black swans

The idea of a Black Swan refers to a highly improbable, but nevertheless devastating event.

Flocks of Black Swans

Prepare for Geopolitical Volatility

The idea of a Black Swan, as popularised by the investor and philosopher Nassim Nicholas Taleb, refers to a highly improbable, but nevertheless devastating event and when it comes to investing Taleb argued that it is likely we will see more of these events than has been the case in the past.

Professor Alan Dupont, a renowned specialist in geopolitics, agrees with Taleb, but believes we can take this argument a step further.

“My argument is that we are going to see flocks of black swans rather than individual black swans,” Dupont says in an interview with [i3] Insights.

The world has entered a stage where volatility in the financial system is combined with an increase in geopolitical volatility and this could result in some very significant changes, he says.

“We are in for an extended period of volatility and it is not just going to financial or geopolitical; it is going to be systemic.

“And it is likely go to be this way for quite a period of time. I’m not talking about this year or 18 months, but if I’m right about this then it will become a defining characteristic of the next 10 – 15 years, because that is often how long it takes for large cyclical shifts in economics and geopolitics to play out,” he says.

China the Challenger

Much of the geopolitical volatility that we are experiencing today is caused by the rise of China as an economic power house.

Increasingly, China is challenging the preeminence of the United States, spurred on by the global financial crisis, which Beijing perceived as foreshadowing an extended period of economic and financial weakness in the US.

The ongoing South China Sea dispute is an example of China increasingly flexing its muscles as it asserts its new power.

Dupont argues that we are living in a period of transition – from the old order, dominated by the US, to a post American world which will be very different.

“The global financial crisis had enormous geopolitical consequences. I believe that the perception of US economic and financial weakness spurred the Chinese into challenging the US position in Asia,” he says.

We’ve had a period of relative peace and tranquillity, particularly in Asia. We haven’t had a major conflict here since 1979 and people started to believe that this was the new normal. War was essentially a thing of the past.

“I think the Chinese thought that the US had come to the end of its dominance in financial affairs, sinking in a sea of indebtedness and increasing beholden to others to support its profligacy.  This provided an opportunity for China to assert itself as a financially strong powerhouse of the world.

“We’ve had a period of relative peace and tranquillity, particularly in Asia. We haven’t had a major conflict here since 1979 and people started to believe that this was the new normal. War was essentially a thing of the past,” he says.

“But now we seem to be returning to an earlier, more fractious time where strategic competition was a defining characteristic of this part of the world. This will have enormous consequences for the business environment as well as political stability.

History tells us that hegemonic change is usually accompanied by conflict. Since the rise of the Portuguese Empire in the late 15th century, every new country to gain world power did so through war, with the exception of the US, which was peacefully handed the baton of global hegemony by an exhausted Britain at the end of World War 2.

“If you look back over the last 500 years, on six of the seven occasions when a rising power challenged the incumbent power there was war.

“We’ve had Pax Americana for 70 odd years and suddenly it is under challenge from a number of global and regional competitors, in particular China. China is a military power, but also a financial and economic power, unlike the former Soviet Union.

“My thesis is that we are seeing a repeat of the long geopolitical cycle,” he says.

Kondratiev cycles

Dupont says that geopolitics, like economics, uses the ideas of long cyclical trends that can last decades or more.

Based on the ideas of Soviet economist Nikolai Kondratiev, geopolitics extrapolates this framework to map shifts in political power.

“When you look at the history of these great cycles, what happens is that as the rising power increasingly challenges existing institutions and norms you get fragmentation of the system and increased volatility.

“That is what I think is happening now. We are on the cusp of a cyclical shift and it will affect everything.”

“My interpretation of long cycle theory is that because we have a smaller, more globally interconnected world the cycles are accelerating, partly due to technology.

“Trillions of dollars are routinely moved around the world instantaneously – literally at the click of a mouse.”

“It is concentrating the volatility and the peaks and troughs are probably larger than they were historically.”

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Unfortunately, no one has all the answers, but the first step to making a sensible decision is to understand what is happening. In an era of heightened volatility and uncertainty a more conservative and granular allocation strategy might be required.

The world has also become more complex, Dupont says. Whereas in the past you only had a few, well-known players on the world stage, today multiple countries are important players as well as non-state actors such as terrorist and transnational criminal organisations.

“It is not just about countries, but it is also about the Islamic States of the world and other non-state actors that are sometimes just as influential as countries.

“You’ve got more players on the geopolitical chess board, moving at greater speed and probably in three or four dimensions instead of two. Think of cyber and space.”

“If you are an investor, then how do you come to grips with this rapidly changing and more complex environment? What does it mean for investment decisions and choices?

“Unfortunately, no one has all the answers, but the first step to making a sensible decision is to understand what is happening.”

“In an era of heightened volatility and uncertainty a more conservative and granular allocation strategy might be required.

“And instead of looking at just equities, you might want to look at small, nimble companies that are better placed to manage risk and adapt to change.

“The people who are best able to identify this pattern shift are most likely to effectively manage risk and prosper,” he says.

See the photo gallery of the [i3] Investment Strategy Forum 2016