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The Next Black Swan Is Right Around the Corner

September 3rd, 2013

black swanDouglas Davenport: Ever since the global financial crisis struck five years ago, investors have been looking ahead in fear and apprehension, anxiously awaiting the appearance of the next black swan.

Nassim Nicholas Taleb developed the black swan theory in his 2001 book Fooled by Randomness and his 2007 follow-up, The Black Swan. Like the occurrence of black swans in nature, these events are rare. What’s more, they tend to come as huge surprises and upend the usual order because they fall outside the realm of normal historical expectations.

The housing bust and subsequent credit crunch qualified as a black swan event because the scope of the damage to the global financial system was disproportionately large, compared with similar events throughout history.

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The next black swan event might be manufactured right here at home.
The next black swan event might be manufactured right here at home.

But even though the stock market has bounced back and the economy is picking up steam, many people are wondering where the next black swan will come from. Some predict a huge storm will hit a major urban area, causing unprecedented damage. Others say a hard landing by the Chinese economy could throw the global financial system back into panic.

But what if the next black swan event is not thrust upon us from an external source, but manufactured right here at home?

Threat of an Artificial Bubble

Lately, President Obama seems to be focusing on the threat of artificial bubbles to the U.S. economy. Last month, he issued four warnings in five days, including during his weekly radio address Aug. 10. “We have to turn the page on the bubble-and-bust mentality that created this mess,” he said.

Some investors are reading the president’s concern as a repudiation of the low interest rate policies implemented by the Federal Reserve under Alan Greenspan, which spawned speculator surges in asset values — first, technology stocks in the late 1990s, then housing prices in the mid-2000s.

Throughout his term as Fed chairman, Greenspan’s successor, Ben Bernanke, has maintained an ultra-accommodative monetary policy designed to spur economic growth. But some are now asking if the elevated prices of stocks and other assets are, in fact, a new bubble that’s bound to burst.

If Obama is worried that this bubble-and-bust pattern will repeat under the Federal Reserve’s current leadership, the thinking goes, he may decide to pass over the central bank’s vice chairman, Janet Yellen, when Bernanke exits the Fed at the end of the year. Yellen is widely considered the favorite for the job, but if the president wants to encourage a change in monetary policy, he may look outside the walls of the Fed. And insiders say he will look no further than his former economic adviser, Lawrence Summers.

Enter Larry Summers

When most Wall Streeters heard that name floated as a candidate, their response was unequivocal: “No way.” They favored Yellen, who would maintain the central bank’s market-friendly stance. Their adamant opposition to Summers seemed to sway sentiment away from him. But many Fed watchers now say Obama still favors Summers over Yellen.

Jack Bouroudjian, CEO of wealth manager Bull and Bear Partners, told CNBC that there’s “a strong backlash from some industry watchers, with one going so far as labeling his potential appointment as a ‘black swan’ event.” That’s because Summers probably wouldn’t continue Bernanke’s easy-money policies.

Summers does have some history battling asset bubbles. In 1997, as President Bill Clinton’s Treasury secretary, he managed the U.S. response to the Asian financial crisis. And he was recognized as the strongest voice in Obama’s ear in the aftermath of the housing bubble’s collapse, when he served as director of the National Economic Council.

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  1. Zac
    September 4th, 2013 at 04:56 | #1

    Black Swans, funny, seem to remember hearing something an awful lot just like just this over a year ago!

  2. Steve
    September 3rd, 2013 at 22:26 | #2

    Black Swan in the US. I see one here in the US id be concerned. Interest rates going up on 10 year US Treasurys. Say they continue and spike upward, then the Interest Rate Swaps Derivatives totally tank. The MSM you won’t hear, but the banks will be screeming for liquidity. Sorry your ATM is closed for the week. Bernakie helicopter will be flying and inflation will be arising because the foreigners don’t like our war parties or our money either.

  3. Rodger Klien
    September 3rd, 2013 at 16:33 | #3

    Guess proof reading isn’t my forte :) .

    Douglas, fact checking is not your forte is it. “ Like the occurrence of black swans in nature, these events are rare.” The Black Swan (Cygnus atratus) is very common, with a current global population estimated to be up to 500,000 individuals in Australia. Go to any fresh water lake in southern Australia and you can find large flocks of black swans.

  4. Rodger Klien
    September 3rd, 2013 at 16:31 | #4

    Douglas, fact checking is not your forte is it. “ Like the occurrence of black swans in nature, these events are rare.” The Black Swan (Cygnus atratus) is very common, with a current global population is estimated to be up to 500,000 individuals in Australia. Go to any fresh water lake in southern Australia and you can large flocks of black swans.

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