Notes From Underground: Low Probability, High Impact Events

When Alan Greenspan was Fed Chairman he would regularly orate on the concept of low probability events that could create disruption in the global financial system. These events are not BLACK SWANS because by definition a black swan is unknowable nor foreseeable. So it is time to take a survey of what Greenie called low probability:

1. Paul Ryan being parachuted into the candidacy for the Republican Party. There is a possibility but is a potential problem, which could rip apart the GOP. What would the fallout be for financial markets if the U.S. was splintered into a three- or four-party system? The same could be said for the Democratic Party if there was a revolt by the left-wing in response to the super delegates. The issue for the Democrats will rise to the fore if Hilary Clinton were to lose New York. Bernie Sanders is a low probability bet but his impact would be great.

2. The probability of Russia attacking Turkey, which could result in the break-up of NATO. If Putin attempts to seek revenge against President Erdogan by providing support to the Kurds against Turkey, the U.S. and its NATO allies would be forced to decide if they were willing to risk war with Russia to honor its commitment to a friend. Imagine what happens to the political situation in Europe if NATO were demolished because of its failure to honor Article 5, which asserts that an attack on one is an attack on all.

3. The June 23rd vote by the U.K. on Brexit results in a vote to leave. Not sure this is a low probability event but it will certainly have a HIGH IMPACT. The greatest outcome will be that others in the EU will request a referendum for this was certainly articulated in the recent Dutch vote on the EU’s agreement with the Ukraine. The most volatile result of a Brexit would be the pursuit of a referendum by German voters. The myriad articles on German unhappiness with the ECB are a mere prelude to what a vote in favor of Brexit would result in for the rest of EU. If you want a good sense of the arrogance of the European elite, watch Mario Monti’s CNBC appearance from today. Mr. Monti decried the outbreak of democracy in Europe and was very critical of David Cameron for falling in the trap and calling a referendum.

The critical assessment by Monti is an infamia for Mr. Monti was appointed Prime Minister of Italy by a “coup” orchestrated by the Brussels elite. Berlusconi was forced from office by threats of Italian debt downgrade and the Brussels eurocrats’ rejection of the Italian budget. When Prime Minister Monti had to call elections in 2013 after the Berlusconi term expired, Monti and his allies received a mere 11% of the vote. So Mario Monti’s views of popular democracy are subject to further review.

4. A failure of a major European bank, something on the order of Deutsche Bank or a major French institution. The cracks in the Italian financial system are well known. It is the exposure of other EU domestic banks that can cause a blind side hit to the financial system. Part of this issue is the BIS view of how sovereign debt is rated. Currently, all EU sovereign debt carries a zero risk weighting. If this were to change, EU banks would be forced to raise a great amount of capital, a total that would dwarf the amount that was recently raised to support the purchase of non-performing loans from Italian financial institutions. The European nations are struggling even with zero interest rates. Imagine what the budget deficits of Spain, Italy and France would be if borrowing rates were to dramatically increase.

This is just the beginning of analyzing low probability, high impact events. The landscape of the global macro system are rife with such possibilities. Now a black swan in an uncertain event this focus will be on those with a probability of occurring. The floor is open to all suggestions.

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13 Responses to “Notes From Underground: Low Probability, High Impact Events”

  1. Frank Says:

    I can’t help but wonder about a collapse in the yen carry trade. Low probability I know but…

  2. Frank C. Says:

    I think the markets are underestimating the Brexit chances of leaving.

    Current polls suggest a 52-48% probability of staying in the EU. However, the margin of error on these polls is 4%. Currently 15% of the voters are undecided. So that is the swing vote. In normal elections the undecided usually break to the incumbency/right and staying.

    However what we are witnessing worldwide is a voter dissatisfaction with the status quo. It is not just a Trump revolution. Jeremy Coburn recent election in England, Frauke Petry of the AfD in Germany are strong bellweathers. Mr. Cameron’s Panama problem doesn’t help.

    In my opinion I think that recent polling data is flawed. Most polls rely on “likely voters” in their surveys. These polls are not picking up on dissatisfied unlikely voters that are turning up at the ballot box. This is not just Trump getting non-voters off their chairs. Take a look at the results in the Michigan primary where Hillary was leading Bernie by 30 points in the polls on the day of the election. Sanders won. How were all of those surveys so far off?

    Should another terrorism event or migrant flood occur that would further push the xenophobic vote. Is shorting the FTSE or pound or the Euro the best way to play the Brexit event?

    As for Paul Ryan. If Trump has the highest delegate count and the party leaders take the nomination away that would be political suicide. It would irreparably splinter the party and Ryan nor Romney nor Cruz would stand a chance against a dogcatcher, let alone Billary. From a Goldman Sachs point of view both Cruz and Billary are good for the market. But me personally, I quit voting after the Supreme Court ruling in Citizens United. So I have no dog in this fight.

    • Alex Says:

      Weather getting warmer in Europe almost certainly means the immigrant problem will grow in strength over the next few months.

      That ‘could’ be a big factor for the 15% undecided voters in the UK. Throw in the media’s usual hyperbole and a NO vote (get out) looks very possible to me. But don’t discount the propaganda although much of it is laughable and quite frankly pathetic.

      For example, many youngsters in the UK go ‘Inter-railing’ over the summer where for a discounted price you can travel around Europe on the trains. But a Tory turkey said a No vote would make Europe far more dangerous for the inter-railers. See what I mean?

  3. Chicken Says:

    Only 10 days remaining till Obama heads to Saudi Arabia.

  4. Rolaf Says:

    Excellent conversation. I now think of China as the perennial LP, HI event. They have a lot of tools still remaining to keep the gyrations within some boundaries, but every shift sends deep and broad ripples. Because a major misstep by their leaders could ignite a 2008-type chain of events, they have to stay atop the LP,HI list.

    • Yra Says:

      Rolaf—thanks for bringing that to the fore and that is certainly a low probability event for the moment but grows in possibility every day

  5. Frank C. Says:

    Here is former IMF Chief Economist Oliver Blanchard opinion on a black swan event

    http://www.telegraph.co.uk/business/2016/04/11/olivier-blanchard-eyes-ugly-end-game-for-japan-on-debt-spiral/

    • Yra Says:

      Frank C.–a great posy link.Always enjoy Blanchard’s analysis and it provokes serious thought and discussion.He outspoken criticism on the central banks is needed and prompts one to inquire–is he buying GOLD for his IRA fund?

  6. Frank C. Says:

    Here is George Soros recent opinion on a black swan event of the EU collapse and his proposal to thwart it.

    http://www.nybooks.com/daily/2016/04/09/europe-how-pay-for-refugees/

    • yra Says:

      Frank C.–Soros says I believe there is a silent majority who wants this—-that is the problem .It is always what George believes rather then what the facts are—the EU has a triple AAA credit rating for one reason–Germany–rmember what the bond prices of the Spanish,Italian ,Portugese,French were in July 2012—Soros wants the Germans to capitulate to all of the demands and desires of the EU—at what cost???

  7. ShockedToFindGambling Says:

    Yra and Frank, it seems to me that the Black Swan event that few are talking about is the demise of the Euro (currency).

    During the next serious recession. France, Spain, Portugal, Greece, and possibly some others will be asking for massive bailouts from the Germans, and I doubt Germany will comply.

    Alternatively, they could hyperinflate out, but Germany will not go for that.

    The current refugee and bank problems in Europe, are minor compared to the financial strains that will appear, once the economy heads South.

    • yra Says:

      Shocked—good to hear from you.Again,I don’t think it is a black swan but a very low probability,very high impact event.I agree Germany will not tolerate the hyper-inflate its way out but a Greek default may really get the wheels in motion–more on this tonight

  8. drifters12 Says:

    Yra, The ultimate low probability/high impact event is a catastrophic solar flare. Very few know how to handle life without our cell phones, computers, etc. (including me). I personally agree with you that money CRAVES stability, but so do most human beings. That is why all of these issues will not yield the impact…until they do. If any event gets out of hand, all the pent up anger you see at the polls worldwide will be unleashed physically, and in that case, God help us all…

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