Emerging Risks in a World Beyond Covid-19

The year 2020 will forever be linked to a pandemic, a known global risk that most years manage to avoid. Such hazards sometimes lead to cascading risks traceable back to its root cause. Already, the virus has led to major disruptions of economies, massive unemployment, and reduced levels of international trade (particularly regarding medical supplies). What other risk exposures lurk as a result, and over what proximate time period?

The Spectrum of Risks

During September and October, 2019, the World Economic Forum (WEF) surveyed 1,047 of its stakeholders regarding global risks during the 2020s. First, the WEF identified 30 specific global risks, across five categories:

A Taxonomy of Risks

Respondents were asked to score each of the 30 risks over the next decade on a scale from 1 (“very unlikely”) to 5 (“very likely), separately in
terms of likelihood and impact. Average bivariate scores are plotted below.

The perceived global risk from infectious disease was deemed 8th-most impactful if it materialized, but 3rd-least likely in terms of perceived likelihood.

Next, respondents were asked the following question: “On a global level, do you think that in 2020 the risks presented by the following issues will increase or decrease compared to 2019?” Respondents were given the option to add perceived risks not already on the WEA list. Results were reported for 40 different risks, with the percentage responding in the affirmative ranging from 79% to 23% — but infectious disease did not make the list. This, despite global outbreaks of SARS, Swine Flu, ebola and MERS during the first two decades of the 21st century. Hindsight is easy.

Actions to Mitigate Risks

Risk management techniques abound. Many global organizations, such as the United Nations (U.N.) , the World Trade Organization (WHO), and the World Health Organization (WHO) exist primarily to identify and prevent or mitigate specific global risks. National, state and local governments do the same on a more limited scale, usually by targeting more localized risks. An international corporation is likely to have a risk management unit focused on anticipating and addressing business risk exposures, whether physical or financial. What risk mitigation strategies are available to deal with global risks at the individual level? There are four categories of tools:

Risk Mitigation Strategies

There is no assurance that an appropriate strategy will be available to match any given risk exposure, and available does not assure recognizable.

Speculation Along the Spectrum

Even the dozens of global risks identified above represent but a fraction of the potential hazards we face, and they are the less consequential ones. There also are existential risks, which The Economist magazine recently defined as those that threaten “the destruction of humanity’s long-term potential”. Examples include the likes of asteroid impacts or volcanic super-eruptions. Immeasurably small odds, with immeasurably immense impact. As Gordon Woo notes: “One of the most insidious aspects of natural disasters is the protracted timescale … over which they occur. Collective memory … tends to fade into amnesia.” The list has only grown with the advancement of bio-weapons. Billions of humans are alive today, but perhaps trillions are yet to come — if only we can hold on to what we have.

The coronavirus has been devastating, and the worst may be yet to come, but it shows no signs of rising to an existential risk. Nonetheless, it has triggered other global risks and is likely to trigger more. Which? When?

Following are some candidates.

2020 Infectious Disease
Half a year after first learning of the novel coronavirus, the U.S. continues with disjointed and conflicting messaging. It remains uncertain if or when a vaccine will be available, and the virus is highly contagious and often lethal. A rational person, living alone with no work or family obligations, has an easy fix: If the risk is outside, stay inside. For everyone else, the choice is more nuanced, relying on some form of quasi-avoidance, such as social distancing.

2023 CLO-driven Banking Crisis
The “Great Recession” has become a distant memory to some, and its lessons perhaps not fully absorbed. Risky investments were the trigger that led to a global economic crisis. Sub-prime loans by banks were known to be risky investments. Collateralized Debt Obligations (CDOs) were created to mitigate these risks, relying on the financial concept of diversification. Lenders would slice their mortgages into tranches of risk classifications, bundle individual loans by tranch, and sell them into a shadow banking community of CDOs that were not subject to regulatory oversight. Bottom-tranches attracted institutional investors because they paid higher rates than Treasury bills but were considered nearly as safe, because housing markets were thought local and the pooling of similar-risk loans was thought to benefit from diversification. But increased interest rates and more sub-prime lending resulted in a cascading of defaults that crossed geographic boundaries and devoured the lower CDO tranches to threaten even a AAA-rated tranch. These “riskless investments” were a myth.

In the past decade we have witnessed a remarkable increase in corporate debt, fueled by relatively low interest rates, lax lending standards and leveraged buyouts. Enter Collateralized Loan Obligations (CLOs). They mimic CDOs, as shown on the left display. Will they soon mimic the right?

2026 Double-digit Inflation
During 2020 governments around the world have chosen to distribute massive amounts of funds to businesses and individuals to soften the economic impact of the pandemic. Many retail stores remain shuttered, and some of those will never reopen. The slump in demand has led to a curtailment of supply as production has been reduced. Presidential wishes notwithstanding, this situation seems unlikely to change much unless and until there is an effective vaccine, which may or may not matetialize. The reality of the deadly seriousness of this threat is settling in, as locales that reopened early are closing again and deaths continue to mount. Schools are making aggressive plans to reopen, often without consulting teachers who may well be unwilling to return to classrooms with their asymptomatic students. A day will come, however, when a “new normal” emerges that facilitates satisfying pent-up consumer demand. Unless supply is prepared to meet that demand, inflation will result. Coupled with massive government debt obligations, inflation easily could reach double-digits. The U.S. has not seen such levels of inflation in more than a generation, so expect a shock.

2029 An Anti-globalization Trigger
The Trade Openess Index is the sum of world imports and exports divided by world GDP. It rose to about 30% during the Industrial Revolution of the late 19th-century, fell to 10% during the period that spanned two “World Wars”, a pandemic and Depression-era move toward nationalism, and rose to 60% just prior to the “Great Recession” of 2008, fueled by post-WWII cooperation, the emergence of China, the decline of the Soviet Union, and technological advances in transportation and communication. The Index has declined during the past decade, as nationalist sentiments have materialized and led to Brexit, the U.S. withdrawal from trade deals,and trade tensions with China. During the first half of 2020, ninety countries have imposed restrictions on exporting medical supplies, a that sentiment is likely to spread to other sectors. By the end of the decade, global trade could return to pre-WWII levels and the Index could drop below 30 — or a couple years of such restrictions could help nations rediscover the many advantages of international cooperation and exchange. A new normal?

2032 Reconstruction of U.S. Social Security
By most measures, Social Security is the most successful social program ever created and run by the U.S. government. It indeed provides security as Americans contemplate life after work, but it comes at considerable cost. About $90 billion is distributed to recipients each month.and the cost is set to rise significantly due to a combination of longer life expectancy, a surge in “Baby Boomer” retirements, and further shrinkage of the tax-paying workforce as fertility and immigration rates drop and machines replace workers. While demand will rise, supply is set to shrink. About one-quarter of benefits are funded by a Trust Fund that is forecasted to be depleted in about a dercade, and the remaining three-quarters are funded by payroll taxes (which President Trump has proposed eliminating) and taxes on Social Security distributions. There are plausible and effective means of addressing the problem. Democrats tend to favor eliminating the cap on payroll taxes (currently on all income beyond $138,000, which would raise about $1.5 trillion annually), while Republicans tend to prefer raising the full retirement age (perhaps to age 70), likely with a rider to opt-out and convert promised future payments to a 401(k)-style account that transfers primary responsibility for a secure retirement from the government to the individual.

The Interconnectivity of Risks

Discussion so far has considered risks in isolation, as if they are independent events. Experience suggests that many are correlated, and science suggests some bear causal relationships. While statistical associations can assist risk predictions, they also multiply the impacts.

The Cambridge Risk Framework offers a taxonomy of risks and states: “The worst catastrophies are combinations of events, where a primary catastrophe causes secondary effects by triggering another ‘follow-on’ catastrophe. The escalation of consequences can be worse than if they had happened separately.”

For example, on March 11, 2011 the “Great East Japan Earthquake” struck the coastline of Honshu, Japan with a magnitude of 9.1. That earthquake triggered a massive tsunami, with waves as high as the equivalent of a 12-story building, that flooded 200 acres of coastal land. That coastline also is the location of the Fukushima nuclear power plant. The earthquake cut off external power to the reactors, while the tsunami diabled backup generators. Limited power led to overheated fuel in the reactor cores, hydrogen explosions in three reactor buildings, and radiation releases that contaminated surrounding areas and resulted in the evacuation of about 500,000 residents. According to World Vision: “The direct economic loss from the earthquake, tsunami, and nuclear disaster is estimated at $360 billion … and caused overwhelming damage and humanitarian needs that required an international response.” So, one hazard triggered several other risk exposures in a cascading manner, including a significant uptick in cancer diagnoses throughout much of the region. I lived about 100 miles away at the time, with no known health issues, but twenty months later was diagnosed with Stage IV cancer (now in remission). Was that causation or correlation?

Your Conjectures Welcome

I’ve offered suggestions regarding how the current coronavirus pandemic might trigger compounding risks spread over the next dozen years. None of us know how the future actually will unfold, which for better and worse is one of the beauties of life, but you’re encouraged to share your thoughts

References

Briefings, “The world should think better about catastrophic and existential risks”, The Economist, June 25, 2020 edition. https://www.economist.com/briefing/2020/06/25/the-world-should-think-better-about-catastrophic-and-existential-risks (Downloaded July 1, 2020).

Coburn, A.W.;, Bowman, G.; Ruffle, S.J.; Foulser-Piggott, R.; Ralph, D.; Tuveson, M.; 2014, “A Taxonomy of Threats for Complex Risk Management” , Cambridge Risk Framework series; Centre for Risk Studies, University of Cambridge. https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/risk/downloads/crs-cambridge-taxonomy-threats-complex-risk-management.pdf

Woo, G., “Downward Counterfactual Search for Extreme Events”, Frontiers in Earth Science, 7:340, Dec. 2019. https://www.researchgate.net/publication/338046148_Downward_Counterfactual_Search_for_Extreme_Events (Downloaded July 3, 2020).

World Economic Forum, “The Global Risks Report 2020”, January 15, 2020. https://www.weforum.org/reports/the-global-risks-report-2020

World Vision, “2011 Japan earthquake and tsunami: Facts, FAQs, and how to help“, https://www.worldvision.org/disaster-relief-news-stories/2011-japan-earthquake-and-tsunami-facts (Accessed July 3, 2020).

— Jerry Platt, Ph.D., Emeritus Professor of Finance, San Francisco State U.

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