Showing posts with label Climate Change. Show all posts
Showing posts with label Climate Change. Show all posts

06 February 2024

Is a massive breakdown in global systems coming? My response

Is a massive breakdown in global systems coming?  

This question has been posed a few times over the past couple of months by people I consider well-informed and thoughtful. And it is easy to see why.  

But before jumping in, I'll declare my own colours. I call myself a “Apocal-optimist”. Yes, an apocalypse is coming, but I'm optimistic about the developed world's mid to longer-term prospects. Too many potential events and situations could lead to a macro-system breakdown, and it is difficult, and a bit crass, to discount or ignore the massive scale of suffering that will occur as some global systems break down. Yet, there are also both inertial and positive feedback and response mechanisms that may mitigate those situations. I have great confidence in humanity and the human mind.  

So, let's begin with why the world is so scary today. Across Africa, there seem to be more coups, civil unrest, and the spectre of starvation linked to civil war and climate change. In the Middle East, there is the real danger of a far wider war, pulling the US (and allies) into a regional war with Iran (and proxies). Add to that the ongoing war in Ukraine and the appearance at least of weakening resolve in European states. Meanwhile, in the East, China is sounding more bellicose by the day in relation to Taiwan. Global migration and illegal migration appear to be on the verge of overwhelming North America and Europe. Climate Change is impacting temperatures, and summer is becoming “fire season” as much as tourist season, and who knows what is happening to Greenland and the Antarctic.  

And to be clear, this is not a taxonomy of the potential regional or global “system breakdown” trigger situations. The list is too long, so I’ll attempt to discuss, at a very high level, a few situations that serve as proxies for so many others. While each may be "separate", in reality, there is a level of overlap and linkage that would be difficult to communicate in these few words. This is without even considering the risks associated with runaway AI, which I'll purposefully ignore for now.

Depressed and worried yet?  

We should be, because there is a lot of uncertainty and instability, and our complex systems appear to be reaching the boundaries of fragility, boundaries that are not marked by points on a graph or dates on a calendar.  

Self-righting nature of systems  

Many of our systems are very fragile and under extreme stress. But not all. And many of our systems have automatic and unconscious feedback mechanisms that provide stability and recovery. Financial markets, for example, have “corrections” that can appear to be a market system failure. Yet these corrections are merely the unconscious processes by which the complex systems of markets ensure that the financial system does not collapse. Capital disappears, but also is reallocated to more productive (or expected to be more productive) economic activities. And when it appears that the financial markets will collapse, the ultimate backup of sovereign intervention reduces the risk and overall impact. To be sure, even this backup is not always successful.  

Modern societies are complex by nature, and it is easy to extrapolate failures in parts of the system(s) as harbingers of overall system or social collapse. This is not to suggest that there will not be a major breakdown in global systems, but only to confirm that most systems are self-righting and are more robust than we can see. Boats tend to float with the right bits upward. Yachts, with their ballast keels, are even more likely to float right-side-up.  But in the biggest storms or the unexpected super-wave, boats and even ships may capsize or be irreparably damaged.  

And when a system or systems collapse, it is not automatically easy to point to a single cause. The cause of the sinking of the Edmund Fitzgerald, with the loss of all 29 aboard, remains undetermined, with multiple potential root causes and exacerbating causes. “The church bell chimed 'til it rang twenty-nine times”, and then 30 times on 2 May 2023.

Some systems are collapsing, while others are shifting and reshaping.  

Europe  

The Russian invasion of Ukraine resulted in a period of concern that reduced or even halted access to grain by much of the developing world was going to result in mass starvation. That was avoided by the deals negotiated to ensure that grain could be exported from both Russian and Ukrainian ports. The alternative would have required external party guarantees of safe passage, potentially bringing others into the conflict. The danger of a much wider conflict was very real, and remains very real, today or in the coming decade.  

If anything, though, the Russian invasion of Ukraine has highlighted the strength of the (NATO) system of alliances that have been instrumental in keeping the peace for many decades. Neither of the belligerents are members of NATO, and the war itself has encouraged two countries to join NATO that have resolutely avoided membership. In the history of NATO, no two NATO member states have gone to war with each other, a remarkable period in European history. European wars of the past three decades have been on the borders of NATO between non-NATO members or civil wars within non-NATO countries. In Asia, the ASEAN (economic) pseudo-alliance system, with its de-facto assumed defensive alliance potential, has acted as a break on overt aggression by countries whose historical animosities could result in conflict at almost any time.  

Paradoxically, the invasion of Ukraine has increased the prospects for a longer peace in one part of Asia, the Korean Peninsula. Kim’s beating the drums of war is just that, beating of drums, and is for internal consumption only. That external parties, including the US and South Korea, are responding is predictable, but also all part of the game. But North Korea is not, for the next decade or more, a threat to South Korea or anyone else. They are or have shipped a publicly stated 1,000,000 artillery shells to Russia, depleting their own stocks to the point of severely limiting any offensive capability they may have had. That probably represents most of a decade’s production capacity for North Korea, or at a minimum, has diluted stockpiles to the point that sustained warfare with South Korea and the United States is not achievable, and Kim knows it.    

Middle East  

To be sure, some aspects of the global order are coming apart. Out of this “coming apart” will come a new set of global assumptions and alignments.  For example, the presumption of Israeli immunity from human rights scrutiny and sanction. We are in a transition period in which the questioning of Israeli actions in Gaza and the West Bank (and elsewhere) invites being labelled antisemitic. That will change, especially as those who do criticise Israeli policy and actions will do so, having prefaced their statements with a standard caveat that they are talking about the policies and actions of a secular government and not the actions of a religion.  

This will result in a realignment of relationships between the Middle East, Europe and Asia, though the relationship with the US will not fundamentally change. But the rule of the right-wing parties in Israel is coming to an end, and unrestricted exploitation and oppression of West Bank Palestinians will be curtailed in the coming years. This will not be driven by any Israeli awakening to the plight of the Palestinians but will come from a recognition that large-scale consumer-driven boycotts of Israeli goods and Israel as a tourist destination will not be balanced by any increases in foreign aid. Israeli strategic thinkers should probably consider the implications of an economy more isolated and with lower foreign investment and aid.  

Attacks on US forces in the Middle East are nothing new. Deaths of American forces is nothing new. But the idea that the US is too distracted to respond is already being disproven, and even before American retaliation, at least one Iranian proxy group publicly stated that they would not be attacking American forces any longer. They understand the potential cost.  

There are almost too many potential conflicts in the wider Middle East to enumerate, with Iran, Saudi Arabia, Pakistan, Iraq, and Turkey each holding overlapping antagonisms with each other and with internal factions and ethnic groups within each. Any of these could “blow up” into wars significant enough to drag in belligerents from outside the region.

Migration  

Migration will continue to be a common-values-stressing problem, and it will only grow over the coming decade. Arguments for open borders (in Europe) and closed borders (in America) will be met by the reality that a certain number of migrants will be needed in both continental masses simply to look after the ageing populations that do not have younger cohorts coming through to take over the responsibilities historically performed by the next generation.  

Yet managing the flow of migrants will be a challenge that to date has been failed by almost all. It is a challenge that will only grow in severity. There is no question that crises spur migration, whether natural disasters or civil conflict, or either one leading to the other. Nigeria, as one example among many potential examples, is projected to have its population grow from 200 million today to 400 million by 2050. That number of people in that environment is unsustainable. Should 1% decide to migrate, one out of one hundred people, that represents four million migrants. Where will they go? How will they get there? And even if those two are decided, will they be accepted or even allowed to reach their destination.  

In Bangladesh today, the Rohingya fleeing Myanmar are being attacked by those who do not want them to encroach on an already overburdened environment. How will Nigerians, or any others, fair in lands that are inhospitable by nature and unwelcoming by the current inhabitants?

Another danger, closer to Europe, I would posit, is Egypt, with 100 million people living along a single river (effectively). Should 2%, or two out of one hundred people, decide to migrate to Europe in a crisis, that is two million migrants, a volume that will overwhelm any attempts to contain it short of sinking the boats (an ugly but possible worst-case scenario).

The migration issue will transition to how to manage migration, both attracting the desirable and dissuading those on the desirable professions' lists (doctors, nurses, caregivers, IT professionals, skilled professionals, etc). That will require a twofold approach: draconian laws to repatriate illegal migrants coupled with far stronger messaging in the source countries and massively larger foreign aid and development programmes.  

Climate  

Overlay Climate Change onto this mix and the urgency of transition, and the level of interventions required to stabilise migrant-source countries will take on a greater urgency. Will Western developed powers be up to the challenge? Eventually, yes. As Churchill famously said about the US (and now applies to all developed nations), “They can be relied upon to do the right thing, after exhausting every alternative”.  

This is not to suggest that there will not be unexpected traumas and events. That most certainly will happen. And we will not be prepared, no matter how much planning takes place. But the inherent resiliency of global systems, and the excess capacity built-in (yes, there is plenty) will ensure that responses will take place and the greatest possible damage will be averted. That is at the macro level. At the local or regional level, we should expect some catastrophic events. Indeed, many are predictable.  

Too many parts of the world are in crisis and under remarkable stress. There are also areas which appear to be functioning but are stressing the underlying capacity of the environment to support the regional systems, cultures, economies, and food production capacity. Some of these are going to suffer catastrophic collapses in the coming decade.  

Yet, to be cold-blooded about this, the collapses will be “local” and not the entire world or “civilisation” impacting, though our humanity may be challenged. Population growth expectations for some countries are unsustainable in almost any imagined scenario, yet the demographics are "baked in". And some of these countries are in environmentally challenged situations already. The Sahel is one such area, and we are already seeing the strains caused by climate disruption coupled with civil war in a "'which came first” situation. It will only get worse. And it will drive local, regional, and extra-regional migration.  

Other parts of the world will (are already) be impacted by Climate Change. In Greece, the idea of summer has become synonymous with the idea of a “fire season". How much more will burn this year? And that problem is going to come home to much of the developed world. Terrible as it will be, it will not result in a societal or social collapse.  

Aquifer depletion  

Depletion of aquifers around the world creates localised threats should rain patterns change along with the climate. We should be clear that aquifers are being depleted because the agricultural and urban loads already far exceed the environmental carrying capacity of their locations. “A map of groundwater storage trends for Earth's 37 largest aquifers using GRACE data, showing depletion and replenishment in millimeters of water per year. Twenty-one aquifers have exceeded sustainability tipping points and are being depleted, and 13 of these are considered significantly distressed, threatening regional water security and resilience.” 

Disruptions or changes in rainfall patterns, even for a season, could create self-reinforcing cycles of localised environmental collapse and resulting social pressures, including forced migration of large populations from those no-longer-viable locations and regions.  

The specific areas of my own concern are the plains of northern India, whose aquifers have seen such exploitation that the drop in the ground level is measurable by satellite. Depletion of the sources of the Ganges coupled with groundwater depletion could have far-ranging negative impacts on crop production. Couple that with a Climate change-induced change in the timing and/or strength of the monsoons and one or more years of very bad harvests could put millions in danger.  

Optimism  

But there is so much that we should also consider on the positive side. Humanity is probably the ultimate adaptable species; in that we can develop and evolve technology and governance systems to see us through calamities. If anything, the very potential Malthusian risks to parts of the world today are the same problems that were deferred by the “green revolution” of the 1060s and 1970s. We postponed that crisis, but for how long?  

Climate Change will be mitigated, though we cannot say at what cost. Fossil fuel will be phased out over the coming decades and become a niche fuel source for non-transport needs. Solar, wind, and very soon SMR (Small Modular Reactor) technology will fill the electricity production space currently filled by coal, oil, and natural gas. Not completely, but by the middle of the century, the existing non-renewable power production facilities will be awaiting decommissioning.  

In the area of healthcare, the revolution is only beginning. AI and genomics are revolutionising medicine, and coupled with the concept of mass personalisation in manufacturing and marketing, it will not be long before personalised treatment and personalised preventive treatment become, in the developed world, the norm. The reduction in burden that this will have on healthcare systems will free resources to care for the great wave of active elderly (of which I hope to be one).  

The world is changing. Rapidly. But that does not mean it is falling apart, or that it will fall apart.  

I hope.  

24 February 2018

103 Months of recovery, what could end it


After years of single-direction trajectory for the markets, the recent correction has jolted people from their complacency. Well, many people. The subsequent rallies are proof to one set that pressure has been taken out of the markets, and the upward track can restart. To others, the expression "dead cat bounce" continues to be the phrase of the week.

Being very clear, I do not know if the top has been reached, or is there more headroom in this market. I have no idea. None. Also being clear, while the discussion focuses on the US markets, there is nothing in here that either does not have or is not impacted by events and economic situations in other countries.

If the markets continue their advances, how far can they go, and for how long? Is theUS in the "demographic sweet spot" that I wrote about in August 2017? I asked if the fall in the US labour market participation rate had been strong enough to create sufficient pools of surplus labour to allow for multi-year growth as that surplus labour drip-feeds into the workforce. If it is, then there may actually be a few more years of growth in the economy and the markets. If not, then the third longest recovery in US history may come to a sudden end.

So what happens when this recovery comes to an end, and the US enters recession? At 103 months as of writing, this recover is the third longest since the end of theGreat Depression, and only 4 months short of being the second longest. The fourth longest was only 92 months, and the fifth a mere 73. This recovery is almost a year longer than its number four, and two and a half years longer than the fifth. Interestingly the longest lead up to the “dot-com” bubble and subsequent crash. Does this recovery have another 17 months, another year and a half, of additional steam, to tie the longest recovery? And if so, will we see continued growth in bubbles that we saw leading up to 2000? Or, do we have enough bubbles already?

Again, I cannot answer that because I simply do not know. The recent market "correction" was a wake-up call, and a reminder that it is not all "sunshine and lollipops". There are systemic pressures building up, and one day, the markets will switch from Bull to Bear. What might make that happen?

There are a number of potential catalysts that could provide the tipping point, and with that a sustained downward trajectory for the markets. The following list is not complete by any means, but gives an idea of the range of potential situations that could, once the fall is well underway, be pointed to as the catalyst.

Most important, there is not one situation that will cause the coming crash, and all are interlinked and interdependent. Each can, and probably will, impact and potentially exacerbate another or multiple others. If housing starts collapse, so will house prices, and with that the “wealth effect” tripping over into consumer credit (although in this example, consumer credit may stabilise instead of continuing to grow) and potentially rising default rates.

I will delve deeper into each one of these in coming posts, but for now, the following outline of each should serve to set the scene, so to speak.

Interest Rates: Off the back of rate hikes by the Fed, the Feb rate could reach as high as 3.25% or even 3.5% by late 2018. This will flow into the 10-year Treasury, already hovering around 2.9% up from a low of 2.06% only six months ago. Should the rate continue to rise, the flow-on effects will be felt throughout the debt-driven economy. At some stage, the forward potential negative impact on consumer credit creation and utilization capability will strike, and with that a sudden loss of confidence.

Inflation shock: Years of QE, QEII, Twist, Abbenomics, and ECB purchases has flooded the system with new money. Where has it gone, what why hasn't inflation appeared as so frequently predicted? Countering the assumption that the new money should be driving inflation, there is an argument that surplus labour is keeping wage inflation in check, and with the, general economy-wide inflation. If they are not making more money, then the average worker cannot drive up prices. What happens when a really bad inflation number prints - in the US, UK or Germany for example?

Budget deficits: But what is the single event that is used by media pundits to 20/20 explain what happened. Could it be a Congressional Budget Office projection stating that servicing of the national debt will exceed 8% of the 2019 federal budget (from a current 6% of the federal budget)? Or could it be a projection for $1 trillion budget deficits for the next four years? After all, no one believes the projected temporary increase in spending followed by a drop to a balanced budget level.

External Shock: Or maybe the markets will react to an external event or geopolitical risk event, such as a US strike against the nuclear capabilities or Iran or North Korea. The intervention in northern Syria by Istanbul has already resulting in a sharp drop in the Turkish stock markets. Such a shock could undermine confidence in international trade or fuel expectations of increased in input costs and commodity costs. The markets have been remarkably resilient to geopolitical risk over the past year, so any shock will probably need to be a big one. Ultimately, the list of potential geopolitical shocks is as long as you wish to spend reading or writing.

We should not forget that there are a number of major economies each under their own strains, with many of those strains being similar to those witnessed in the US economy. The UK has suffered a 5.7% drop in year on year private auto sales, with predictions for a further drop in car sales in 2018. And before saying "but they are a small country" remember that they represent 65 million people, and that this slowdown will impact German auto makers as well, providing some stress, albeit minor, to the German economy. 

Housing market: Bad news in the housing market could tip the scales, and send the marketing into a self-reinforcing negative spiral. This potential shock is tied closely to underlying interest rates, inflation, and the Wealth Effect based on an ever-raising stock market. A multi month sustained drop in housing starts, completed sales, or house prices could shock the markets, and become the 20/20 hindsight event that causes a crash.

Automotive Loans default rates: Current default rates are increasing, and the total outstanding loan period is also at a record high. In 2016 the average outstanding car load was 5.5 years. It is possible to get an auto loan at 72 or even 84 months duration. In addition, over 30% of used car trade-ins areunder water. Combine the two, and the consumer is likely to become trapped in the vehicle they are in, and with that trap will come a reduction in car sales, and an expectation of future poor performance by the automotive section, a sector that accounts for X% of the US economy.

Credit Card default rates: The American binge on consumer credit continues, and in fact never really stopped. Net savings rates are at historic lows of around 2% (average across the entire economy) while credit card debt continues to rise. This is unsustainable. The only questions are, what is sustainable and when will the bubble pop, and will we recognise that it has popped. A failure in confidence that consumers will be able to afford the current credit load will not come as a slow dawning, but will come as a sudden shock, and that shock could rock the markets.

Productivity: Linked so closely with that credit crisis is the concept that worker productivity will continue to improve. Yet for the past few quarters that has not been the case, or has been true at a much reduced level. A failure to continue to increase productivity will directly impact worker wages, company profitability and therefore achievement of earnings expectations. Again, a sudden realisation of future down-trend impact on company values may arrive as a shock, and may be the catalyst for a market collapse.

Environmental event: To this point I’ve focused purely on potential economic events or situations, and have avoided environmental events. These could range from the hurricane that breaks the insurance industry, storms in Europe that result in a short term economic downturn, or a major earthquake on the West Coast of the US. I’m ruling out volcanos and meteors, as the probability is simple too low. I’m not ruling out Climate Change related events or situations, major droughts, or resource depletion such as a collapse of the water table in the San Joaquin valley of California.

Maybe the "dead cat bounce" is just a slightly longer bounce, and the fall is already coming.

Whatever the trigger, when the fall in the markets come, it will be steep and quick, followed by months if not quarters of a cyclical bear market. And while I am writing based on the US economy and markets, the same issues highlighted above are true for so many economies, and any individual large economy could provide the trigger for a global rout.

02 April 2015

Why CSR is an important part of your risk universe

Well isn't that a pretty CSR / Sustainability report? All the right tables, indexes, pictures of windmills and daisies, but yes, some fairly data rich tables and reports. There is also the great summary that shows that the company met 80% of its CSR targets for the year, and can even show how those targets have evolved over a number of years. 

That report, of course, is your competitors. And the boss is not terribly happy about that.

Call in the troops, raise the alarm, set some goals, and produce that CSR report that makes us look like we care, dammit.

Yes sir, no sir, three pages full of pretty pictures sir!

And so the company starts down (or continues down the already well worn) path to CSR or Sustainability or ESG (Environmental, Social, Governance) reporting. Goals are set and agreed, business cases are produced, and external consultants are engaged to help with the process. A standard is selected, and soon, but realistically most of a year later, the company has its first CSR report ready to go. All that is needed is a nice front-piece from the CEO, written by marketing or the CSR team, and it is time for the press release and marketing event.

Did you, as the Risk Manager or Internal Auditor, know what was happening, and have you included the CSR reporting process on your risk register or audit programme? If not, why not?

I know of one Risk Manager who was invited into the CSR programme from the beginning, and he is convinced that the result has greater validity and value because of Risk Management's participation.




CSR (Corporate Social Responsibility) reporting is important, but it also exposes the business to a new set of risks; operational, reputational and regulatory. CSR (or similar) reporting processes and content represent an uncharted area for too many risk managers and internal auditors. The information has rarely been determined to be “material”, so even when the CSR programme or report has been in the risk universe, it infrequently rose to a perceived level of significance to draw attention and review.

Yet I would argue that the reputational risk alone should be enough to encourage attention. Add the regulatory risk and there is a clear rationale for Risk Management and Internal Audit (IA). IA in particular has a mandate to review and report on the effectiveness of the system of internal controls, and that the programme of reviews should be based on a risk weighting of processes, systems and operational areas of the business. For too long we have assumed that this means controls over financial reporting and IT systems.

Consider the easiest regulatory and reputational risk. Does the CSR report contain the same information as the regulatory reports? In an SEC context, are the risks reported in the 10K the same as in the CSR report. As a specific example, does the CSR report in any way discuss climate change or the risks associated with exploitation of scarce resources such as water? If these are discussed in the CSR report, then they must also be in the risks section of the 10K, or face the danger of an investor or regulator asking why there are different risk factors being reported as being important to the current or future of the company.

This is as true for statutory reports in other jurisdictions. 

This is also true regardless of the reporting standard that you use, be it the GRI, IIRC's Integrated Report, UN Global Compact, SASB, or any other standard.

There are also metrics. Imagine reporting the level of carbon emissions or carbon offsets in a CSR type report, only to not report this information in statutory reports, regardless of what IFRS or US GAAP (or any other GAAP) requires.

While there are valid and important reasons to produce CSR/Sustainability reports, the information contained should be subject to independent review, and Internal Audit would be well placed to confirm the effective functioning of controls over the production of the information.

Likewise, Risk Management can provide valuable support in the establishment and operation of a CSR programme, and can ensure effective consideration of the risks being reported, both in range and in depth. This can include ensuring that common data sources are used for CSR and statutory reports, reducing the risk of different and potentially contradictory information being reported.

Key points:

·         The world of CSR/Sustainability reporting is undergoing massive change
·         Most CSR data is financial data, just packaged differently
·         Many CSR reporting standards are little more than marketing standards
·         Most CSR reports cover only a subset of the actual business. Disclosures in CSR/Sustainability reports do not always mirror disclosures in statutory reports
·         One activist with a smartphone can seriously ruin your day
·         CSR/Sustainability reporting practices can be a bellwether of other reporting practices, good and bad

For these reason Risk Managers and Internal Auditors should take a close look at what the company is saying to the world, and IA should confirm the effectiveness of the control environment that is producing the information that is reported, including the process (and costs) and the benefits.