Nassim Nicholas Taleb on Thinking Through the Financial Risks of 2016

Essayist, scholar, statistician, risk analyst, and author of The Black Swan
and Antifragile: Things That Gain from Disorder Nassim Nicholas Taleb offers advice on investment decisions in 2016, via the WSJ:

Asking “How should we think about financial risks in 2016,” Taleb points to (1) increased stability in banking institutions; (2) declining values in asset categories in which low interest rates encouraged speculation; (3) potential negative impact of low commodity prices in certain sectors; (4) poor recognition of emergent physical risks such as epidemic; and (5) acute nonlinear risks associated with climate change:

First, worry less about the banking system. Financial institutions today are less fragile than they were a few years ago. This isn’t because they got better at understanding risk (they didn’t) but because, since 2009, banks have been shedding their exposures to extreme events. Hedge funds, which are much more adept at risk-taking, now function as reinsurers of sorts. Because hedge-fund owners have skin in the game, they are less prone to hiding risks than are bankers.

This isn’t to say that the financial system has healed: Monetary policy made itself ineffective with low interest rates, which were seen as a cure rather than a transitory painkiller. Zero interest rates turn monetary policy into a massive weapon that has no ammunition. There’s no evidence that “zero” interest rates are better than, say, 2% or 3%, as the Federal Reserve may be realizing.

I worry about asset values that have swelled in response to easy money. Low interest rates invite speculation in assets such as junk bonds, real estate and emerging market securities. The effect of tightening in 1994 was disproportionately felt with Italian, Mexican and Thai securities. The rule is: Investments with micro-Ponzi attributes (i.e., a need to borrow to repay) will be hit.

Taleb identifies risk in commodity prices and consequential effects in other energy sectors:

Dubai is more threatened by oil prices than Islamic State. Commodity people have been shouting, “We’ve hit bottom,” which leads me to believe that they still have inventory to liquidate. Long-term agricultural commodity prices might be threatened by improvement in the storage of solar energy, which could prompt some governments to cancel ethanol programs as a mandatory use of land for “clean” energy.

Most interesting to me was Taleb’s concern about areas of concern outside of the financial markets, specifically the physical risks of disease and climate change:

We also need to focus on risks in the physical world. Terrorism is a problem we’re managing, but epidemics such as Ebola are patently not. The most worrisome fact of 2015 was the reaction to the threat of Ebola, with the media confusing a multiplicative disease with an ordinary one and shaming people for overreacting. Cancer rates cannot quadruple from one month to the next; epidemics can. We are clearly unprepared to deal with such threats.

Finally, climate volatility will produce some nonlinear effects, and these will be compounded in our interconnected world, in which disruptions are more acute. The East Coast blackout of August 2003 was nothing compared with what may come.

photo:     Balon Greyjoy (Own work) [CC0], via Wikimedia Commons

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