Posts Tagged ‘debt default’

Shhhh! Don’t mention the government debt

Thursday, December 17th, 2009

In the infamous September 11 terrorist attack, everyone, including the authorities, are caught completely by surprise. Who would have thought that even box cutters would be used to hijack airliners? Even the training given to instruct pilots in the event of hijacks were outdated- previously pilots were instructed to submit to hijackers. But on September 11, this piece of instruction proved to be a big fatal mistake.

In view of the lessons learnt from September 11, authorities have changed the procedures, training and instructions to ensure that a repeat will not happen again. But do you know what the problem is? The the next successful terrorist attack is likely to be another left-field event in which the current procedures, training and instructions are not designed to prevent. In other words, the next successful terrorist attack will be a Black Swan event.

Worse still, the absence of successful terrorist attacks is not evidence that the authorities are successful in combating terrorism. As we said before in Mental pitfall: Lazy Induction, the absence of evidence is not evidence of absence. For all we know, there could be a terrorist plot brewing right now that the authorities could not detect. The only evidence of such lack of detection is a successful terrorist attack. That is, if terrorists are to strike from the left field, it can only mean that the authorities are not successful in detecting their plot in the first place.

Now, back in the world of finance. The Panic of 2008 was indeed a trauma. In response to that, regulatory requirements, risk management techniques and financial processes are overhauled to either prevent or limit the damage of a repeat. Like the authorities after September 11, our guess is that the financial system is probably getting more and more prepared against a repeat of another 2008-style shock. Indeed, many businesses have sprung up to help measure and protect against such risks, post-2008.

But do you know what the problem is? The absence of such shocks does not imply that the authorities are successful in girding the financial system. All we need is another financial shock from the left-field to prove that the authorities are not successful in detecting it when it is brewing in the first place.

You know what is worrying? From this news article, Barnaby Joyce, Australia’s opposition finance spokesman was blasted by the Prime Minister Kevin Rudd for suggesting a debate for a contingency plan against the United States government debt default. As this article reported,

Senator Joyce told Fairfax Media he did not mean to alarm the public but there needed to be a debate about Australia’s ”contingency plan” for a sovereign debt default by the US or even by a local state government.

”How would Australia go forward in a position where the dynamics of the global economy are all changed,” he said on ABC Radio today.

We think Barnaby Joyce is right in this instance (note: the word “default” is a loaded word. It does not necessarily mean a literal repudiation of US government against its debt- it can mean repudiation in the metaphorical sense of “printing” money to inflate the debt. The purpose of such a debate is to trash out such subtleties). As we wrote in What will be the next market panic?, our suspicion is that the next financial shock will have something to do with currencies.

Joyce’s idea of contingency planning is the whole point behind what we wrote in Failure to understand Black Swan leads to fallacious thinking,

First, as contrarians, we are not in the business of prediction. Rather, we prepare for Black Swans. To give yourself an idea why such preparation is important, ask yourself this question: Why do parachutists pack a second reserve parachute? Since the statistical probability of a parachute failure is extremely low, does that mean we should completely ignore such a possibility (of the primary parachute not opening)? Therefore, those people who fallaciously believe that preparing for Black Swans is ?predicting? is like believing that the parachutist who packs a reserve parachute is ?predicting? that his/her primary parachute will fail.

So, what is Kevin Rudd’s response to such a suggestion? That’s what was reported in the papers,

Mr Rudd dismissed the senator’s comments, describing them as ”not responsible economic policy”.

He accused Senator Joyce of engaging in a series of thought bubbles that were unbecoming of a senior economics spokesman from either government or opposition.

Barnaby Joyce was labelled as an “extremist” for even suggesting that Australia needs a contingency plan. Is there anything wrong with planning for a contingency? The military always do that because they always have to be prepared. Disaster planning is all about planning for contingency. Hospital emergency departments are in the work of contingency planning.

Our stand is that we need a contingency plan. Having a contingency plan is not predicting that it will happen. Without a contingency plan, we will be like a parachutist jumping without a backup parachute. Kevin Rudd’s response gives us the impression that Australia should be jumping without a backup parachute. That’s because, according to him, entertaining the thought that there is always the slim chance that the primary parachute may fail, is “irresponsible” and “unbecoming.”

If this is real stand of the government, than we can be sure that the government will not “see” a brewing crisis.