Risk and Uncertainty

Need to distinguish between risk and uncertainty. Risk is a "known unknown" while uncertainty is an "unknown unknown". This concept refers to

- "known known" refers to when a question has an exact answer

- "known unknown" refers to a question with an imprecise answer

- "unknown unknown" refers to when we don't know what question to ask, ie it is not being considered; it can not be imagined; it is as though it does not exist

As binary categories of either "predictable" or "unpredictable" are very rare, we need to handle uncertainty by using probability, ie based on past experience, there is a certain probability of the event happening again

We need to be careful not to mistake "unfamiliar" for the "improbable" or "unlikely" or "unimaginable", eg

- Pearl Harbour attack by Japan in WW2

- Cuban missile crisis

- 9/11 terrorist attack on World Trade Centre

Some financial "unknown unknowns" examples and their impacts

- Switzerland (January 2015) - Swiss National Bank abandons its 3-year currency cap of 1.20 franc to the euro, sending the currency skyrocketing by more than 30% against the euro in minutes

- Russia (December 2014) - Russian Central Bank increases interest rates from 10.5 to 17 percent (the largest one-day increase since 1998 Russian financial crisis). It was designed to store up the collapsing Russian ruble and stave off skyrocketing inflation, but instead triggered further panic in the Russian markets and the ruble plummeted, hitting a low of 80 against the US dollar

- USA (1994) - US Federal Reserve increased interest rates by 200 basic points in a series of unexpected decisions over a two-month period. This impacted bond portfolios and hedge funds; banks plunged into the red

- Britain (1992) - when George Soros placing a US $ 10 b. speculative bet against the UK pound, the Bank of England countered by hiking interest rates by nearly 5 percentage points to 15%; it failed. Sterling was pulled out of the European monetary system and the pound collapsed. Soros's profit was estimated to be over £1 b.; UK Treasury lost £3.4 b.

- Australia (1973) - Australian import tariffs were cut by 25% by the new Labour government led by Gough Whitlam, resulting in hundreds of Australian factories shutting down, manufacturing output plunged by 10% in the year, and over the next 5 years, almost 200,000 manufacturing jobs were lost

  - USA (1971) - US President Richard Nixon uncoupled the US dollar from the gold price; this ended the Bretton Woods system of fixed exchange rates established at the end of World War II. Other currencies were no longer able to peg to the gold standard, giving rise to the notion of globally floating exchange rates for major currencies.

Another example of unexpected events impacting one business is James Packer's casino business. In January 2015, the unexpected change in President & government in Sri Lanka crushed Packer's proposed hotel and casino in the capital, Colombo, as Packer was seen as too close to the previous regime. Then the unexpected Queensland election result in early 2015, resulting in a change in government has delayed the tender for the new casino and entertainment complex in Brisbane. Followed by delays in building Crown Sydney - a $2 b. hotel and casino plan for Barangaroo waterfront development area.

Some more examples include

- negative impact of the movie "Jaws", it sequels and copycats, on the diving industry in the Pacific, especially those firms that encouraged swimming with sharks, ie people did not want to swim with sharks after seeing these movies

- high food prices in the US in 1970s encourage increased corn production. This resulted in the considerably cheaper fructose (corn syrup) replacing natural sugars in processed foods, drinks, etc. This provided the basis for the current obesity epidemic

- when Australian superannuation guarantee was first introduced in the mid-20th century, its purpose was to provide an opportunity for ordinary people to have a half-decent retirement and also reduced the demand on the aged pension. On the other hand, it has evolved into the savings vehicle of choice for the typical high net-worth Australian, owing to changes made to it, like one-off, after-tax contributions to super of up to A$1 m. (James Frost 2016)

- atomic bomb

"...Albert Einstein never worked on the atomic bomb but his research on mass-energy equivalence paved the way for nuclear fusion and the development of humanity's most destructive weapon..."

Cheryl Praeger as quoted by Bo Sen 2019

Unexpectedly and unintentionally, Einstein's research resulted in the development of nuclear weapons

- junk food (with the increasing popularity of the health and wellness trends, McDonald's put salads, wraps and good coffee on the menu and later introduced fresh beef patties. They hoped to win back female customers who had been denouncing unhealthy junk food. It got the women back into McDonald's cafe and resulted in a 30% increase in the quarter pounder-variety burger sales over the next 12 months.

"...represented its biggest operational shakeup since the all-day breakfast..."

Vesna Poljak 2019

Thus the overt push towards healthier foods resulted in an unintended consequence: a significant increase consumption of 'junk food', eg quarter pounder-variety burger.)

- TV & exercise (television exploded in America in the 1950s, ie
"...In 1950, there were 3 million TVs in the United States. By the end of the decade there were more than 50 million.........and millions of new couch potatoes and extra pounds along with them. Lives have become leisurely. The good times have become too good..."

Yancey Strickler 2019

Americans had become overweight. This resulted in President Kennedy making fitness a national priority (1960s) and exercise has since become the norm.

Thus exercise was an unintended, ultimate consequence of the introduction of new TV technology. There is a similar story for organic food and recycling).

- Internet & data collection (initially the Internet was developed for military communications. Then it was seen as a way to increased democratisation by allowing people to express their point of view on a public channel uncensored and to communicate with each other. It was not expected that it would become dominated by a few tech-giants like Google, Amazon, Facebook, etc who would be collecting personal data of its users on a massive scale for commercial use. Now, governments are collecting data for your own purposes.)

None of these events were easily foreseeable!!!!

This is called "mind-blindness" when we believe that we can control our own fate, ie we can control nature (not live in harmony with it)

 

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