We have known for a few years the famous black swans that Nassim Nicholas Taleb developed. Swan lakes... black swans, a sign of an exceptional and unpredictable catastrophe. We had also talked more recently, and I am one of them, about “grey swans”, a kind of intermediary between the norm and the exceptional. But now we're talking about "green swans," a kind of "climate black swan." They could be the most dangerous of all... and yet their exceptional, unpredictable and sudden character seems to us to be non-existent.
Of course, a climate catastrophe is not always foreseeable, think of Fukushima tsunami, recent earthquakes, especially in Turkey and in Italy. We know that an area is at risk, but the magnitude of an earthquake can be exceptional and reach top range level on the Richter scale. The potential magnitude is unknown. The Corona virus that we are dealing with and whose consequences seem enormous is certainly disturbing and deadly but may not have caused more deaths than the flu in Europe this winter. The consequences are sometimes unpredictable and the indirect effects significant. The Corona virus could meet the definition of a black swan. The power of a black swan is priceless. For too long, the world believed that only whites existed. One day in Australia, we discovered a rare black swan. Black then became less and less rare, alas. But that's the concept you must look at. The black swan is the exception of a great series. The black swan, if I were to define it, is an unpredictable event that can have considerable consequences. Ideally, these events should have three characteristics: they are (1) rare and unexpected, (2) their impact is significant, even extreme, and (3) they can only be explained after the fact.
« But what if that moment’s right now, right now” (The black swan – BTS)
Other swans, other times
The 9/11 attacks or an atypical climatic feature are these black swans. Corona virus would only become so, in my opinion, if the contagion took on excessive. The grey swan is it in between. They are more predictable than blacks but have significant impacts. The Sino-American trade war could be a grey swan, if it escalated. Today, I would like to talk about green swans (closer to black ones). The latest addition to the swan family. It's a black swan, but it's a climate-like swan. However, they do not differentiate themselves in several ways. The climate impact is uncertain, proportions greater and global contagion but there is a high degree of certainty compared to black swans that some risks will materialize in the future. Climate disasters could have cascading consequences, chain reactions with unpredictable effects. Finally, the speed of materialization is greater than expected. Their consequences could be more disastrous than any systemic financial crisis, since they can threaten all of humanity, as some climate scientists predict.
Central banks and coloured swans
The BIS (i.e. Bank for International Settlements) has just published a rather voluminous report with the Bank of France on this topic. Central banks are concerned about the now guaranteed and obvious climate effects on the global economy and finance. For example, the recent Corona virus has an impact, albeit limited at this stage on the Chinese economy and in turn on the world economy. If it were to expand and could not be contained, it could be an example of a "green swan". The risks are of two types: (1) the physical risk is the natural disaster that does the damage, the San Andrea fault that would wake up and open cutting California in half. Banks, insurance and humans would be affected by human and material damages. Or the rising waters that would engulf buildings and affect the real estate sector of Holland or Belgium. Financial stability could be severely affected for a long time to come. But (2) the second type of risk is the risk of transition. Changes can affect sectors that would suffer from the transition to a low-carbon economy. Think of the automakers and Tesla's recent valuation that reflects these profound changes. Certainly, the abandonment of fossil fuels will affect some and benefit others. It may be an opportunity, but at what cost? These necessary business changes could (if the turn is not properly taken) generate bankruptcies and some companies could even disappear. The necessary regulatory pressure can sink companies that are too inert and unagile to adapt. According to the Governor of the Bank of France, François Villeroy de Galhau, the increase in frequencies and the magnitude of disasters, as well as their intensity, especially weather events could lead to financial losses colossal, non-linear and irreversible. Without exaggerated catastrophism, we gradually realize that the disaster films and crazy scenariithat we are told are no longer so "impossible". Central banks want to incorporate climate risks into all their forecasts. Many believe that central banks will always be there as the last bulwark to save the world economy (i.e. the famous principle "TINA" - There Is No Alternative). If we know that always someone will be there to help you, it pushes you to let our guard down. That is where and when you become vulnerable.
Climate risk, newcomer
The enterprise risk manager I am has found that in the past, depending on the industry, there was little, or no climate risks addressed. Things have changed and the annual surveys at the Davos summit (i.e. World Economic Forum) show that this risk is on the scale of major risks estimated by CEOs. I wanted to highlight two major quotes: “Climate change is striking harder and more rapidly than many expected” and “Climate-related issues dominated all of the top-five long-term risks in terms of likelihood”. Central banks were the lifeguards of last resort, like the States during the last major financial crisis. We need a dam or a last resort. States will play their part, but the global economy must adapt, according to regulatory frameworks to be defined, to avoid the risk of domino effects. Globalization has removed all barriers and a pandemic in China, or a Tsunami in Japan can have effects beyond their borders. Let us remember the supply of electronic components affected after Fukushima and hope that China will not see its economy slowed too sharply at the risk of coughing up the rest of the world. We see the swans are similar in the magnitude of the impacts, but the duration and chain reaction effect are stronger for green than black. The prediction of black is less easy, without being impossible (some had not predicted the crisis of "sub-primes" and had not the alerts been given?). An economic crisis may not affect the climate or kill people. A climate crisis can have serious and long-term material and human consequences. Certainly, regulation can help prevent both. But for each one a part of the solution is in behaviour, culture, approach and common sense. The green swan may be unavoidable because finance and money sometimes dictate behaviours that are contrary to what is needed. We could stop fossil fuels earlier, close coal mines, ride better and less with less CO2 emissions or change our climate footprint. Fatalism and impossible hope dictate the pace of preventive solutions. We think we have time until it's too late. The acceleration of the melting of glaciers is the very example of this acceleration which could be uncontrollable.
Market reactions, sometimes surprising
Isn't the market reaction and recovery despite the Corona virus proof of the blindness of market players? Investors do not expect a negative impact of the pandemic on the global economy. Yet the "Tesla smiles like in 1999" can be scary. The strength of American technology actions can be frightening. So "pocket of froth" as Greenspan said in 2005 or speculative bubble? Who knows? Tesla has a Price Earning (P/E) ratio of nearly 100 times. Isn't that clearly overvalued? It is the combination of extreme or dangerous situations that could explode in a cascade. The important thing for the market is often the narrative and the “story” behind. Look at the index S&P500 which has taken nearly 4% since the beginning of the year and the Nasdaq 8% during the Sino-American trade war, tensions between American and Iranian, and even the recent Corona virus. This is sometimes to say the small impact of events that are considered serious. Will the Corona virus have a deeper impact on the economy? We don't know. We are told that this new virus would cut car production by 115,000 units for European manufacturers (source: Goldman Sachs). This is a clear and measurable impact of the pandemic. But the markets seem to rule it out. Does the latest SARS (i.e. Severe Acute Respiratory Syndrome) pandemic, which was lower than expected reassure them? Maybe... The risk is more to underestimate than to overestimate the consequences of such a crisis.
Higher-frequency climate disasters
No insurer or reinsurer will contradict the fact that the magnitude and frequency are increasing logarithmically and there is a fear that the slope of this curve will stiffen too quickly. Without insurers or with too expensive premia, the economy would be topless. We must also protect them like we did with our banks in 2008, so does global stability. You wouldn't drive without insurance and maybe one day you won't be able to financially insure your building along a coast or close to a seismic fault. There we would be without any net and the material and therefore financial consequences would be appalling. Let's not forget the risk of swans appearing in any colour. According to the English historian Ian Kershaw, "Europe may well experience new fractures. The only certainty is uncertainty. Insecurity will remain the hallmark of the global age." Without predicting the colour of the next swan, I fear that sooner or later we will have to face a critical crisis and perhaps the dominant colour will be green. In conclusion, let’s keep in mind my favourite Paul Claudel’s quote: “The worst is not always certain”.
François Masquelier, SimplyTREASURY - February 2020
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