A list of possible Black Swans - Part 2
In my first post, I listed 2 black swan scenarios that are playing out but their ultimate consequence may take a long time to materialize. In this article, I am going to explore several scenarios that may happen sooner than expected. Once they materialized, the impact on the financial market will be almost immediate.
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Quick recap on what a black swan event. Based on Wikipedia,
Black swan is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight. The term is based on an ancient saying that presumed black swans did not exist – a saying that became reinterpreted to teach a different lesson after black swans were discovered in the wild.
A list of possible black swan events
As mentioned, this is a list of scenarios that have not happened but may happen sooner than expected. As no one is able to know exactly what is the chance of them occurring, I can only order them based on what I perceive the impact will be.
Major cyber attack on critical infrastructures
The September 11 attack in 2001 killed 2,977 people, injured over 6,000 others, and caused at least $10 billion in infrastructure and property damage. The world was shocked by it and unsurprisingly, the financial market took a quite hit. On the first day of NYSE trading after 9/11, the market fell 684 points, a 7.1% decline, setting a record for the biggest loss in exchange history for one trading day. European stock markets fell sharply as well, including declines of 4.6% in Spain, 8.5% in Germany, and 5.7% on the London Stock Exchange.
On top of the shock dealt to the stock market, it was estimated that there were over $40 billion of insurance losses, 430,000 jobs were lost and there were $2.8 billion in lost wages over the three months following the 9/11 attacks. That is still not counting the economic losses due to drop in tourism and air travel during that time. In addition, the attack also directly led to the war in Afghanistan which is estimated to cost $975 billion.
Since 9/11, there were many other terrorist incidents across the world and the total cost is difficult to estimate. However, the 9/11 attack remains to be one of the most deadly and high-profile incident thus far.
Fast forward 18 years, most governments have stepped up their physical security. However, cyber security remains a weak link. As technology progresses, we become more reliant on them. Many critical infrastructures such as power plants, banks, harbors, airports, telecommunication centers and etc are increasingly connected to the internet. We know that terrorists strike where one is most vulnerable and I think these infrastructures connected to the internet have become the prime targets.
Imagine a cyber attack which simultaneously bring down all power plants, cutting off the main power supply for large cities. What about an attack on the telecommunications backbone, instantly disconnecting everyone from the internet. Picture a week without banking facilities due to system outages. Any of these disruptions will be enough to cause massive panic. The financial market will plummet (if it is even still operational). Are we ready for this scale of attacks?
Social unrest due to wealth disparity
The widening wealth gap is a real problem and a big one. In the book "Principles For Navigating Big Debt Crises", Ray Dalio, CEO of Bridgewater Associates, opined that as wealth gap increases, so does populism sentiments and the chance of political/social conflict. He said this,
Wealth gaps increase during bubbles and they become particularly galling for the less privileged during hard times. As a general rule, if rich people share a budget with poor people and there is an economic downturn, there will be economic and political conflict. It is during such times that populism on both the left and the right tends to emerge.
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The chart above shows the total wealth of the bottom 90% and top 0.1% of people in the US. As the wealth gap increases, the curve will cross-over. It is during those times that populism emerges thereby increasing the risk of actual conflict. The last time this happened was during the 1930s, which we saw the beginning of World War 2.
Consider the following diagram and notice how 3 people have a combined wealth of more than the bottom 50% in the US.
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If you think this is just a problem in the USA, think again. Take a look at the following diagram depicting how the world’s richest 1 percent, those with more than $1 million, own 45 percent of the world’s wealth. Adults with less than $10,000 in wealth make up 64 percent of the world’s population but hold less than 2 percent of global wealth. Wealth disparity is a global problem!
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The rise of populism sentiments had already started. Look at how Donald Trump appealed to the Rust Belt workers during the 2016 election. The "Yellow Vests Movement" in France was also due to rising prices and general discontentment of the wealth gap. Even the ongoing Hong Kong riots and protests may just be a consequence of decades of rising wealth gap.
We have seen signs and it is probably a matter of time a far greater level of social unrest emerge. A movement that spreads like wildfire across multiple countries will be hugely detrimental to the financial markets.
Failure of a major fiat currency
Fiat currencies have a notorious history of failing due to hyperinflation. The table below shows how many fiat currencies of once great nations had succumbed to hyperinflation, losing value quickly over a short period of time.
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In more recent times, we have seen how the Venezuelan Bolivar lost its value, the Turkish Lira plummet, and even the British Pound crash due to announcement of Brexit.
By definition, fiat currencies are not backed by anything except for government words. Their strength comes from the stability and power of the governments issuing them.
In recent decades, the US debt-to-GDP ratio is on the rise. In fact, it has been racing towards the all-time-high in 1946, which was the post-WW2 period.
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It is therefore not impossible for a scenario where the US economy comes crumbling in debt, resulting in hyperinflation of the USD. The likelihood, albeit slim, is non-zero. Considering that the USD is the world's reserve currency, that will spell huge trouble for the world.
The US government benefit from the fact that most, if not all, of their debts are denominated by the USD. That means that they can always print more money to pay off their debt. Doing so simply erode value for the creditors. A shrewd creditor (e.g. China) will not want that to happen. Hence, it is very unlikely that the USD will collapse soon. So, let's take a look at an alternate scenario.
The creation of Euros is a miracle considering the fact that the European Union is made up of so many different countries having different agendas, cultures and priorities. However, that also means it is relatively fragile. There is a chance that following Brexit, other countries may follow suit thereby weakening the utility of the Euros and hence its value. If this becomes a domino effect, then the Euro is likely to go on a death spiral. When that happens, the global financial markets are bound to take a plunge. While both both scenarios are not entirely unfathomable, the collapse of Euro may have a slightly higher chance as compared to USD.
Conclusion
In this article, I presented 3 scenarios that will have immediate impact of the global financial markets if they become true. The collapse of a widely adopted fiat currency (e.g. USD or Euro) will be extremely detrimental and almost a doomsday scenario for the financial markets.
Being a cyber security professional myself, I have been reading about trends of how hackers are getting ahead of defenders given that they are not bounded by any rules. Knowing all these just makes be feel that it is inevitable to see a major cyber attack in our lifetime.
Finally, the widening wealth gap is a ticking time bomb and it is just a matter of time the problem morph into something more violent (e.g. in the case of Hong Kong). If governments around the world do not attempt to reduce the wealth gap, the level of discontentment will just keep rising and eventually lead to something more unsettling.
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Hi @culgin
All the scenarios you are considering, I believe that at any moment they can happen.
and we are at the mercy of everything you say ..
And the metaphor used gives more reality to the statement, since black swans do exist.
This was a great read. I did enjoy every single black swan identified here, except that I am one of those persons who believe that climate change is a hoax. Cheers!
Weyhey, I'm still having fun, glad I bought some crypto with my GBP, as it softened the blow!