan. Or that it was a collective mania. Or any number of things. Just as the proverbial butterfly flapping its wings in the Amazon triggers a storm in Europe, we may conclude that a borrower in Las Vegas triggered the subprime crash.

Crazy? Maybe not. Today we will look at what complexity theory tells us about the reasons for phenomena as apparently diverse as earthquakes and the movement of markets. Then we’ll look at how New Zealand, Fed policy, gold, oil, and that lone investor in St. Louis are all tied together in a critical state. Of course, how critical and which state are the issues.

This is an encore appearance of the letter that is clearly the most popular one I have ever written, updated with a few thoughts from recent times (it was also part of a chapter in Endgame). Numerous reviewers have stated that this one letter should be read every year. As you read, or reread, I’ll be enjoying a week off. I have gone off to a secret location to relax and get away, all by my lonesome, which is something I have really not done for years. It will be interesting to see if I can adjust to all the peace and quiet, but so far I am coping quite well. And now, let’s think about ubiquity.

Ubiquity, Complexity Theory, and Sandpiles

We are going to start our explorations with excerpts from a very important book by Mark Buchanan, called Ubiquity: Why Catastrophes Happen. I HIGHLY recommend it to those of you who, like me, are trying to understand the complexity of the markets. Not directly about investing, although he touches on it, it is about chaos theory, complexity theory and critical states. It is written in a manner any…

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Russ Abbott

Aug. 24, 2012, 5:55 p.m.

I’ve been riding my bike a lot. It’s the only exercise I know of that’s really fun. I just love the feeling of gliding along. Also you can make it as challenging or easy as you like. There’s a hill near where I live with a road to the top. It’s a steady incline all the way up. It takes me about 7-8 minutes. I would never put in sustained effort for that long under different circumstances. But of course I don’t have to go up the hill at all. If I just won’t to relax I ride the bike path along the beach. Last week my wife and I were in Tokyo. She was giving a paper at a conference. I was along as a spouse. I took advantage of it to join a bike tour of Tokyo. So much fun that I kept the bike an extra day and rode around by myself!

Giovanni Isaksen

Aug. 19, 2012, 10:13 p.m.

RE: [A] smooth bell curve, with the ends tapering off into nothing… normal distribution, standard deviations, Gaussian distributions, fat tails, standard deviation and covariance are steam age concepts according to Sam Savage, author of “The Flaw of Averages” ( on Amazon). The problem is that in areas as diverse as finance, healthcare, accounting, the war on terror and climate change, plans based on averages of such uncertainties as customer demand, completion time, and interest rate are below projection, behind schedule, and beyond budget. The same applies to markets as Savage’s solution is Probability Management which is based on a distribution of outcomes rather than a single ‘average’ probability.

Regarding humans and whether they actually have ‘free will’ I read an interesting bit called “Does Contemporary Neuroscience Support or Challenge the Reality of Free Will?” on

Keith McCombs

Aug. 19, 2012, 12:14 p.m.

If one perceives the sand pile analogy as a problem to be solved, the solution is quite simple:  More smaller sand piles instead of fewer big ones!

Lawrence Goodman

Aug. 19, 2012, 12:10 p.m.

I am no expert on complexity theory but am a careful observer of human events and have an anthropological perspective that has provided a sense of understanding where the world is headed. I enjoy your missives and will continue to read them along with Casey, Martinson, Peterson and David Stockman.

I offer some advice on health. I am 86 and relish high altitude powder skiing. What keeps me in shape is the fear of losing the ability to do what I love. It drives me to exercise each day and to eat a healthy diet. The genetic advantage of having a 95 year-old mother certainly doesn’t hurt your outlook. A pastry-free household also is a boost. Incidentally, one of my ski companions is 90 year-old Naomi Wain who is first in line when there is a 12 inch powder dump.

peter fleischhacker 21259

Aug. 19, 2012, 8:10 a.m.

Peter Fleischhacker
The sand metaphor – applies to life as well …
Congratulations to your mother’s 95th birthday of “advanced youth”
And to “the young lad at almost 63” many happy returns when
reaching “advanced youth” of 64 – think positive, never program
yourself negatively, hence never use the “o” or “a” word, stay young!

Dan Buttry

Aug. 19, 2012, 8:01 a.m.

Thanks for the thoughts about complexity, John. Been reading in that area for years. One must be careful, however, not to “project” critical states onto all phenomena. They are not the norm. And, they more often happen with systems with only a few key drivers, not many (as in financial markets). However, certainly at the macro level it may make sense to expect such behavior, for example, when things are so strongly influenced by a few things (Europe, central banks, state of housing, etc.). By the way, I also stopped drinking a little over a year ago. I feel MUCH better. Never really had a problem with it, just had reached my lifetime limit, as you put it. I don’t agree with the others commenting that you should have a glass of wine with meals. You should do what feels best for you. In spite of having been a wine buff, I’ve actually lost my taste for it. Anyway, keep writing - we all appreciate your work.

David Oldham

Aug. 18, 2012, 4:33 p.m.

John, I would feel a much happier friend if you permitted yourself the luxury of one glass of red with your main meal of the day. The French have a comparatively low rate of heart disease (even though they eat almost anything that moves) which I believe is attributed to red wine. Speaking as a 68 yr old Brit I would hesitate to punish myself too severely for fear of provoking the irony of getting run over tomorrow. I am also a dedicated enemy of Mr Murphy monkey so please choose your words very carefully when talking about your lifespan aspirations. I too want to be reading you in 20 years time :-)

Hope you have a rewarding retreat John.

Gordon Foreman

Aug. 18, 2012, 3:54 p.m.

In the last day or so you posted an article by George Freidman who proposes that to invest profitably in a politicized economy, we just have to consider the constraints facing the politicians. I think this article explains why this approach is inadequate. I suspect that most of us have an internal sense for pending catastrophe. We understand that as the sand pile builds, and the small avalanches become more frequent, the risk of a big one is rising. Of course, after a big avalanche it takes a while for us to settle down and realize that it is safe to come out again, but somehow I don’t feel like the last financial crisis reduced our financial sand pile to a stable configuration.

John Bengfort

Aug. 18, 2012, 8:23 a.m.

At 70, I would observe that you always are going to be sore and stiff though you will be more functional with the exercise.

Wes Hopper

Aug. 18, 2012, 7:56 a.m.

thank you for reprinting this letter! The point that really struck me was this one:
“After all, every avalanche large or small starts out the same way, when a single grain falls and makes the pile just slightly too steep at one point.”

This is certainly applicable to currencies and other markets, as you pointed out, but it’s also very important in relation to the changing climate, which will affect our lives even more directly. As giant insurer Munich Re has said, “Climate change is a subject that concerns us all. It is one of the greatest risks facing mankind.”

This year, with less than 1 deg C of warming, we have a massive loss of Arctic sea ice, the crop disaster in the US, and the Mississippi so low as to stop barge traffic. Similar effects are being felt around the world.

The reaction of the international energy companies is to line up to drill in the Arctic, instead of connecting the dots. This is the sand pile and we are adding sand.

Where is the “last grain of sand” point? Is it 1.5 deg, 2.0 deg, 3.0 deg of warming? We don’t know. Unlike our play sand pile we can’t sweep it up and start over. The only intelligent and rational choice is to stop adding sand, since we know from the fossil record that runaway temps may lead to mass extinctions from ecosystem destruction.

Our choices here will determine the world we leave our grandchildren. A liveable planet should be at least as important as an investment portfolio.

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