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Cascading Black Swans – 2018

Space Shuttle Discovery LI-900 silica tiles – Hold on! It’s going to be a bumpy ride.

December 30, 2017

By Richard L. Wottrich, Senior Consultant, International Services 

There are shadows in 2018 that are contradictory.

Central banks are turning off the stimulus spigots at an excruciatingly slow pace. Yet the entire U.S. yield curve is flattening and a steep credit market correction is in the cards. A Danish energy company just issued a 1,000-year bond with a maturity date of 3017, and some corporations are selling negative interest rate bonds. Global stock markets are at record highs, yet extraordinarily low volatility across most asset classes belies investor worries.

Total global debt has topped 325 percent of total GDP as government sovereign debt jumps past $63 trillion [Pew Research Center analysis of International Monetary Fund data]. China’s shadow banking assets grew more than 20 percent in 2016 to 64 trillion yuan ($9.8 trillion), equivalent to 86.5 percent of GDP. The U.S. unemployment rate has fallen to a 50-year low, yet wages have hardly budged.  And Congress just passed a corporate tax bill that blows a hole in the U.S. budget.

Yet no one seems to be concerned. As Alfred E. Neuman said, “What me worry?”

What are the “Black Swan” risks and events that could cause this ‘Alice in Wonderland’ world to collapse. Or is that just foolish worry. Has exploding technology taken the risk out of humanity’s endeavors? This is our take on plausible Black Swan risks on the horizon.

Electromagnetic Pulse (EMP) Event 

Governments are concerned about North Korea’s burgeoning nuclear weapons program. We however are far more concerned about their ability to create an EMP event, which would detonate a nuclear device in the atmosphere over the United States. This would cause catastrophic damage to the nation’s electricity grid and server farms, resulting in long-term, national power and Internet outages.

You will note that North Korea’s recent intercontinental missile tests go far higher than necessary to deliver a conventional nuclear weapon. But they are just right to deliver an EMP device. North Korea famously has an almost nonexistent electrical grid, which means they are somewhat impervious to an EMP counter attack.

But such an EMP device need not reach the U.S. South Korea is the twelfth largest GDP in the world at $1.5 trillion. Exploding an EMP over Seoul would throw its economy into chaos and rock markets worldwide. Or detonating an EMP over Tokyo would throw the third largest GDP in the world into a tailspin that would demand an immediate counterattack by the U.S. We would be in world war three.

2018 Probability – .37%

Nano Drone Terrorism

The proximate cause of modern terrorism was the coupling of international commercial airlines and smart phones. Suddenly anything was reachable and possible.

Today we are facing the development of inexpensive Nano drones, posing the question, “How can military or security forces cope with swarms of tiny intelligent Nano drones skimming but inches above land or a body of water?”

Imagine if you will a barge loaded with ubiquitous yellow rubbish containers moving slowly up the River Thames through London. One of these containers could be filled with 500,000 Nano insect drones. At an appointed time, a terrorist utilizing a GPS controller and a cell phone could remotely activate aerosols that fill the container with Anthrax spores. The container top could then be opened remotely as the Nano insect drones are activated. With a light wind blowing the Nano cloud of drones could be widely dispersed across London. Even if just five percent of the drones find human targets the potential for 25,000 drone disease agents making contact in a densely populated city is quite high. This is the unknown danger of drone technology in the wrong hands.

2018 Probability – .50%

Tactical Nuclear Weapon Detonation

Pakistan today has the world’s fastest growing nuclear stockpile with over 100 nuclear weapons, according to a report published in 2015. The production of its nuclear stockpile has been associated with an unusual feature: most nuclear warheads produced by Pakistan in the last decade are thought to be low-yield tactical weapons.

It has been speculated for years that small tactical nuclear weapons could fall into the hands of terrorists. Pakistan has faced some devastating attacks on its defense apparatus by jihadists in the past decade or so. This internal chaos, coupled with perpetual tensions with its eastern neighbor, India, makes Pakistan the most dangerous Black Swan in the world.

A tactical low yield nuclear weapon could, for example, be smuggled aboard a freighter and then detonated five miles offshore of Tel Aviv. Estimated casualties could be as high as 10,000, plus the dynamic effects of a tsunami battering 50 miles of coastline. What could we expect Israel to do in retaliation?

2018 Probability – .75%

These examples are just riffs on the theme of terrorism. The fact is, most Black Swan events are unimagined, or as Donald Rumsfeld famously said, “Unknown unknowns.” And more disturbingly, most Black Swan events are the culmination of an unimagined series of unrelated events that cascade into catastrophe.

Cascading Black Swan Events

Imagine a unique electrical vault failure under Manhattan that shuts down electronic trading on Wall Street. North Korea, sensing an opening, triggers an EMP event over Tokyo that shuts down Japan’s electrical grid for 48-hours. While losses cascade across global markets, credit markets freeze up, causing most trading floors to shut down. Now enters the unknown unknown – Iran decides this is a good time to drop a nuclear weapon on Israel. Armageddon.

Farfetched? Perhaps. But in order to plan for unforeseen Black Swan events we need to first imagine them:

  1. Include rather than exclude.
  2. Accept that the improbable will occur, and that the effects may be wide-reaching and not now fully understood.
  3. Understand as much as possible about the conditions under which these improbable effects will become visible.
  4. Define those conditions where cascading effects will occur – trace these linkages through the social fabric to know where the breaks will occur – especially when the impact seems minor at first, so that you can identify it as early as possible
  5. Be alert to gathering evidence that the situation is growing much worse very quickly in multiple areas.

Our Prediction 

Our prediction regarding possible cascading Black Swan events in 2018 is quite simple:

FED overshoots – ECB runs out of ammunition – China’s Shadow Debt crashes 

There you have it – Global Financial Meltdown.

2018 Probability – 5.00%

As Alice said in Alice in Wonderland, “I see nobody on the road.” The King replies, “I only wish I had such eyes; to be able to see Nobody! And at that distance too! Why, it’s as much as I can do to see real people,”

Richard Wottrich, Blog Author – richard.wottrich@gmail.com 

 

 

Six Mega Trends – 2018

“Existentially all the water on earth is all the water we have.” – Lower Tennessee Watershed, Henry County, Tennessee USA – Photo: R. Wottrich

“If you think in terms of a year, plant a seed; if in terms of ten years, plant trees; if in terms of 100 years, teach the people.” – Confucius

Charting global mega-trends is perhaps a fool’s errand, but there is order in the fractal universe – if you know where to look. Certain historical currents run strongly and are perhaps not immediately apparent, but nevertheless their impact will be felt in 2018 and beyond.

1. Insurance and Climate Change

Zillow recently reported that $400 billion in Florida real estate values could be at risk from climate change by 2100. Property insurers will not be willing to insure real estate unless rates are substantially raised. Homeowners will naturally lower coverages to fit their budgets. Many will move away. Behaviors will change.

Meanwhile many homeowners whose homes were flooded by Hurricane Harvey have no flood insurance – they cannot afford it. But a wealthy owner of a $2 million home on Bird Key in Florida gladly pays $25,000 a year for that same flood insurance. That owner knows their claim will likely be in the hundreds of thousands, so the federal flood ‘insurance’ subsidy is a bargain.

Right now insurance rates are set on arbitrary vectors, such as zip codes. But risk analysis and big data will fine tune these methodologies and homeowners at the greatest risk from climate change will face enormous insurance rates – many will move.

These mismatches in insurance coverage and uneven federal flood insurance subsidies will ultimately be reflected at the ballot box, changing political behavior in favor of working to control and plan for climate change.

2. The Energy Revolution

The United States has become the largest energy producer in the world. This is nothing less than a tsunami in the world political order, as the ripples of surging U.S. fracking production of oil and gas reach across the globe. Venezuela, Russia, and other oil producers are struggling with oil under $50 bbl. Saudi Arabia has been forced to sell more oil than seems logical, just to defend its market share. Economies the world over are benefiting from the drop in energy costs, which ultimately will spur their GDPs.

This American shale oil revolution is occurring primarily on private land, as America is perhaps the only nation on earth to allow private citizen ownership of energy assets. When the U.S. federal government loosens antiquated bans on exporting oil, coal to liquid (CTL) and liquefied natural gas (LNG), this revolution will take on even greater importance. The dropping price of oil is a reflection of lackluster global economies, but it will not stop the tide of U.S. energy independence and all that means to the world order.

3. Robotics and the Great Decoupling

The unrelenting convergence of robotics and ‘cloud’ systems integration is putting irresistible pressure on employment opportunities across the globe. Make no mistake, digital convergence is a jobs shredder – it leaves behind a wake of disenfranchised workers ill equipped to jump the cloud-based divide.

This is not a new concept. Erik Brynjolfsson, a professor at the MIT Sloan School of Management, and his colleague Andrew McAfee have been making the case that Moore’s Law advances in computer technology is the proximate cause of anemic jobs growth over the past several years.

To Brynjolfsson the pattern is apparent: “As businesses generated more value from their workers, the country [USA] as a whole became richer, which fueled more economic activity and created even more jobs. Then, beginning in 2000, the lines diverge; productivity continues to rise robustly, but employment suddenly wilts. By 2011, a significant gap appears between the two lines, showing economic growth with no parallel increase in job creation.” Brynjolfsson and McAfee call this the ‘great decoupling.’

4. Water Wars

Water resources are dwindling across America. The Ogallala Aquifer, which sprawls across eight Western states, is the largest and most important agricultural aquifer in America. Estimates are that it will be exhausted in 20 years.

According to the WHO/UNICEF Joint Monitoring Programme for Water Supply and Sanitation (JMP), 37 percent per cent of the world’s population – over 2.5 billion people – lack adequate clean water for bathing and cleaning, and nearly 1 billion people still use unsafe drinking water sources.

Aquifers the world over are being drained by inefficient agricultural irrigation methods. Over 70 percent of the water in the US is used for agriculture. In California almonds account for $11 billion of the state’s GDP and represent 80 percent of the world’s almond production. But it takes over 1,900 gallons of water to produce one pound of almonds, which cost under $7 a pound at Costco. Water rationing is in America’s future and it will not be pretty.

Existentially all the water on earth is all the water we have. But in 1950 our world population was a bit over 2.5 billion, while today it is roughly 7.5 billion. When an advanced civilization visits our earth one billion years from now they will ask, “What were they thinking?”

5. Deconstructing Education

Higher education is still modeled after a centuries-old monastic tradition of exclusionary practices that myopically shower enormous benefits on an exceptionally privileged few. Available data suggests that 50 million students worldwide attend traditional colleges and universities; constituting just .7 percent of the world’s population.

Higher education resources are mismatched. In 2010 only 44 percent of U.S. professors reported that they spent more than 9 hours a week teaching in the classroom. Meanwhile college students have amassed over $1.3 trillion in student-debt, granting universities and colleges what amounts to a stealth taxpayer subsidy and carte blanche to raise tuitions across the board. Higher education tuition has increased 1,000 percent since 1989, as exemplified by a Harvard Professor’s average 9-month salary today of over $225,000.

Meanwhile in New York City, Department of Education (DOE) high school teachers removed ‘for cause’ and other severed tenured staffers remain in limbo. Sources estimate 200 to 400 of these folks sit in ‘rubber rooms’ and are paid for years while awaiting disciplinary hearings. Their salaries total $15 million to $20 million a year; money that could go to teaching children.

But help is on the way. On-line e-learning resources have increased exponentially across the globe, driven by Internet connectivity. You can watch any course taught at M.I.T for free on iTunes U. Major universities are putting substantial education content on-line for minimal or no cost, begging the comparison to matriculation costs of $50,000 a year and higher for ‘in residence’ students.

There are many nuances that collectively define the on-campus higher education experience. There will always be a place for the few who can afford that experience, or for fields such as medicine requiring extensive hands-on real time instruction. But do not for a moment underestimate the enormously disruptive influence of technologies that can educate the hundreds of millions of people across the globe who desperately want an education, which now can be viewed on a smart phone app.

6. Jobs for Young People

Just a few years ago China had a 12.5 percent GDP growth rate versus a U.S. rate of less than one percent. Today China struggled to hit 6.7 percent in 2016, while the U.S. second quarter GDP growth rate was 3 percent. Such volatility should be considered a harbinger of the future.

U.S. workers “not in the labor force” exceeds 94 million; a labor participation rate of 62.7 percent in August of 2017. Yet its unemployment rate for 18-25 workers is 8.8 percent, versus the general unemployment rate of 4.3 percent.

In China over 7 million college graduates poured into its economy in 2016, yet available jobs came with lower income expectations – resulting in 77.2 percent of graduates ‘showing an interest in entrepreneurship.’

Both the U.S. and Chinese economies suffer from mismatched labor markets – critical skilled labor shortages in key industries – as educational institutions struggle to match accelerating employment trends.

The unemployment rate across the European Union remains above 10 percent, but the larger problem is the EU’s inability to employ its young people. In Italy real unemployment is roughly 15 percent, but exceeds 45 percent for its young people! Unions and governments protect employed union workers, who represent a ‘set-in-place’ aging workforce. Young workers are left out in the cold.

A recent EU Higher Education Authority (HEA) survey shows that one in four EU graduates who found employment last year were working overseas, compared to one in ten in 2008. This represents an EU brain drain that it can hardly afford.

Perhaps the overriding question facing economies across the globe is, “How can we employ our own young people?”

Richard L. Wottrich, CEO & Senior Consultant, DSI Global View LLC

The Uncertainty Principal

The ‘observer” and the observed, Andy Warhol Exhibit, High Museum of Art, Atlanta USA [Photo: R. Wottrich]

The Uncertainty Principal was first articulated in 1927 by the German physicist Werner Heisenberg. It states that the position and the velocity of an object cannot both be measured exactly, at the same time, even in theory. The very concepts of exact position and exact velocity together, in fact, have no meaning in nature. Only with exceedingly small masses of atoms and subatomic particles does the product of the uncertainties become significant. “Any attempt to measure precisely the velocity of a subatomic particle, such as an electron, will influence it in an unpredictable way, so that a simultaneous measurement of its position has no validity. This result has nothing to do with inadequacies in the measuring instruments, the technique, or the observer; it arises out of the close connection in nature between particles and waves in the realm of subatomic dimensions.”

But in the world that is our reality we have ‘observed’ what seems to be the Uncertainty Principal at work when buyers circle a company that may be in play as an acquisition. The very knowledge that buyers are ‘observing’ a corporation as a potential acquisition can cause the target’s ownership to change their behavior. The most common question I receive once an offer has been tendered for a company is, “What should we do now?” The correct answer is that ownership should run their business as they always have, but in practice this often isn’t the case. In one case a private seller injected personal cash into the business to meet cash-on-hand requirements, which in turn influenced the purchase price upwards based on the EBITDA multiple being paid.

Once it is clear that a transaction is possible sellers tend to become more conservative. A risk that they might have taken previously to grow the business, suddenly is perceived as a threat to the purchase price. Capital expenditures that would normally be made, are now seen to drain cash and potentially impact the control numbers that set the price. New employee hires that would usually be considered as additive to the business, now may be put off in favor of not expanding the payroll. An increase in the company’s bank credit line to fund routine growth may be delayed in anticipation of the closing of the acquisition.

Buyers compound this behavior by the very terms of their proposed offers. They insert financial control numbers that cause the seller to become risk adverse, lest they drop the price by opening new business opportunities. They insert debt-equity ratios that discourage adding debt to fund new business. They insist on employment contracts with key executives, which as anyone might imagine causes those executives to think long and hard about taking any business risk that might backfire on them. They insist on a closing audit that freezes the company at a point time, which is the dynamic opposite to how companies live and breath. It is only natural that the sellers seek to keep their company exactly as it was when the offer came in. In essence, the buyers freeze the seller into a defensive position that usually will have an adverse effect on the growth of the business.

I call this the Big Game Hunter Effect. The buyer views the acquisition target as a trophy – in stasis. To the contrary, the buyer should view the company for what it is – a living dynamic entity that is moving upward and onward. The buyer should propose terms that partner them with the sellers from the day the offer is accepted. The purchase agreement terms should allow leeway for normal and customary decisions that can be supported  as correct for the business. the purchase agreement should not penalize the sellers for taking risks and investing in new business that is consistent with the reason the buyers find the company to be attractive in the first place.

Richard Wottrich, DSI Global View LLC

 

 

 

Spooky Action at a Distance

Spooky Action at a Distance – In July 2017, a Chinese team of scientists, led by Ji-Gang Ren at the University of Science and Technology in Shanghai, confirmed Spooky Action at a Distance in a satellite entanglement experiment (Photo: Shanghai by R. Wottrich)

By Richard L. Wottrich, CEO and Senior Consultant, International Services, July 29, 2017, Atlanta USA 

Code Talkers

When the U.S. entered World War I, encryption of Allied communications was a major problem, as their codes were generally based on either European languages or mathematical progressions. The Germans routinely broke their codes. Sending out runners proved ineffective, since about one in four runners were captured or killed. Other methods, such as carrier pigeons, or signal rockets, were slow and unreliable.

During the war, over ten thousand Native Americans enlisted in the U.S. armed forces to fight the Central Powers, even though America had not yet granted them citizenship. Near the end of the war, on October 26, 1918, members of the Choctaw tribe were put to use for the first time using their native language as a code. They played a major role in an attack on a strongly fortified German position, Forest Ferme. “The enemy’s complete surprise is evidence that he could not decipher the messages,” Colonel A.W. Bloor later wrote in an official report.

These so-called “code talkers” were utilized to even greater effect in World War II, when the U.S. government specifically recruited Chippewa-Oneida, Comanche, Hopi, Meskwaki, and Navajo tribal members. The Navajo code talkers developed the most complex code, with over 600 adapted Navajo terms, for use in the Pacific Theater. The Germans did not decipher a single code talker message in either world war. The encryption key (their language) was known to all tribal code talkers, but completely unknowable to the Germans.

Today with Big Data, super computers and complex algorithms, codes can be broken through sheer brute force in ever shorter time periods. What can insure security in encrypted transmissions?

Spooky Action at a Distance

Albert Einstein’s “Spooky Action at a Distance” paradox was first discussed in the early 1930s in his battle with Bohr over the completeness of quantum mechanics. Spooky Action was the result of thought experiments announced in 1935 by its inventors Einstein, Boris Podolsky, and Nathan Rosen.

Spooky Action at a Distance refers to what is today called Entanglement. It’s a phenomenon by which one particle can effectively “know” something about another particle instantaneously, even if those two particles are separated by a great distance.

Tribal code talkers in a sense were similar. They ‘knew’ a common language – the encryption key – hence they could read any message. But suppose you were an observer outside of the tribe (like the Germans were); hence looking in from a distant vantage point. All you could deduce in that case would be that the code talkers were “entangled.”

We are like the Germans, when we act as observers “looking in at a distance” to measure entanglement experiments. The paradox of Spooky Action at a Distance in the world of quantum mechanics is that it seems to violate the axiom that nothing can exceed the speed of light. The paradox is that we do not know how the ‘message’ is transmitted from one particle to another.

Chinese Entanglement Experiment

In July 2017, a Chinese team of scientists, led by Ji-Gang Ren at the University of Science and Technology in Shanghai, fired a laser from a station in Tibet to a satellite 1,400 kilometers above the Earth’s surface. Millions of photon pairs were created. The pairs were then split and sent back to separate receiving stations in Delingha and Lijiang, 1200 kilometers apart. The scientists then entangled a third set of photons and measured the quantum states of the original photon pairs. The scientists found that the photon pairs had opposite polarizations far more often than would be expected by chance, thus confirming spooky action over a record distance.

These results are based on large numbers. The scientists recovered only about one photon out of every six million sent from the satellite — better than ground-based experiments, but still far too few for practical quantum communication. However, when a more reliable quantum entanglement connection is achieved, it would be theoretically unhackable, which means that people could use it to securely transport information. Any attempt to hack either of the entangled photons would be immediately evident to the sender and the receiver.

“This is the first time you have a quantum channel between a satellite and the ground that you can actually use,” said Norbert Lütkenhaus, a professor at the Institute for Quantum Computing at the University of Waterloo in Canada.

Quantum Key Distribution

Quantum Key Distribution (QKD) uses quantum mechanics to guarantee secure communication. Inherent in entanglement is that any two communicating users could detect the presence of any third party trying to gain knowledge of the key. Hence a fundamental aspect of quantum mechanics is that the process of measuring a quantum system in general disturbs the system. A third party trying to eavesdrop on the key will introduce detectable anomalies.

QKD is only used to produce and distribute a key, not to transmit any message data. This key can then be used with any chosen encryption algorithm to encrypt (and decrypt) a message, which can then be transmitted over a standard communication channel.

Quantum cryptographer Artur Ekert, a professor at the University of Oxford and director of the Centre for Quantum Technologies at the National University of Singapore, said, “There is still a way to go before it [QKD] becomes a standard commercial proposition, but we are getting there faster than I expected.”

ID Quantique (IDQ)

It’s later than you think. ID Quantique (IDQ), located in Geneva, Switzerland, has been providing “Quantum-Sate Crypto” since 2001. IDQ was founded as a spin-off of the Group of Applied Physics at the University of Geneva. IDQ is a world leader in quantum crypto solutions, designed for the long term protection of data. IDQ provides quantum network encryption, secure quantum key generation and QKD solutions and services to the financial industry, enterprises and government organizations globally.

IDQ also commercializes a quantum random number generator, which is the reference in the gaming and lottery industries. In the world of quantum research, IDQ is a leading provider of optical instrumentation products including photon counters. IDQ was the first company to bring a QKD system to a commercial market in 2004.

Other quantum cryptography companies include Qubitekk (CA USA), QuintessenceLabs (Australia), Nano-Meta Technologies (IN USA), and Post-Quantum (UK).

These companies have scores of strategic partners including major banks, governments and multi-national corporations. Quantum crypto solutions are not theoretical any longer, but rather are being integrated into the IT fabric of the world as we contemplate Spooky Action.

Richard L. Wottrich