The Next Black Swan

I am sure that you know it, but a black swan event is a calamity that is difficult,nearly impossible to predict. Thus, the worst catastrophes are ones that we do not expect, that we do not even imagine. It's feels like a branch of contrarian analysis. This, by the reasoning of Nassim Nicholas Taleb.

By extension, this implies that the calamity everyone is predicting is the one that is least likely to happen. If everyone believes that we are facing a climate change catastrophe, then, the chances are miniscule that it will occur.

Unless you have been completely caught up in the ambient hysteria, you should console that when many, many people predict that the sky is falling, you should feel confident that the sky is not going to fall.

At the same time, among the pending calamities that no one thinks can happen is this: the national debt. Right now, conventional opinion seems to be that we need not worry about debt. This means, by black swan theory, that we ought to worry about debt. Or better, that we should worry about what will happen if, perchance, the dollar loses its reserve status and we can no longer print our way out of debt.

It’s not just America. The world entire is loaded up with debt. What if the bill comes due? What if someone starts defaulting on debt? What is central bankers lose control of the world banking system?

These thoughts came to mind while I was reading this article in the Daily Caller. Charles Kolb wrote:

For almost a decade, the Federal Reserve’s easy monetary policy entailed three rounds of quantitative easing (pumping money into the economy by expanding its balance sheet to include some $4.5 trillion in government bonds and other asset purchases) plus a zero-interest-rate policy (after inflation) that has distorted real asset price discovery and deepened the financialization of the American economy.

Only now are economists beginning to assess the potential distortions of the Federal Reserve’s accommodative monetary policy. Theoretically, financial markets exist to direct capital to its most productive economic uses. So far, the biggest beneficiary has been Wall Street, with record mergers and acquisitions, stock buybacks, dividends, and exorbitant CEO compensation. Tech stocks are flying high with share prices often divorced from earnings reality. Meanwhile, American manufacturing still languishes.

Kolb is warning the Trump administration about what might happen during the next economic downturn:

Fiscal policy also presents an alarming trend. Barack Obama almost doubled the national debt during his term, and Donald Trump’s policies have us, again, anticipating $1 trillion annual budget deficits. It’s a vicious circle: low interest rates entice the politicians to amass more deficits and debt, and the politicians want more spending given ultra-low borrowing costs. Profligate monetary policy enables profligate fiscal policy.

Immediately before the 2007-2009 Great Recession, the prevailing assumption among economists and on Wall Street was that housing prices would never go down. Today’s prevailing assumption is that interest rates will never go up. As we have seen with previous bubbles, prevailing assumptions are often wrong, and today’s economic assumption is clearly unsustainable. The late Herbert Stein, chairman of President Nixon’s Council of Economic Advisers, put it memorably: if something is unsustainable, it will stop. The question is when?

I will spare you further reflections on a topic that is very, very far from my competence, but yet, we ought to pay some attention to the fact that the ambient climate hysteria suggests that the sky is not falling while the ambient debt complacency should be taken as a bad omen.

Have a nice day.