What A Black Swan Event Can Do To International Investment And The World Economy

As international events continue to become more dangerous investors are becoming more apprehensive. The crisis in Ukraine will proceed to be an area of conflict between the West and Russia for some time to come. Many people remain uneasy that Russia may well decide to destabilize additional countries in Europe and other former republics of the Soviet Union. In the Far East the crisis in Hong Kong may not be abated. China refuses to allow real democracy in the former British colony. It does not matter what the Chinese government agreed to in the past. There are fears that a popular elected government in Hong Kong, will be a threat to the stability to the rest of China. Lastly, there is the Middle East which is rapidly developing into a quagmire for the Western democracies.

Ebola Virus

Along with these world events there is the growing pandemic with the Ebola virus in West Africa. After assurances from governmental officials that the virus would not make it to North America and Europe, now the issue is how to combat it since its arrival in the United States and Europe.  An infected patient is now critically ill in Texas.  Spain has now reported that a nurse has contracted the virus from a patient she was treating in Madrid. Worse yet, the United States has already temporarily exhausted the supply of Zmapp, a drug which seemed to work rather well in combating the disease. It will take months to restock the life saving medicine. There are a number of alternative drugs, but they are also not sufficient to meet the growing needs of a rapidly spreading disease. It is important to remember there has been three pandemics that have hit the United States in the 20^th century, and each time the country was unprepared for what followed.

Territorial Control Of ISIS

The growing calamity of the ISIS movement has become even more apparent with the coming fall of the leading city of the Kurdish area of Syria. The city of Kobani near the border with Turkey has become a major battle zone between the Syrian Kurds and the terrorist ISIS group. Despite the halfhearted attempts by the United States and a growing coalition to stop the military surge of these militants, they continue to expand the territory and population under their control. The bombing campaign against ISIS may have slowed the advance, but it has not stopped it.

The central governments of Iraq and Syria are no longer functioning in large swaths of their former territory. The American government continues to pretend that there still is a country known as Iraq. The Sunni portion of the country has been overrun by ISIS. To the north and northeast the Iraqis Kurds are acting as an independent nation. The Kurds are mostly on their own in defense of their territory.

Al-Qaida in North Africa

After an attack by American and European forces against Libya which led to the overthrown of Qaddafi, the country has been mired in a civil war. There is a number of Islamic insurgencies across Africa’s Maghreb region including Algeria, Burkina Faso, Chad, Mali, Mauritania, Morocco, Niger, Nigeria, Senegal and Tunisia. In the Horn of Africa there are similar disturbances in Eritrea, Somalia, Djibouti, Ethiopia, and the Sudan.

The same is the case in the Arabian Peninsula, mostly centered in Yemen.

The ongoing tensions between Israel and the Palestinians complicate the situation in the Middle East even further.

Another dangerous situation is the soon to be completed process of Iran acquiring nuclear weapons. Although a number of political leaders including the American President Obama insist they will not allow such a development, only Israel is serious about attempting to stop it at this point.

The sanctions and costs of war in the Ukraine have taken their toll in Russia, with the domestic currency and stock market in decline. The economy is ready to tip into a recession.  The cost to expand Russian influence in former Soviet republics is becoming quite high.

South China Sea Island Disputes

In China, the economic growth rate is slowing much faster than the leadership would like. There is still a risk that internal debt and the housing bubble could implode, causing a major economic crisis. The more belligerent stance the country has taken in border disputes with Brunei, Japan, Malaysia. the Philippines, Taiwan and Vietnam, has only lead to the rising unease in East Asia.

The economy of Japan continues to sputter. Despite quantitative easing and new stimulus spending on infrastructure, there has been little real growth.

In South America, the two leading economies of Argentina and more recently Brazil are no longer doing well.

Europe on the whole is seeing diminutive growth. That is why the ECB (European Central Bank) has introduced negative interest rates and seems to be moving forward on quantitative easing. Even the German economic juggernaut is finally slowing down. It is not surprising if one considers how the world economy is doing overall. The United Kingdom is for the moment an exception, but with world trade growth in jeopardy, there will be strong headwinds against further growth.

It is no wonder that international investors started looking favorably towards the United States and the American dollar. The United States dollar (USD) has increased in strength for the past 12 weeks as a result. It has not hurt either that quantitative easing is ending in the United States at this time. Interest rates are still at historic lows, but will most likely start rising next year. That is what most economists are predicting. Wage growth is minuscule so there is no immediate need to raise interest rates. Official inflation at 1.7% and a unemployment rate of 5.9% (U3) are enviably low.

Of course, actual rates for inflation and unemployment are much higher than what is being reported by the government. Labor participation is at a 36 year low. It dipped again in September to 62.7%. When an individual stops looking for work or is underemployed they are no longer counted for the official statistic . If one were to include the unemployed, underemployed and discouraged workers you have over 90 million people looking for work. Therefore the true unemployment rate (U6) is 11.8%.

The corrosive public debt is nearing $18 trillion USD which now exceeds the total size of the Gross Domestic Product (GDP) of the United States. The GDP of the United States in 2014 is 17.5 trillion USD. This only occurred once before, and that was at the height of World War II. Government debt reached a high of 121.70% of GDP in 1946 before declining. The record low was achieved in 1974 when it was just 31.70% in gross debt to GDP ratio. The total debt continues to grow each year as the annual government budget deficits proceed forward.

There is still no real plan to deal with the annual government budget deficits either beyond the previously agreed sequester, which is already in danger of being abandoned. This was an earlier attempt to slow the growth of spending in certain sectors of the budget, including discretionary items and defense. Unfortunately, these two spheres are not the main driver of the deficit. What is forcing the deficit upwards and hence the national debt ever higher, is entitlements.

Entitlements and the unfunded liabilities of the United States is the Achilles heel of the United States economy. It was estimated in 2013 that the United States unfunded liabilities were already at $128 trillion USD. The total net worth of the country is only $94 trillion USD.

Unfortunately, the main focus of the United States government and its political leaders at this time, are the mid-term elections to be held in early November. The political battle for control of the Senate, which is one part of the bicameral legislative branch, triumphs other issues at this juncture.

Remarkably, the United States is still considered one of the safest places to invest money. This is why the dollar is still rising in value, and the stock market is still near all time highs at or above 17,000 points. After a decline of 2.1% in the first business quarter of 2014, economic growth surged 4.6% in the second quarter. Job expansion although slow and lower paying, is continuing. In addition,most investors both domestically and internationally, are altogether unaware of the precarious situation of the United States fiscal situation.

Enter the Black Swan. What event can occur that will shake investor confidence in the United States economy and the American dollar? In the short term it will be one of two things. Either a natural disaster which is possible but unlikely, or a man made disaster. It is the second one that is far more probable. This would be a terrorist attack or a series of onslaughts on American cities and infrastructure.

The 2008 Collapse Of Lehman Brothers Investment Company

This would deal a powerful blow to the economy of the United States. It would shake confidence in the banking and insurance sectors first. The central government already overburdened with debt, would be hard pressed to deal with a financial meltdown of these two aforementioned sectors. Like in 2001, the United States Stock Market would decline rapidly, as sellers outnumber buyers. The value of the United States dollar would plunge as investors abandon it en masse. Commodity prices especially in energy and precious metals like gold and silver would spike sharply upwards.

Following that, stock markets overseas would soon start losing value as well. Financial panic would be the result, as investors everywhere start liquidating positions to raise cash. The only investment deemed worthy will be tangible assets. Certain sectors of the American and world economy will be devastated including travel, entertainment and other non-essential items. There will be panic buying by many citizens, as well as hoarding of foodstuffs,medicines, energy supplies and other necessities for survival.

There are likely to be a number of domestic disturbances in the United States and other countries, that will be the result of the financial chaos.  A need to pass emergency legislation to deal with consumer shortages and to maintain law and order will soon arise. Martial law may actually be declared, if the situation starts becoming uncontrollable.

The possible targets in the United States are too numerous to be easily secured in an open society. The electrical power grid, water supplies, communications systems, transportation hubs, energy storage, food and medical networks are all vulnerable to attack, which could easily create a panic. Just destroying some vital computer systems through a cyber-attack, would be sufficient to achieve a major catastrophe.

An actual terrorist attack could employ biological, chemical or nuclear materials, possibly a combination. A detonation of a dirty bomb in a major metropolitan area especially in a city like New York or Washington, would be a calamity of mammoth proportions at the local and national level.

Given the present international situation in the Middle East, the above scenario is all too possible. It is a reminder to investors to consider the unthinkable and plan for possible emergency contingencies. A dramatic change in world markets including those in the United States, is becoming far more likely given existing world events.