From black swans to grey rhinos
EVERY crisis event is best remembered by a concept that explains it in simple terms.
The 2007/9 Global Financial Crisis is well-described as a black swan event, a term coined by contrarian risk manager, Nassim Taleb, as a low probability but high impact event. Most swans are white, but every now and again a black swan appears. Black swans are notoriously difficult to predict, as we don’t see them often, but their impact can be devastating.
Since we are at the 10th anniversary of the Global Financial Crisis, a fashionable term has been coined by best-selling author Michele Wucker, The Gray Rhino: How to Recognise and Act on the Obvious Dangers We Ignore, St Martin Press, 2016. The grey rhino is the highly probable, high impact yet neglected threat, which when it charges, can cause severe damage. She includes in that category issues such as climate change, terrorism, financial stress and social unrest.
The official People’s Daily in China this week, commenting on the National Financial Work Meeting, exhorted regulators to prevent black swans as well as gray rhinos. This caused a flurry of comments within the blogs on what constitutes the grey rhino?
An obvious candidate is the property market.
Since real estate markets are valued at roughly 2½ times to three times GDP, any sharp correction in prices would have considerable stress on the banking system and national wealth. In 2007/8, the subprime crisis caused a fall of roughly 15% in US property prices, but with the US real estate valued at 365.7% of GDP in 2007, that caused a loss of US$10.4 trillion in household wealth or 70.4% of GDP.
With stock market crash of nearly 30%, the grey rhino shock was nearly 100% of GDP, which led to failure of Lehman Brothers, and the US$700bil TARP (Troubled Asset Relief Program) bank capital rescue package.
The second is the exceptionally low interest rate regime, partly caused by slow growth and the unconventional monetary policies, resulting in peak prices in stocks, bonds and real estate. The system is now a Catch-22 problem – damned if you do and damned if you don’t – whereby if the Fed raises interest rates further, asset prices may collapse, but if interest rates are not “normalised”, productivity remains low, as will growth. So far, global markets are touching peaks, as liquidity remains high.
Thirdly, what many financial analysts are concerned about is the rising level of corporate leverage in China and elsewhere. These have implications on the non-performing levels in China. Mixed up in the uncertainty is the quality of assets backing the wealth management products.
Fourthly, increasing income and wealth gaps are threatening social stability. So far, in those countries with relatively low levels of unemployment, the situation is manageable. But the growing level of youth unemployment is of major concern.
Fifthly, technology disruption is accelerating as the speed of new technology adoption in artificial intelligence, robotics, big data, 3D printing and the like are transforming business models and social change. Kodak certainly ignored its grey rhino from digital photography and got ran over. Firms like Takata, Toshiba and Volkswagen all ignored signs of trouble from their product quality and risks to the brand, causing sharp falls in their share prices. None of the troubling signs were completely unknown.
Wucker’s wise advice is not to ignore the rhinos, but to tackle the issues head on. She recommends the practical and completely sensible steps such as:
First, admit the existence of the impending danger and risks.
Second, determine the nature of the beast – the scope and scale of the risks.
Third, you should not freeze and do nothing.
Fourth, take real lessons from what is happening.
Fifth, take the long view and big picture and focus on strategy and execution to get out of the dilemma.
Sixth, the one who recognises the grey rhino is the one who will be able to control the grey rhino risks.
In Sun Tzu Art of War terminology, know yourself, know your enemy, win all battles.
Books like The Gray Rhino are great help for us to deal with the rising level of uncertainty and discomfort with rapid changes in the environment. We are shaken from our complacency because too many changes are going on at the same time. What used to be comforting and stable is changing before our eyes.
To do nothing does not seem to be a safe option. At the same time, with markets that are so correlated with each other, there seems to be no place to hide.
The current state of financial markets reflects exactly that complex mixture of greed and fear. Investors are worried about the possibility of another financial crash, without appreciating where that trigger will come from. At the same time, the liquidity in the market is such that you have to be invested, or you may miss the market boom, in case the bubble goes even higher.
The analogy I like very much is the black elephant, because the unspoken “elephant in the room” or a huge issue that everyone sees, but no one wants to talk about, is often the unseen problem. We do not see the problem because we do not wish to see it. The black elephant is the combination between the black swan and the elephant in the room – namely, the elephant in the room does something no one predicts. The grey rhino is a variation of the black elephant, large enough to do serious damage. Elephants are big and will cause problems one way or the other.
Black swans, grey rhinos or black elephants are nothing compared with the golden monkey. Visiting the famous Monkey Forest in Ubud, Bali, I saw a sign: Do not feed the monkeys and take care of your valuable possessions. We live in an age in which Hanuman, the monkey god from the Indian saga, the Ramayana, greatly disturbs the realm.
Great advice from the Monkey Forest.