Flip through the latest issue of Gulf Weekly.
These are curious times. Recently the Dow Jones Industrial Average (DJIA) powered through the 13,000 level for the first time.
At just about the same time, the dollar’s value against a basket of global currencies was at its lowest since the demise of the Bretton Woods fixed exchange system.
In the UK, the Bank of England expressed concern about the increased risk-taking in the City and the exposure of heavily-borrowed private equity groups.
So what could go wrong? Certainly, the macro-economic backdrop is less favourable than it was. Interest rates are going up across the world – in China, New Zealand, Britain and the euro zone. In the US they are on hold and are unlikely to come down until later in the year. The American economy is slowing. A fall in the value of the dollar, while necessary to reduce the US trade deficit, will add to imported inflation, already rising as a result of higher Chinese prices and oil at close to $70 a barrel.
Nor does the geopolitical situation look that clever.
Kofi Annan was in Berlin recently to lambast the laggards of the G8 for their failure to keep promises made to Africa at Gleneagles two years ago. What went unnoticed was Annan’s view that a broadening of the Middle East conflict to Iran risked sending oil prices to $120 a barrel. Despite its travails in Iraq, the Bush administration is still taking a hawkish stance over Iran’s nuclear ambitions; military action – air strikes rather than an invasion – is still an option.
And yet the stock markets float serenely upwards, as if they had not a care in the world. The great and the good of the financial markets have a rationale for this, which goes as follows.
Share prices are high because corporate profitability is high. Corporate profitability is high because the global economy is growing rapidly, with demand more evenly spread around the continents than it was three or four years ago. There may be risks out there, but these risks are both discernible and quantifiable. The chances of a serious market disruption are, therefore, extremely slim and the likelihood is that stock markets will ride out any short-term problems caused by a touch more inflation or slightly tighter monetary policy.
This is a comforting analysis. It may also be hugely complacent. Nassim Nicholas Taleb certainly thinks so. His new book, the Black Swan, is a fascinating study of how we are regularly taken for suckers by the unexpected. Why Black Swan? Well, apparently, before the discovery of Australia it was assumed that all swans were white because nobody had ever seen one of a different shade. It took only the sight of one black swan to disprove a theory based on millions of previous observations.
Taleb argues that there are three attributes of a Black Swan. The first is that they lie outside the realm of regular expectations, with nothing that has happened in the past able to point to its possibility. The second is that they have a huge impact. The third is that despite being unforeseeable, human nature means we construct convincing explanations for the appearance of a Black Swan once it has happened.
Markets tend to work on the basis that Black Swans either don’t exist or appear with such irregularity that they are not worth worrying about.
By larry elliot
