Elevator Music

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It is funny but apt, chaos theory holds that the fluttering of a butterfly’s wings can culminate in a massive storm somewhere else. It is all non-linear and weirdly contingent. Just so, ill-considered policy choices, along with venal decision-making, can unleash the weather-controlling geopolitical whirlwind. Global risk-takers are now contending with the knock-on effects from choices made in Washington. Everyone who lends and invests toward cross-border business must keep his or her proverbial “powder dry.” Things of course could be worse, much worse, but dependable liquidity backup sources and effective scenario building + contingency planning are first order considerations. 

Sometimes human organizations and other social arrangements can function like a metronome, moving predictably, providing anticipated results – people signal, others follow, etc. At other times, human agency can throw any organization or social arrangement into distemper. And distemper is “non-linear.”

No one knows what the extent of a manifest development and (ill-considered) change may be, or what its “speed” and its true nature is, until said development has played out – insofar as one can see with reasonable certainty that it has indeed played out.

Perhaps, to get the ball rolling, the current US administration ushered into the economy in March 2021 the “American Rescue Plan” package of fiscal expenditures that amounted to USD1.9trln. The administration initiated this package even though the economy had been recovering from Covid, and was well on its way to achieving better economic growth. Just from that action – plying more demand on top of recovering demand – ensuing knock-on “chaotic” effects, large and small, began manifesting.

This fiat creation of purchasing power proved to be damaging, at least in part. Priming society with more ready cash, especially when demand had already been suppressed and was pent-up due to Covid, yielded foreseeable but not readily anticipated consequences. Inflation, which had posted only at above 1.4% at the end of the previous administration, rose sharply during the months following the American Rescue Plan enactment, reaching above 9.1% by June 2022.

So, seeing this, the FED began reacting. On March 17th of last year, US monetary authorities voted to raise the benchmark Federal Funds Rate band from zero to 0.25%-0.50%. With surfeit cash priming price inflation, the FED continued to react, raising its benchmark in a straight-up, elevator-like direction to post at a range of now 4.75%-5.00%, which has thus far numbered nine rate hiking instances since tightening was underway. It has really been straight up – this being the steepest tightening in roughly forty years.

And, there really has not been soothing, euphonious elevator music accompanying the tightening ride. What happened along the way has been the appearance of discontinuities, or failures, or sharp real-time adjustments. We have seen global equity markets bend, if not break, during the US tightening process.

We have seen financial institutions fail from not hedging interest rate risk, like Silicon Valley Bank (SVB) (they apparently had not gotten the memo that the “Great Moderation” had been cancelled), or we’ve even seen capital rich but problem-riddled institutions like Credit Suisse face a “torschlusspanik” situation, as confidence in its viability worsened critically, requiring a shotgun marriage to cross-town rival UBS. The sound accompanying that monetary elevator ride mentioned has not been musical, but rather that of crockery dropping to the kitchen floor or heavy furniture tumbling down an apartment building stairwell.

To consider, just one more marginal, ill-conceived public policy action, i.e. the Biden administration’s “American Rescue Package”, arguably ignited forces which managed to scupper the Great Moderation. Chaos theory at work.

Think about this, too. On August 30, 2021, US forces unilaterally exited from Afghanistan – without alerting anyone ahead of time, including NATO forces positioned along aside the United States in the Afghan mission. The abrupt American pullout – possibly because of parochial and venal political consideration – arguably did much to lessen international perceptions of US resolve and probity in the global environment.

And again, arguably, absence of US resolve and ham fistedness in Afghanistan may well have piqued Russian adventurism and the invasion of Ukraine.

Knock-on effects being what they are: Russia’s aggression toward Ukraine spurred wide-spread condemnation and the imposition of significant economic sanctions – which pushed Russia into a much more cohesive relationship with China, while also facilitating a greater sharing of interests among Russia, China, Turkey, Iran, and North Korea. The baleful warning from Henry Kissinger that neither Russia nor China should ever be better friends to each other than each is with us has gone unheeded.

Recent geopolitical developments are, not to use the word too loosely, spectral. Commenting on his recent diplomatic mission to Moscow and prospects for greater ties with the Russian Federation, Chinese leader Xi Jinping observed, “We’re now witnessing changes that haven’t been seen for more than a century, and we’re (that is, Russia and China) pushing them forward together.” So again consider, perhaps an ill-considered ploy to garner better polling numbers among US voters oddly led to a fundamental re-calibrating of geopolitical dynamics: more realized chaos.

As it so happens, some of the pointy-headed types at McKinsey & Company this past February published a tight paper, “Black Swans, gray rhinos and silver linings: Anticipating geopolitical risks (and opportunities)”, by Andrew Grant, Ziad Haider, and Anke Raufuss. In it, McKinsey emphasizes the need to step away a bit from linear thinking. The past may be prologue but distinct events can be seminal, yielding or rather flowering with consequences – large and small, foreseen, and unexpected.

A useful management exercise is to use one’s imagination – to think about possibilities that can materialize and affect one’s business. In the McKinsey article, the authors cite a menagerie – black swans, gray rhinos – those events that have a higher probability and can be material to business viability, and silver linings – that is, discerning favorable potential consequences arising from volatility and abrupt change.

In essence, what the McKinsey authors are stating is what seasoned risk managers know intuitively in their bones: See the world for what it is, to the extent you can. Ask questions that you believe to be relevant, think of even additional relevant questions – after drawing a breath, that you may never have considered. Hope for the best, prepare for the worst.

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