What if everything were to go wrong?

    COVID And Economy

    Tariq Carrimjee

    By Tariq Carrimjee  The author is a financial consultant and emerging market specialist. Tariq Carrimjee is Bombay born and raised, US-educated, and has 25 years of experience in the banking & financial services industries. Now based in Dubai, Tariq runs a successful business, advising clients on investment opportunities in emerging markets.

    As investors and market watchers it usually pays to look at the possibilities and eliminate the ‘unlikelihoods’ to arrive at the probabilities of events to consider exposures and risks involved. Banks follow strict exposure limits and scientifically assess the risks in each category of exposure and set aside capital and stop loss limits for their traders. Investors do not- usually, follow as rigorous a risk assessment as banks do and yet- as we have seen in the past, banks have also got it horribly wrong. The entire decade of the teens was spent in banks shoring up their undercapitalised bases. Their lower equity prices to book value reflected this lack of confidence in banks abilities to assess their own portfolio risk.

    Worst Case Scenaro

    So, let’s look at the world as it stands today and look at what could occur in our event horizon. Let’s consider some hypothetical scenarios. Let’s consider the question: What if everything were to go wrong? What if the worst-case scenario panned out-realistically speaking of course, though Black Swan hypotheses suggest that we don’t pay enough attention to fat-tails at the extreme ends of possibility? People usually conduct this exercise when everything seems to be going wrong and it translates into market crashes and over-reactions. It’s better to conduct this exercise when things seem to be recovering smoothly so that one can be aware of the downside and act before the crowd.

    Let’s start listing out the list of things that look like it can go wrong from here. And we are just considering the known list of factors currently at play. No-one could have foreseen nine months ago that billions of people would spend months at a stretch in home isolation this year.

    Situation Is Deteriorating In America

    The US elections are two months away at this point. The situation there is deteriorating rapidly with law and order problems- protests and rioting in various cities, accusations of presidential violations of numerous laws and attempts to subvert the election results. There is a strong likelihood that the US election results will be contested whichever side loses amidst accusations of fraud and tampering. Given the heated environment and polarised political atmosphere we can imagine a situation where violence escalates, and a de-facto civil war erupts. This may sound outlandish but with over 350 million guns in the ownership of ordinary civilians and a history of gun violence, embedded racism, a desperate President and high unemployment this is not out of the question. Already allegations about large scale vote-rigging (from the President) to counter-allegations of the destruction of sorting machines at postal centres across the country to sabotage the counting of mail-in votes are setting up the stage for this. The mitigating factors would be bi-partisan cooperation to avoid a constitutional crisis and the fact that it is likely to be localised unrest- civil unrest versus civil war since there will be partisans on both sides in each state. Furthermore, the unrest may be limited to just the contested states (where the final vote count is uncertain). The ramifications will be felt globally in terms of geo-political uncertainty and trade and market disruptions if any of this were to reach a high level of disruption and breakdown of law and order.

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    Countries Are Reaching Straining Points Economically

    What if the pandemic takes a turn for the worse? As countries open up again and social distancing becomes less relaxed outbreaks could continue to disrupt normal resumption timelines. Add to this the seasonal increase in cases usually experienced with flu as we head into the northern hemisphere winter. There is a concern amongst medical professionals of a surge in both normal flu as well as Covid-19 cases going into the end of the year which may overwhelm health services. The other factor is the mutation of the virus. In Indonesia they’ve identified a much more virulent strain (although less deadly) of the virus. The mutations could be resistant to vaccines being developed for the main strains and divert resources due to its easier transmission capabilities. Countries are reaching straining points economically due to the lockdowns and shuttering of many businesses is going to cause hardship for a few years still. Any further complications to the resumption of normal activity will only add to the fiscal burdens of nations and their people.

    The Trade War Alarm

    The US-China trade war is not disappearing overnight. Neither are China’s economic and territorial tiffs with regional nations. There is a lot of brinkmanship involved in current Chinese behaviour and actions. The remote region stand-off against India could escalate into a bigger conflict especially with troop build-ups happening on both sides. Until now, by mutual agreement, troops did not carry any weapons in the region- hence the deadly episode between them recently being limited to sticks and stones. Once weaponry is brought into the equation and used the potential for escalation rises significantly. This could then bring Pakistan- a long-time hostile neighbour for India and ally of China, into the fray given the location of the dispute. And, while India may be the conflict with the greatest potential for escalation, China is involved in disputes with most- if not all, of its neighbours. Economic weaponry is already being deployed concurrently as well against trade partners so Chinese actionsare being viewed with suspicion and alarm by many. Given that Covid-19 originated in China and has crippled the world there is already an air of resentment which would not take much to fan to create an anti-China backlash. It’s already happening in India.

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    The Nature Factor

    Climate change is real. Whatever we may attribute it to there is undeniable evidence that extreme weather conditions are becoming more frequent. This is going to cause further disruptions to millions of vulnerable people and may soon start impacting major cities. One should not forget that the Syrian war followed six years of drought which sent millions of people into cities where poverty led to unrest. Economic turmoil does not remain isolated for long. It reaches out. The Syrian war increased the number of refugees fleeing to Europe- through both official channels and through desperate boat crossings. These have in turn created internal debates in Europe and have contributed to right-wing resurgence and backlash.This is a problem that is likely to only get worse. And in the middle of a pandemic induced slowdown- where unemployment of citizens is likely to remain elevated, this could flare into unrest and violence through provocation- as has happened in Malmo in Sweden the last few days and which is now spreading into Norway.

    Financial Market Crisis

    The probabilities and timelines of these events vary. Some may play out over the next few weeks or months whilst some will continue to plague us for years. The effects on financial markets will be real in this day and age of globally mobile capital. The question is the capacity of the globe to handle further shocks to the system: We have been riding a historically long stretch of low interest rates since the last financial markets crisis, unable to bear the weight of higher returns for savers;global debt has ballooned, sustained by easy money policies which are justified by anaemic growth rates and stubbornly low inflation;the equity markets are overstretched given the uncertainty of final global economic damage and ability to recover but propped up by ample liquidity. It’s a fragile chain and I mention these factors because they make both markets vulnerable to any form of systemic shock.The nature of the lifeline- low interest rate/ ample liquidity, has created highly leveraged markets which are- at the same time- overstretched in terms of levels. The same set of conditions also explains the rush for gold.

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    The markets are- in a way, schizophrenic: they are simultaneously buying equity and borrowing money because they believe that money is free and aplenty whilst panicking that free, easy money is going to spell the end of the monetary system. That looks and feels strange: one of them has to be wrong. What could go wrong here? That would take another article to cover. 

    These are all hypothetical situations but within the realms of possibility. Hopefully none of them will take the worst course. But there are perhaps other random events out there that we haven’t even considered- black swan events that seem too remote and harmless to have any impact. Do remember, the Coronavirus was exactly that less than a year ago.