Lately, everyone all over the world has been talking about the harmful consequences that the market turmoil could bring to the economy due to the low GDP, the start of a possible recession, and the existing geopolitical conflicts. We can all remember the Black Swan events that have left a permanent mark in human history, events that formed collective traumas, such as the 11 September air attacks, the unfortunate events in the Middle East, the sudden financial crisis of 2008, and even the COVID-19 pandemic.
Every field has a standard of probability and prediction. Still, when it comes to unforeseen events – like the so-called Black Swan events – we don’t have enough data or information to prevent them. Black Swans are those events that occur suddenly when we least expect it and most often have a devastating event over the long term.
What does the Black Swan mean when it comes to the economy?
Although we can talk about Black Swan events in many fields and domains, their origin traces from the financial world, being a theory developed by Nicholas Taleb, a Wall Street trader and professor in economics, in a book that he started working on back in 2001. Black Swans are unpredictable, shocking events with severe consequences for the general population. They are quite rare and can occur in almost any sector: finance & economy, politics, healthcare, the stock market, etc. It is believed that nothing can prevent such an event, given its rarity and the lack of information before the actual event, leading to the conclusion that devastating consequences would follow.
How do Black Swans happen?
It is an unpredictable event but explained as if it could be predictable if we had thought hard enough about the possible outcomes. In his book, Taleb says how psychological biases often blind us and distance us from possible catastrophic events that may happen, such as confirmation bias, a common logic error in traders’ mindset, and the fact that the probability is minimal compared to positive results, as well as many other examples we can think of. After the event occurs, people begin to search for answers and make specific connections leading to that event, precisely to be considered when applying new risk management strategies.
What are some Black Swan examples that have occurred?
Swiss Franc Crisis: In 2015, the Swiss National Bank removed Franc’s peg against the Euro, leading to a 30% raise, desiring to remain unpegged to the European currency after the European debt crisis. Well, at least that’s what the officials declared, without thinking about the consequences that were extremely bad who had loans against the Swiss Franc at the time (which was a relatively good idea before the event, given the currency’s stability during the previous cycle, when it was considered a safe haven currency). Brokers have also suffered considerable losses in Forex, one of the safest financial markets out there.
The Financial Crisis of 2008, when Lehman Brothers went bankrupt, is one of the strongest examples of a Black Swan, with devastating effects on the entire population of the globe. Banks were massively borrowing money to invest in the US housing market bubble (at the time). When they reported the quarterly numbers, it all looked over-inflated because of the included potential profits.
It was the worst crisis since the one from 1929 – 1933, which was also considered a Black Swan event. In that particular case, a nasty stock market crash was followed by a drop in people’s confidence in the markets, and a drop in consumption and spending, which proved disastrous for the entire economy.
This is also why economists were so scared at the start of the COVID-19 pandemic two years ago, in order not to repeat the old scenario that happened over a century ago. That is why central banks came to the rescue, printing vast amounts of money to aid the economy – a decision that resulted in high inflation.
How can we avoid a financial disaster?
We can’t simply predict a Black Swan event, but we can take care of our investment portfolio through diversification and cash allocation. It is essential to have an even distribution according to the degree of risk in all existing markets: cryptocurrencies, commodities, stocks, bonds, and so on. Taleb specifically talks about sound risk management techniques, including the strategy of keeping the majority of your portfolio in safe havens.
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