Facing our "Gray Rhinos" with Michele Wucker
A conversation with author Michele Wucker on Gray Rhinos vs Black Swans, Climate Change, Financial Fragilities, Inequality, The Robinhood Trader, Korean Pop Culture, The Debt "Albatross" and More
On July 17, 2017, the government-controlled People’s Daily of China ran a front page editorial warning financial regulators of the need to “defuse financial risks, especially systemic ones.” The piece warned against the perennial “black swan” event, but also suggested precautionary measures against a “gray rhino” event.
Several thousand miles away, in Chicago, Michele Wucker, author of The Gray Rhino: How to Recognize and Act on the Obvious Dangers We Ignore, could hardly have known that the concept she first unveiled in Davos in 2013 (see the 6 minute talk here) and published in a book in 2016, would be part of an editorial that led to a sharp sell-off in China’s markets the next day.
Shortly after the editorial was published, China's small-cap Shenzhen index dropped 4.3%, and the ChiNext, which focuses on high-tech companies, dropped 5.1% to close at its lowest point in 2 years.
“It was a wild moment,” she told me recently. “I had just come back from a trip to New York and when I got home and opened my email it was full of messages from friends in China and from reporters requesting interviews. I went to a cocktail party that evening, where people making small talk asked what I had been up to that day. Little did they expect the answer to be ‘crashed Chinese stock market prices’,” she joked.
I recently had a conversation with Michele, someone I’ve known for many years and always found to be very insightful. We touched on a wide range of issues, including:
today’s gray rhinos (climate change, inequality, financial fragilities)
the day she and her term — the “Gray Rhino” — helped tank the Chinese stock market
Debt Sustainability (she calls today’s massive debt “an albatross” dragging down poor countries)
the Robinhood Trader vs the Big Institutions (“This is not going to end well.”)
her upcoming book (You Are What You Risk)
what she is watching, listening to and reading: (Korean pop fare from Empress Ki to K-Pop band BTS, who used “gray rhino” in one of their songs).
Even beyond the stock market fall, what was striking to Wucker at the time was how Chinese authorities and analysts immediately embraced the concept of the Gray Rhino - high impact, highly probable events that we are more likely to ignore than we’d like to think, “but not condemned to do so,” she adds.
In the Western world, “black swan” events were on everyone’s minds from Nassim Nicholas Taleb’s best-selling book, which was published right before the Great Financial Crisis and which policy makers and the financial industry “misused as a convenient cop-out for the missed warnings that led to it,” Wucker told me. The gray rhino concept took a bit longer to gain traction.
But in China, Wucker said, “they got it right away.” It went into three printings in the first month after it was published early in 2017, and her concept became widely used in Chinese media. The Chinese edition of the book was prominently displayed on President Xi Jinping’s bookshelf in a 2018 speech, and he referred publicly to gray rhino risks in major speeches in 2019 and again in January of this year.
In our conversation, I asked her to start with the day after the People’s Daily editorial tanked China’s markets, and then we moved on to discuss today’s gray rhinos and her new book, You Are What You Risk: The New Art and Science of Navigating an Uncertain World.
Michele Wucker’s comments lightly edited below, with some in bold (as chosen by Emerging World):
The Gray Rhino in People’s Daily and The Day China’s Markets Crashed
In July 2017, economic policy makers discussed the gray rhino extensively at the National Financial Work Conference, focused on financial policy strategy for the next five years. The closing remarks referenced financial risk gray rhinos. The next day there was a front-page editorial in People’s Daily warning of the need to watch out not just for black swans (which by definition you cannot see ahead of time) but also gray rhinos. It listed a set of specific financial risk gray rhinos: shadow banking, unexpected market volatility, high debt levels, real estate bubbles, and new financial products that weren’t sufficiently regulated. The markets rightly interpreted this as a signal that regulators would start cracking down on financial risk. That’s why tech and small-cap stocks, which were seen as the riskiest, fell sharply.
It was a wild moment. I had just come back from a trip to New York, and when I got home, my email inbox was full of messages from friends in China and reporters requesting interviews. I went to a cocktail party that evening, where people making small talk asked what I was up to that day. Little did they expect the answer to be “crashed Chinese stock market prices.”
The Gray Rhinos Facing Us Today: Climate Change, Financial Fragilities, Inequality
There is a standing triad of interrelated gray rhinos that worry me.
A gray rhino, of course, is something that's big and obvious and high impact. And in general, they're not being dealt with as well as they should --but we have a choice of how to respond. When I started talking and writing about gray rhinos, a lot of Western audiences pushed back. ‘Why do we need someone to tell us to pay attention to obvious things? We're dealing with them because they're obvious. That's what we do, we deal with obvious things.’ This, of course, is not true. Because people didn’t want to believe that we fall so far short when it comes to obvious dangers, I emphasized the ignore part in the book’s subtitle and in talking about gray rhinos. And it's been very interesting to see the recent news stories after comments from President Xi and Chinese securities regulators. They've tagged that ignoring to the definition. So now I know they get that part of the concept, but am now emphasizing that the real reason for the concept is that we are not condemned to ignore the obvious dangers in front of us. Nor should CEOs, politicians, or investors get a pass for pretending that ”nobody could have seen” these clear and present dangers coming.
There are three gray rhinos facing us today and they all connect to each other.
The first one is climate change. Last year may turn out to be the hottest one on record. We've been seeing an increasing number of wildfires and freaky weather, and lots of damage caused by climate change. And we are seeing scary projections.
So climate change is the first gray rhino and it's very closely related to the second one, which is financial fragilities, which take different forms including asset bubbles and unsustainable debt. Super low interest rates have created lots of asset bubbles. In some cases, tax policies subsidize financial asset bubbles and speculation, which is a terrible idea. Record high corporate debt has created zombie companies that can't pay their debts out of their earnings and often are borrowing just to keep up with interest. These companies are sinking slowly, and in some cases quickly.
Financial fragilities are related to climate change. Central banks around the world and big investment funds have been increasingly sounding the alarm that climate risk is investment risk. Extreme weather affects cities and in turn municipal bonds. It affects any company that's located in those cities, which often are located in vulnerable coastal areas. Climate change affects insurance companies, many of which worry that they are undercapitalized in face of the projections of the damages that climate change is going to do. Insurance and climate change are inseparable. Recall how during the Great Financial Crisis, AIG was an insurance issue, and it brought the rest of the cards tumbling down after the failure of Lehman Brothers. So you see a lot of links between financial fragility and climate change.
And the third top-of-mind gray rhino is inequality, which the pandemic has intensified. The people who have financial assets, real estate, stocks and bonds have done tremendously well. You've probably heard about the K-shaped recovery that my friend Peter Atwater references often. There's a feedback loop back between inequality and financial fragilities because as financial assets suck money out of the real economy and the bottom leg of the K struggles more and more, it slows the economy. That dynamic, in turn, affects the underlying value of assets that depend on a healthy economy. And money that could be going toward job creation and economic growth is going into paper profits that can and will disappear. Right now you're seeing people paying prices that are astronomically higher than the underlying value of financial assets would suggest. Just like the Dutch tulip craze, this is not sustainable.
Inequality, in turn, links back to the first gray rhino I mentioned: climate change. This is because the people who are contributing most to climate change are the ones who are suffering least. And the ones who contribute least to the problem are the ones who are hurt most by extreme weather and don’t have as many resources to deal with its consequences.
So climate change, financial fragilities and inequality and the ties among them are top of my mind.
On Debt Sustainability: What Do you Do With a Problem Like Argentina?
I started my career writing about the defaulted debt from the 1980s, the trading of those loans and their restructuring into Brady bonds throughout the 1990s. A lesson learned from those times is that we need to start thinking about our looming debt dangers in a proactive way, rather than waiting for things to go to hell.
We need a system that corrects itself, rather than waiting for humans to bumble along and step in when it’s too late. Now, after the Argentinian crisis of 2000-01, you started to hear talk about GDP linked bonds. The way these work is that when the economy is growing faster, payments and interest rates increase, and conversely when the economy is slower or even shrinking, those payments and interest rates fall. So you get this automatic counter-cyclical stabilizing effect. That would be a good idea to reconsider today, particularly since low interest rates have created an opportunity to refinance in smarter ways.
In Latin America in the 1990s we also saw a lot of debt for equity swaps, whereby investors would get a share in privatized companies or countries would commit to preserving the environment, in exchange for canceling debts. I see a slightly different application of this concept, via debt to SDG swaps, whereby countries would get debt forgiveness in exchange for investing toward achieving the Sustainable Development Goals. Right now, super-low interest rates are mainly being used to subsidize financial markets and the very rich, and we’re missing a chance to spread the benefits of inexpensive financing more equitably around the world. We’re going to need private creditors alongside official creditors, whether multilateral institutions, or countries that have made bilateral loans, to work together to come up with a better system for dealing with the debt albatross that is dragging down the world's poorest countries.
Frothy Markets and the Rise of the RobinHood Trader
There are two schools of thought on Wall Street. One is that while the music is playing, you’ve got to dance and ride the market as high as you can. On the other side are people who are pointing out these huge price to earnings ratios that are out of whack with reality, and the corporate debt problems that could bring things down.
I saw a very insightful comment the other day about how you tend to see a surge of retail investors coming in at the peak of a boom, right before you go into a bear market And have we ever seen that this year, in a big way! It reminds me of the tech boom in 1999-2000, when I was still writing a lot about Latin American debt. Many of my journalist friends were getting poached from one financial news organization to another amidst the hype. There was a lot of talk along the lines of ‘We're going to democratize finance. We're going to let more people come in on this.’ Of course, that means that we're setting up more people for a fall as well. This whole RobinHood and GameStop phenomenon reminds me so much of that rhetoric. Anyone who's a small retail investor going into these markets and believing that they can beat the big guys is suffering from delusions. It's very dangerous and it's not going to end well.
Pandemic Gray Rhinos
I remember during the Ebola crisis, which I wrote about a bit in The Gray Rhino, one of the recommendations for combating a pandemic was making sure that you have basic health care on hand. You had people in Africa who couldn't get Tylenol, who couldn't get fluids, who couldn't get the very most basic things. The lesson is that by investing across the board, and especially in the areas that have the worst health care deficits, you can improve people's daily lives and you build resilience against another big disaster. So I hope that governments are wise enough to start putting more money into health care. The kind of SDG linked financing that I talked about before could have a big component under which countries could put money into health care, and in exchange get debt forgiveness.
You are What You Risk: The Art and Science of Navigating an Uncertain World
My new book, which comes out April 6 in the US and May 6 internationally, is a sort of mirror image of The Gray Rhino, which I wrote for a policy, business, finance, and strategy audience but which was surprisingly relevant on a personal level. As I was on book tour around the world, so many people asked, ‘How do I apply this to my personal life?’ One super hip young man in Shanghai told me that he already applied it to his life and thanked me for how helpful it had been. These personal gray rhino applications were such an organic response so I wanted to explore them. And I realized that we too often make the mistake of separating personal and professional issues. That led to You Are What You Risk, which is written with personal gray rhinos and attitudes in mind, but it has huge implications for business, finance, and policy.
I also got asked a lot why The Gray Rhino first took off in such a big way in China and across Asia. When the book came out in 2017 in China, people told me: ‘You gave us an easy way to talk about what was on our minds.’ In the United States, the view was: well, it's obvious and we're dealing with it. So we don't need a book. Or they just kept repeating “black swan, black swan.” There's a lot of money being made from people focusing so intently on black swans. If an investment manager makes a bad call he can say, ‘Oops, sorry, I lost all your money, but black swan, nobody could have seen it coming.’ So I think there was a little defensiveness there -a huge contrast to Asia.
So I started looking at at risk attitudes across cultures and at this feedback loop between societal and cultural attitudes towards risk, social safety nets, and government approaches to risk. The new book also looks at how that mix relates to the risks --both dangers and opportunities-- that companies and individuals take or shy away from.
The new book looks at what I call risk fingerprints and the sometimes surprising influences on them. What says identity more than a fingerprint? Individuals have them, companies have them, societies have them. There are cultural elements, baked-in genetic parts of our innate personality traits. There are demographic and gender differences (though likely not the way you think), how your experiences shaped you, how your habits and how your awareness of that risk fingerprint affect the risk decisions that you make, and the role of culture and physical environment. Finally, the book looks at how these elements play into the feedback loop between individuals, organizations, and societies.
Binge-watching Empress Ki and listening to BTS
I recently binge watched Empress Ki. Think of a Latin American telenovela set in a 14th century China and Korea with a K-pop soundtrack, evil villains, comic sidekicks, and badass female characters. So good. It's absolutely amazing, a must-watch. I’ve been going through a Korean pop culture phase. The Good Doctor, now a US TV series, was inspired by a Korean series. Then, of course, there is BTS, the biggest band in the world right now. They actually talk about depression as a gray rhino in their hit song, Blue & Grey, which was released last November. So, I certainly like them!
As for reading, while I was finishing the new book I didn’t read as much as I would have liked outside of research material. I am really looking forward to Mariana Mazzucato’s new book, Mission Economy, and Noreena Hertz’s The Lonely Century. Now that my new book is done, I am looking forward to reading more fiction too. I just started Viet Thanh Nguyen’s The Sympathizer.