Quantifying Black Swans

An essay identifying and quantifying potential black swans relevant to the financial markets and to the world.


Introduction

Taleb’s term ‘Black Swan’ refers to an unexpected, rare event (or chain of events) of major impact, typically eluding foresight and rationalized with hindsight. Recent examples include the 2001 US terrorist attacks, the 2004 Indonesian tsunami and the 2010 flash crash (Dow 1000 points in a day), the internet transformation and the discovery of DNA identification.

Periodically, the media bring a potential ‘unfriendly’ black swan into focus and create a climate of fear, only for little or nothing to happen and interest to be eventually lost. Think Y2k bug, new Ice Age, Bird Flu, Nuclear Fallout, Mad Cow Disease. Of course ‘fear sells’, but the themes in that list are actually all still valid. Y2k came to nothing, but a paralysis of our IT-based world by a virus pandemic or geomagnetic superstorm is possible. Similarly a major biological pandemic is a real threat, even if bird flu and mad cow disease didn’t deliver. Climate change is occurring, and local nuclear conflict between neighboring countries would have global fallout implications. We know from history that the Earth has experienced large asteroid collisions, supervolcano eruptions and mass extinctions. So we have to stay alert to, and monitor, potential major black swans, and not dismiss as scaremongering.

In this 21st century, trying to identify and quantify potential black swans might be particularly fruitful because we are under threat from exponential trends in population, natural disasters, climate change, species extinction and debt. However, we must not overlook the probability of ‘friendly’ black swans from exponential technological evolution. We might identify Artificial Intelligence, biotechnology, nanotechnology, alternative energy, geoengineering and space exploration as possible generators of paradigm shifts in the years ahead, such as previously experienced with the invention of airplanes and computers, for example. Broadly speaking, these technological black swans would support economic growth and be positive for financial markets, whereas the ‘unfriendly’ black swans would provide growth shocks and potential commodity price spikes, or something much worse for humanity.

By their very nature, black swans are difficult to predict. The aim of this article is to quantify ‘known’ black swans as well as likely sources of ‘new’ black swans, but we have to accept that occasionally the world will be surprised by something that failed to register in a document such as this. How might we prepare for events of major impact which are difficult to predict or even difficult to conceive of? Well, the slogan might go something like: make an allowance for the unpredictable, or expect the unexpected. In practical terms this would mean: spread your risk, don’t go all in (both apt for traders), make some general defense provisions or at least know your plan, own some hard useful assets, nurture a network of relations with other human beings, be flexible, seize opportunity and find a balance between working for the future and living for the now.


Asteroid

Averaging every few hundred thousand years, an asteroid large enough (a few miles across) to cause massive devastation (a ‘great dying’) hits Earth. We therefore scan our solar system for NEOs (Near Earth Objects) but recently several ‘near misses’ (tens of thousands of miles away) by large objects were not detected until they had passed. Approximately once a year an asteroid several metres across will hit our atmosphere, sometimes the size of a bus. However, at this size the rock explodes on entry and falls to the ground in small fragments. None of the known potentially hazardous space rocks of 100m or greater are on a collision course with our planet currently, but astronomers are finding new ones all the time. There is still some way to go in completing detections and implementing some degree of prevention for this threat.

If we do successfully detect an asteroid or comet on course for a direct hit, we have several options depending on the object’s size. For the smallest NEOs, co-ordinated evacuation and shelter would suffice. Using spacecraft to exert slow push/pull gravity force would work on NEOs tens of metres to hundreds of metres across, but would require decades of warning. Flying a spacecraft directly into an NEO to change its orbit could defend against moderately sized objects up to 1 kilometre wide, but would also need preparation several decades before impact. Finally, detonating a nuclear device close to a large NEO is the only current practical means of dealing with objects several kilometres or miles across. Whilst all these methods are conceptually valid, none are ready to be implemented at short notice. However, there are current plans to send spacecraft to attempt the forcing and crashing options.

In summary, an asteroid is a potentially catastrophic black swan, capable of mass extinction (megatsunami, landfire, sunblock, major climate change), for which we currently have no defence. It is a certainty that at some point in the future, an NEO of high impact will head for the Earth. The question is whether the human work in progress to identify and successfully create defences is achievable by that point, if humans are still in existence.


Supernova

A supernova is a stellar explosion that can radiate as much energy as the Sun is expected to emit over its entire lifespan. One would need to be within about 100 light years of the Earth to severely deplete the Earth’s ozone layer, which would severely impact the planet’s biosphere. Gamma radiation emitted by the supernova could threaten the Earth with an energy equivalent to 1,000 simultaneous solar flares and the production of nitrous oxides in Earth’s atmosphere by the gamma rays would be the destroyer of the ozone layer. On average, supernovae occur about once every 50 years in a galaxy the size of the Milky Way. The nearest supernova candidate is IK Pegasi (HR 8210), located at a distance of 150 light-years. This closely-orbiting binary star system consists of a main sequence star and a white dwarf 31 million kilometers apart. The dwarf has an estimated mass 1.15 times that of the Sun. It is thought that several million years will pass before the white dwarf can accrete the critical mass required to become a Type 1a supernova. However, a supernova could occur unpredictably, somewhere within reach of Earth, because they arise from dim, common stars, so we cannot rely on early detection. The proximity is key. Partial or total destruction of our ozone layer would expose life on Earth to harmful radiation. Conditions on our planet would become hostile.

Supernova

Image: Nasa

In summary, a supernova is a potentially catastrophic black swan, for which there is no defense. We have not currently detected any potential supernovae near enough in time or space to pose a threat, but detection remains a work in progress, as with asteroids.


Supervolcano

Geologists recently became aware of supervolcanoes on Earth and their potential for super-eruption. There are six known supervolcanoes: Yellowstone, Long Valley, and Valles Caldera in the United States; Lake Toba, North Sumatra, Indonesia; Taupo Volcano, North Island, New Zealand; and Aira Caldera, Kagoshima Prefecture, Kyushu, Japan. Such supervolcanoes are now thought to have been responsible for some mass extinctions in the past. An eruption of the Lake Toba supervolcano around 74,000 years ago is believed to have eradicated 60% of the world’s human population.

There is an inverse relationship between eruption size and frequency. It is estimated that smaller supervolcano eruptions may occur perhaps every 3000 years on average, whilst the very biggest supervolcanic eruptions may take place only once in 500,000 years. We may be able to detect a forthcoming eruption through advances in seismology technology, but this is not guaranteed. Even if we could, we would not be able to prevent the subsequent planet-wide dense and persistent cloud of debris in the atmosphere that would block out sunlight and produce a large-scale death of plant and animal life. A supervolcano could also cause a megatsunami.

In summary, a supervolcanic eruption is a potentially catastrophic black swan. It is considered that in terms of risks to human civilization, supervolcanoes pose one of the bigger threats, as the frequency of devastation in the past has exceeded asteroids, for example. We may be able to detect such an eruption in advance, but there is no defense.

Supervolcano

Supervolcano locations – Source: solcomehouse.com


Geomagnetic Superstorms

Geomagnetic storms can have a biological effect on humans and can disrupt communications, navigation, satellites and power grids. Solar activity produces geomagnetic storms on Earth and the chart below shows how cyclical peaks in solar activity precede peaks in geomagnetic storms.

Geomagnetism

Source: Susan Macmillan, British Geological Survey

The last really powerful superstorm happened in 1859 and caused aurorae all over the world. Telegraph systems all over Europe and America failed and there were many electric shocks and fires. However, in 1859 the world was fairly agricultural and mechanical. In today’s world of electricity grids, satellites, television, radio, telephones and internet, a repeat of such a superstorm could cause massive system failure and a short term global crisis.

In summary, a geomagnetic superstorm is a potential black swan that is more frequent, but less devastating in impact, than an asteroid, supernova or supervolanic eruption. As we have not experienced a superstorm since the world became so dependent on electricity and telecommunications, the impacts are not fully understood, but an economic growth shock is likely. Areas of the Northern Hemisphere are most at risk from geomagnetic storms, such as the USA and Northern Europe.


Pandemic

The spread of a new killer disease, plague or virus is is one of mankind’s biggest threats, based on likelihood, risk and impact. Due to global travel, new biological strains can quickly spread around the world. However, the very worst plagues in the past always found at least some resistance, so a population cull of perhaps 60%, rather than a species extinction, would be the worst possible outcome.

Pandemic

Source: UNSW

As well as biological pandemics, we are also vulnerable to electronic virus pandemics. Our world is now very much dependent on interconnected information technology systems. A major new kind of virus could quickly wreak havoc on communications, navigation, distribution and processing.


Alien Invasion

The nearest star to our sun is 4 light years away, or 75,000 years by rocket at our current spacecraft speeds. Stars on the other side of our galaxy are thousands of light years away, and other galaxies millions of light years distant. Biological beings that have evolved on a planet orbiting a star elsewhere in the Universe would face the same constraints as ourselves: the laws of physics, the incredible distances involved in space, and the interdependence with their own environment. They would also undoubtedly face similar ‘economic’ issues: dedicating resources to a prohibitively expensive interplanetary attack would be resources not applied to local needs.

On Earth we compete for resources, hence conflict. So let’s assume an alien race finds itself needing a new planetary home, as their own planet has become inhospitable, and identifies our own planet as a suitable destination (as we believe conditions for life elsewhere will be fairly similar to our own planet’s make-up and position). Maybe then we have a potential resource conflict in space. However, their race would still have to somehow overcome the distances involved, and they would also need to be an aggressive race with no interest in our ‘discovery’, only our extermination. This black swan, is therefore particularly remote.


Overpopulation, Exponential Debt, Peak Resources, Climate Change, Ecological Disaster

Exponential trends in population, consumption, debt (which is brought forward consumption) and economic growth are unsustainable in a world of finite and non-renewable resources. On current trends we are heading for peak energy (where demand permanently exceeds supply), water scarcity and human population hitting the Earth’s carrying capacity all within the next 50 years.

Growth-based capitalism, which has become the dominant system globally, does not account for pollution, climate change and falling biodiversity. The consequences thus far include exponential global temperature, exponential natural disasters (from floods to storms to earthquakes and volcanic eruptions), and an exponential rate of species extinction on par with previous mass extinction events. On current trends we are heading for cross-eco system collapses and serious climate change disruptions by mid-century.

Extinction

Source: UGCS

In the decades ahead, our exponential debt-based money system, and associated inflationary policies, threatens to accelerate to a conclusion of system collapse, sovereign default or exponential inflation (hyperinflation) – as it is an unsustainable system.

See Appendix A for charts of all these exponential phenomena.


Technological Paradigm Shift

Due to the exponential pace of technological evolution, it is highly likely that in the years ahead we will see increasing numbers of and increasingly frequent paradigm shifts that will alter life in major ways we may not be able to imagine. We can identify certain potential candidate areas: Nanotechnology, Biotechnology, Artificial Intelligence, Space Exploration, Geoengineering and Alternative Energy. But ultimately we cannot envisage all. From past examples, electricity and the internet are two such phenomena for which we had little foresight. Major technological shifts from the past century also include the motor car, the airplane, computers, mobile phones, and DNA identification.

Unless we reduce global population and switch to steady-state economic systems then it will become a question of whether exponential technological evolution can delay the end games for exponential debt, species extinction, climate change, and peak resources. Technological evolution will also determine the extent to which we ultimately can cope with other black swans such as asteroids, biological pandemics and other potential disasters. That makes Technological Paradigm Shift the black swan of hope, and yet it also generates its own ‘unfriendly’ black swan gaggle, such as electronic virus pandemics, chemical warfare attacks and nuclear conflict.

Computing

Source: Ray Kurzweil


Nuclear Conflict

At least 9 countries are known to possess nuclear weapons. A small-scale, regional nuclear war between two countries is estimated to be capable of producing tens of millions of direct fatalities and disrupting the global climate for a decade or more (soot into the atmosphere resulting in global cooling by several degrees for several years), bringing about famines and eco system disruptions. A large global nuclear war involving 30% of the world’s nuclear arsenal would bring about a greater climate cooling than any previous ice age, resulting in no food production for several years, potentially eliminating humanity.

Economic hardship is closely associated with war. Another Depression could usher in protectionism, conflict, civil unrest and potentially the election of hardliners more inclined to use force. War cycles suggest a 30 year cycle of war could erupt around mid-century. By that time trends in peak resources, climate change, overpopulation and debt could have reached crunch point, providing a multi-layered backdrop for conflict.

Nuclear


Conclusions

There are several potentially cataclysmic black swans, such as a large asteroid collision, a nearby supernova, a major supervolcano eruption or a large scale nuclear conflict. For the individual seeking to collectively mitigate these most devastating of risks, preparation might go something like this:

Build a large fireproof bunker with an air filtration system. Drill a water borehole or a well down to the water table. Buy a gravity based water purifier and a supply of long-lasting foods. Honey, sugar and salt (in suitable storage containers) and unopened distilled spirits all never go off. All other foods have a finite life but dedicated retailers like sell dried and tinned foods specifically prepared to last up to 25 years. Keep a survival guide book and a stock of slow burning candles and matches. Purchase a protective suit with radiation shielding in the lining plus helmet (a hazmat suit) for each member of your household.

Whether investing in such a defense is worth it, given the ultra low frequency of these natural phenomena, the relatively low likelihood of a large scale nuclear conflict, and the likely common bleak aftermath into which the defendant would survive, is a matter for personal consideration. For a pandemic, the individual could implement healthy living to maximize resistance and increased personal and domestic hygiene to minimize chance of contagion. For infotech or telecoms electronic infections or debilitations (geomagnetic storms, viruses), he or she might anticipate distribution grinding to a halt by keeping emergency food and fuel supplies or embracing self-sufficiency.

But the average person (and the trader) might wish to give maximum focus to the gaggle of potential black swans ahead that is the crunching of unsustainable exponential trends in population, growth, debt, resource usage, climate change and species extinction. Crunch points might include a deflationary depression, hyperinflation, eco-system collapse, mega natural disasters or resource exhaustion, and on current trends we are likely to be flirting with all within next 50 years. We therefore need to be alert to ‘events’ as we remove links from the food chain (species extinction), break interlinked eco systems, spend up the natural resource heritage, drive up trends in natural disasters, increasingly bring forward consumption, and push the Earth’s human carrying capacity. It is highly unlikely that the world pro-actively moves to steady-state economic systems with population growth reversal and a complete new infrastructure not based on fossil fuels, until the situation is forced. It falls then to technological evolution – ‘friendly’ black swans – to delay hitting these limits. For instance, the global roll-out of a genuinely scalable renewable energy source and the successful harnessing of nano-engineering at the molecular level (which allows us to create any substance) would help cut natural plundering, global pollution and reliance on natural harvests. Geoengineering solutions could perhaps stop or reverse global warming, and AI might provide massive productivity gains which could reduce dependence on debt. So in contrast to the theme of defense against the other black swans, ‘attack’ would be appropriate for these ‘friendly’ black swans, by pursuing and investing in technological evolution.


Appendix A: Exponential Phenomena

1. Exponential phenomena occur in nature and typically end with a collapse down the other side, as echoed here in human population scenarios:

Population

2. Energy (with predicted collapse):

Energy

Source: Oildrum

3. Species extinction:

Extinction

Source: USGS

4. Global warming:

Temperature

Source: NOAA

5. Droughts and Floods:

DroughtsFloods

Source: emdat.be

6. Hurricanes (tropical storms or cyclones):

Hurricanes

Source: Globalwarmingart.com

7. Tornadoes:

Tornado

Source: High Plains Regional Climate Center

8. Tsunamis:

 Tsunami

Source: National Geophysical Data Center/World Data Center

9. Earthquakes (black line):

Earthquakes

(Red Line: Solar Cycles)

10. Volcanism:

Volcanism

 Source: Michaelmandeville.com

11. Global debt:

Debt

Source: Goldcore

 

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4 thoughts on “Quantifying Black Swans

  1. Fantastic work John.

    I recently had the inclination to check the population density of the planet and its estimated carrying capacity for different ways of life.

    Using these two pages:

    https://metinmediamath.wordpress.com/2013/10/23/how-much-habitable-land-is-there-on-earth-per-person/

    http://www.trunity.net/sam2/view/article/51cbf44b7896bb431f6af515/?topic=51cbfc9ff702fc2ba8130178

    I was shocked to see that we are, right now, hitting 100 people/km^2, which is only sustainable using farming and modern farming methods. As someone with a “Daniel Quinn” view of the world, this is worrying and suggests to me that we are really at the limit before we descend into the unknown world of limited biodiversity…

  2. John H, thanks very much for this very well thought through and explained essay.

    The charts in the Appendix clearly do show a rising trend. However I was wondering if you had any sense of the ‘inherent’ distortion that may exist simply because volume of information recording has improved in and of itself, as well as it’s accuracy over the time periods compared?

    1. That is indeed an argument put forward and may partly account. However, data recording has been pretty consistent for 30 years now and we still see rising trends if we just isolate that period.

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