Things That Go Bump in the Night

Near Risks, Immediate Risks and Argentina

Looking backward relies on facts, looking forward requires imagination. It’s tricky to weigh potential outcomes that, at present, seem far-fetched, at the outside realm of the possible, but, should they happen, are of such extreme consequence that much of what is considered safe changes. This is what investors call “tail risks,” events that are outside the norm. There are innumerable future scenarios, of course, but the clash of frameworks relied on to distill reality across countries (US versus China or Russia versus Ukraine) and within countries (Trumpists versus the rest) significantly increase the risk of extreme outcomes.

In summary:

We have recently experienced a series of “unthinkable” shocks.

It is reasonable to expect more unthinkable surprises going forward—perhaps China attacking Taiwan or US elections breaking down—because powerful groups operate according to wildly contradictory frameworks.

These frameworks relate to how to adjust to and process change, particularly given today’s information revolution. Change or disruption is often two-sided—a pandemic kills and spurs vaccine innovation, something is gained and lost.

Adjusting to such shocks puts intense pressure on governance systems and our lives. This in turn is a major cause of unstable wealth. When these pressures fracture a governance system, national wealth slides. Argentina is a less famous case study.

Recent and Less Recent Shocks

If you look back at the last 20 years, shocks that we are now accustomed to would have seemed wildly far-fetched before they happened. A short list: 9/11, the 2008 credit bust (“housing prices don’t go down”), a global pandemic and a modern ground war in Europe. The key point: surprises, by definition, must be outside the bounds of the seemingly reasonable.

The same is true if you look at longer time frames. Over the last 100 years, shocks include WW2, the use of nuclear weapons on civilian populations and Mao and Stalin killing millions of their own. There are also miraculously good surprises, like big increases in life expectancy, computer technology and the collapse of the Soviet Union.

Predicting future shifts is challenging, though it helps to know what you are looking for. Churchill famously predicted the beginning of World War 2 based on tracking German steel consumption and George Kennan accurately described the conflict with the Soviet Union merely by being there and watching.

Taiwan, the Baltics & Disputed US elections?

We are in the midst of an acute clash of perspective. Consider Russia and China. Both Putin and Xi could not have ended up where they are without being smart and calculating. In this, they are similar to many Western politicians, like Trump or Johnson. However, Xi and Putin are also both products of the Soviet system, which gives them a particular analytical framework.

By Soviet, I mean someone with a specific ideological bent. Marx believed, and modern Chinese and Russian theorists believe, that Western structures are inherently self-destructive, not self-corrective. Marx believed Capitalism fueled competition, which drove down prices. This deflation, he believed, in turn forced a collapse in corporate margins, a reduction in wages, which then created social instability.

Xi is openly Marxist, Putin merely studied Marx. From a Soviet perspective, the 2008 credit crisis confirmed their narrative in the same way that the 1929 US stock market crash and Great Depression did for Stalin. The Soviets also believed efforts to break free of their rigid controls on thought and movement was less human instinct and more US plotting. Thus, Ukraine is a US puppet, not a nation striving for autonomy. The point is, Putin and Xi operate by a radically different framework, just as loyal Trumpists do.

What would it look like if these clashing views intensify? It looks like China taking Taiwan and Russia testing Lithuania. It looks like a close US election where a Trumpist candidate loses and calls armed supporters into the street. Far-fetched, yes, though these are the things that go bump in my night and lurk in the background.

Two-Sided Shifts

The roots of these clashing frameworks are complicated. Both the leaders and the population often don’t clearly understand what is going on while it is going on, motivated as they are by a swirl of emotion, history, culture and other forces. It’s only clear in retrospect. But a key ingredient seems to be how best to respond to disruptive change.

For instance, we now know a combination of losing a war, hyperinflation (1923) and new political communication technology (radio) contributed to Germany’s descent into homicidal chaos. A lot (too much?) changed in a short period of time. Political systems buckled and seemingly rational people (Heidegger is one example of many) lost their way.

Today we have been trying to figure out how to productively use an explosion in information technology. Does the technology liberate us or control us, distract or educate? This confusion has led to two tech stock bubbles (2000 and 2022), the rise and fall of innumerable companies and fortunes (i.e. Blockbuster versus Netflix) and significant political shifts, both Obama and Trump used this technology to their advantage.

In this light, that Russia and China have turned inward makes some sense. This technology is disruptive to authority and existing business everywhere. But for China’s Communist Party or Putin’s Russia, a free-wheeling discussion of the whole truth, which not only includes their accomplishments (like poverty reduction) but also rampant corruption and a genocidal past, is intolerable.

The Argentina Case Study

Studying history helps to understand the range of outcomes. Germany is an example of a country that imploded and bounced back. Argentina is an example of slow implosion. I’ve written before about how short-lived most companies are. The same flux applies to countries.

In the 1900s, Argentina was one of the top ten economies in the world. Rich in agriculture and with an excellent climate, there was no reason why it could not become a Latin Australia or New Zealand or Norway, a small rich country that exports commodities. Today, however, Argentina has dropped to 30th place and, in investment circles, become a byword for a bad investment. Why?

I am not an Argentina expert and reading the literature, it isn’t entirely clear, which in and of itself is scary. Some facts stand out, however. Argentina adopted a constitution about 60 years after the US did with roughly the same design—two chambers of Congress, independent judiciary, etc. Yet, rule of law never quite took hold. In 1930, shortly after Argentina reached its peak global wealth but in the midst of a global Depression there was a coup, which then led to counter attacks and see-saws of power from which they have never recovered. Translation: rapid change fractured a fragile stability.

Today, Russia is moving backwards and may well end up becoming an Argentina. But it isn’t difficult to see how the same can happen in other countries as well, including the US or China. If China attacks Taiwan, won’t the West be forced to completely unplug from China-based production? And if US election integrity snaps, isn’t that another Germany? (Tweet this out if you find it interesting).

Investment Implications NOT INVESTMENT ADVICE