Tag Archives: black swan

Depression and Decline: American Irresponsibility is Ending the American Era with a Bang

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Despite the assurances of US Treasury Secretary Timothy Geithner it is increasingly likely there will be no debt deal. The United States is going to default on its debt. I know it sounds crazy, but I believe it is going to happen. If it does, this is the black swan event no one imagined or was prepared to contemplate. Its impacts are going to be significant. Possibly immeasurable.

For history, August 2nd, 2011 could end up marking the end of the American Era. Sadly, it will not have been inevitable, it will have been entirely self-inflicted and it may now be irreversible. Even if an agreement is reached tomorrow I suspect the world will increasingly be unwilling to entrust the role of global financial system caretaker to the United States. The world has lost faith in America. And why not. Its Congress has demonstrated that it can no longer be trusted with the responsibility of global financial management. Indeed, even its closest allies have had their confidence shaken.

The economic and geopolitical ramifications of this outcome cannot be underestimated.

Economically, we may now be closer to a global depression than at anytime since 1930s. For all the talk of the financial crises being a near miss, this could potentially be much, much worse, simply because the consequences fall outside our predictive models.

What is clear is that America is trapped. In the short term spending less will devastate its population. Today more Americans (18.1%) than ever use food stamps. It takes American workers 40 weeks (and rising) to find a job, twice as long than in any previous recession. 1 in every 6 Americans use Medicaid. Any cuts to these services will have an immediate and harsh affect on the quality of life of a huge number of Americans.

Longer term, America cannot restart its economy. Already the top 5% of Americans by income account for 37% of all consumer outlays. This is unsurprising given the top 5% of Americans account for 34.7% of all income. This is similar to 1929 when the top 5% accounted for the top third of all personal income. This is precisely the type of economic structure that Kenneth Galbraith argues in The Great Crash, 1929, transformed the great crash into the great depression. Rather than being able to rely on a broad consumer base to power economic growth, the United States then (as now) was dependent on a high level of investment and luxury consumer spending driven by a small elite. The crash caused that elite to seize up, leaving the American economy paralyzed.

In other words, the Bush Tax cuts may have killed the US economically, and possibly geopolitical. By killing the surpluses they have broken the US treasury. By radically curtailing wealth redistribution they have fatally eroded the capacity of the US domestic economy to power new growth. Combine this with two wars that have sapped trillions of taxpayer dollars, and it is hard not to see a United States more ill prepared than at any time in its history to deal with an economic crisis. The only question that may remain is how much of the rest of the world it drags down with it.

Of course economic decline could become a leading indicator for political decline.

When I arrived to grad school in 1998 to study international relations the field had spent much of the previous decade grappling with the issue of American decline. Books like The Rise and Fall of Great Powers and Lester Thurow’s Head to Head seemed to suggest that economically and militarily, the United States was in, at the very least, relative decline as a the world’s leading power.

But then the successes of the US economy – coupled with the turn around in the size of the US government’s debt –  meant that as a peer, China felt a long way off while Brazil and India seemed more distant still. Europe was too old, disorganized and unambitious to matter. Russia, was fading quickly from the scene. Suddenly decline theory was, itself in decline.

But today the writings of Kennedy feel even more urgent. America, with or without a raised debt ceiling, cannot afford its empire, or the means to protect it. It may be able to find allies to help shoulder the burden – today the central challenge of 21st century geopolitics is the integration of India into the Western Alliance, something that proceeds apace. But if it defaults (and maybe even if it does not) it’s capacity to raise money at a reasonable rate should a major conflict arise, may be compromised. War, for America, is going to get more expensive because investors may be more nervous.

I want to clearly state that I don’t write any of this with any glee. Leftish non-americans who relish a world without the US hegemony should look at the what the period after Britain’s decline, or any period of hegemonic decline. They generally aren’t pretty. Indeed, they are often unstable, violent and nasty. Not something any country should wish for, especially smaller countries (such as my own – Canada). Moreover, while there is no immediate peer that could take America’s place, it isn’t clear that the most likely candidate – China – is one that most people would feel more comfortable with. Be careful what you wish for.

I hope that I’m wrong. I hope a deal will be reached. And that if it is, or if it isn’t, the impact on the markets will be minimal or non-existent. Or maybe, I just need to have more confidence in what I have often tell others: do not to underestimate America. As Sir Winston Churchill famously noted: “Americans can always be counted on to do the right thing…after they have exhausted all other possibilities.” And maybe they’ll have enough time to boot.

But I genuinely fear that in the haze of summer this crisis, as much as it has spurred some scary headlines, remains a sleeper. That we are confronting the mother of all black swans, and that a period of financial turmoil that will make the last two years look like a merry ride, could be upon us. Worse, that that financial turmoil will lead to other, great military and/or political turmoil.

These are scary times.

I can honestly say I never written a blog post that I hope I’m more wrong about.

Update: The Atlantic has a great article worth reading about the origins of the deficit published later this morning that includes a reference this fantastic graph from a few months ago.

How the Mighty Fall vs. The Black Swan

blackswanI’ve almost finished listening to Nassim Nicholas Taleb’s The Black Swan, a book about how large-impact, hard-to-predict, and rare event beyond the realm of normal expectations. At the same time, Tim O’Reilly caused me to stumble upon this article previewing Jim Collins‘ (author of Good to Great and Built to Last) new book “How the Mighty Fall.”

In some way the two authors’ could not be more different. Taleb writes in a harsh, sarcastic, cutting tone that heaps scorn on many of the worlds finest minds as well as, one senses, the books readers. His harshest barbs are reserved for academics, who if often sees as being to interested in theory to help with real world problems. I’ve never seen Taleb in person or on video, but after listening to The Black Swan I can’t help but see him as an lethal and angry intellectual street fighter, mad at a world that didn’t notice his brilliance earlier.

How the Might FallCollins, in contrast, reads like a classic business academic writer who has gone mainstream. He never offends, and his tone is never harsh – he seems like the archtype westcoast Business school Professor – smart, driven and direct, but slightly geeky in that friendly way and not overly intense (hence westcoast).

But while their styles (and I hypothesize, personalities) are dramatically different, they overlap in some curious and interesting ways. Both are concerned with business issues and both are writing about outliers. Taleb is concerned with the outlying events that can completely alter one’s world. Collins in concerned with outlier companies – those that experience impressive and continuous success. And while I’m sure there are lots of areas where the two will disagree, it is interesting to focus on where the two almost completely overlap.

The first appears where Collins talks about the first symptom of a company going into decline: Hubris Born of Success:

“The best leaders we’ve studied never presume they’ve reached ultimate understanding of all the factors that brought them success. For one thing, they retain a somewhat irrational fear that perhaps their success stems in large part from fortuitous circumstance. Suppose you discount your own success (“We might have been just really lucky/were in the right place at the right time/have been living off momentum/have been operating without serious competition”) and thereby worry incessantly about how to make yourself stronger and better-positioned for the day your good luck runs out. What’s the downside if you’re wrong? Minimal: If you’re wrong, you’ll just be that much stronger by virtue of your disciplined approach. But suppose instead you succumb to hubris and attribute success to your own superior qualities (“We deserve success because we’re so good/so smart/so innovative/so amazing”). What’s the downside if you’re wrong? Significant. You just might find yourself surprised and unprepared when you wake up to discover your vulnerabilities too late.”

This whole paragraph sounds like a friendly version of Taleb. Praising leaders who don’t claim to understand the full complexity of their world, their business or even their own success? Classic Taleb.

More interesting however, is the emphasis on luck. Taleb regularly argues that luck is (at a minimum) underestimated and more often ignored outright, as a factor in a businesses success. No CEO wants to stand up and say, yes, we become $10B dollar company not just because we were good, but because we were lucky – it doesn’t exactly send a positive message to share holders (or does it justify their enormous bonus). But Collins not only agrees that luck is a factor, he argues that good companies admit to themselves that luck was a factor.

In hockey you hear people say you’ve got to be good to be lucky and lucky to be good. The point is, if you work hard, bounces will eventually come your way and you’ve got to be good enough to pounce on them and make those opportunities count. Begin to think you don’t need luck, you stop seeing the opportunities and also begin to believe you are inherently better than anyone. Fact is, you’re not. You’ve got to work. Hard. And hope for some luck. Even then, you probably never become Google.

The second interesting place of overlap is in Collins discussion about how companies begin to deny that they are at risk or in peril.

“Bill Gore, founder of W.L. Gore & Associates, articulated a helpful concept for decision-making and risk-taking, what he called the “waterline” principle. Think of being on a ship, and imagine that any decision gone bad will blow a hole in the side of the ship. If you blow a hole above the waterline (where the ship won’t take on water and possibly sink), you can patch the hole, learn from the experience, and sail on. But if you blow a hole below the waterline, you can find yourself facing gushers of water pouring in, pulling you toward the ocean floor. And if it’s a big enough hole, you might go down really fast, just like some of the financial firm catastrophes of 2008. To be clear, great enterprises do make big bets, but they avoid big bets that could blow holes below the waterline.”

In The Black Swan, Taleb has an entire piece on assessing risk which parallels this quote. He notes that too often business people and – in particular – financial types, focus on predicting the likelihood of an event – even when a prediction model is deeply flawed or essentially meaningless. Since often assessing the likelihood of an event is often impossible Taleb argues it becomes much more important to ascertain the likely magnitude of it’s impact. So avoid doing things or exposing yourself to risks that, if they go wrong, will blow out your hull. Indeed, the Black Swan is essentially a 250 page book on this paragraph.