Economies may be more fragile than they seem

by Eric Knutzen, CIO, Multi-Asset Class, Neuberger Berman

The acclaimed drama reminds us of the possibility of the highly improbable, and the importance of clear assessment of difficult facts in a crisis.

Hot days and sunshine tell us it is summer in the northern hemisphere. Normally this is the time for traveling to see friends and family, gatherings on the lakeshore or the beach, and of course summer reading.

But this is not a normal time. The pandemic has shaken up so many things, from markets and the economy to our social cohesion and ability to have personal interactions—and yes, our vacation plans, too.

For the last three years, I have shared some thoughts on a book from my summer reading list. War and Peace was a reminder that vacation can be a good time to step back and consider the big picture. Walter Isaacson’s biographies of Einstein and Leonardo underlined the power of unconventional thinking in an unconventional world. Last summer, Hans Rosling’s Factfulness showed how data can surprise us by revealing that things are rarely as bad they sometimes seem.

Shock

Well, what a difference a year makes.

I see COVID-19 as a warning that our complex societies and economies may be more fragile than they seem. And much of my summer reading this year has been aimed at understanding more deeply the issues of race, inequality and social unrest that have been exacerbated by the pandemic. I recommend Ta-Nehisi Coates’ letter to his teenage son, Between the World and Me. Articulating the challenges faced by black people in America in painful but enlightening language, it’s a sobering reminder that, even as the world gets better in so many ways, the lives of some fellow citizens remain much worse than they seem to many of us.

Having said that, lots of us have found that being locked down with family is less conducive to the solitary pleasure of reading than it is to the shared anticipation of binge-watching television. So in the midst of this year’s pandemic vacation, I am digging in with you on Chernobyl, a gripping five-part series that mixes nail-biting horror, vivid history lesson, Kafkaesque political thriller and heroic human drama.

‘Tail Risks’

Why does the story of a nuclear disaster 34 years ago resonate in our COVID-19 summer?

It’s partly about the importance of resilience to “tail risks”—rare, low-probability but high-impact events. The residents of nearby Pripyat watching the Chernobyl reactor explode did not grasp the danger they were in because that danger was invisible, just as the coronavirus spreads unseen among us. But tail risks can be invisible in another sense, too, because they are not in the historical data, or they happened too long ago to remember, or have been washed away by long-term averages. Both Chernobyl and COVID-19 created a range of potential outcomes that challenge traditional models and measurement.

Generally, resilience against tail risks requires redundancy in our systems. Fail-safe mechanisms in our nuclear power stations; more beds, medical devices and protective equipment than we strictly need in our health care systems; less complex but more flexible supply chains in our economy; cash on our balance sheets; diversification and liquidity buffers in our investment portfolios.

But therein lies the challenge. Most of the time, resilience and redundancy are costly—economically and ideologically. And this is what Chernobyl is really about.

False Choice

Valary Legasov, the chief of the investigative commission, discovers that the explosion was triggered by an emergency shutdown. The engineer Anatoly Dyatlov fatally refuses to credit the evidence of a reactor explosion, partly due to political pressure, but also because he genuinely believes that it is impossible for an emergency shutdown to cause such an event.

But it wasn’t impossible. It was just a tail risk, lurking in a flaw in the reactor’s control rods. The same flaw had caused minor accidents in Leningrad 11 years earlier—but all details were suppressed by the authorities.

When it came to choosing between safety and the prestige of Soviet nuclear power, safety lost out. Ultimately, of course, it was a false choice. Physics is physics. Chernobyl exploded, and some count it as a key contributor to the fall of the Soviet Union.

Today, it’s understandable that all of us, not just incumbent politicians, want our society and economy to get “back to normal.” But biology is biology. Until we have the means to reassure society that the virus will not run out of control, there arguably cannot be a “normal” economy. It is important for policymakers to grapple with all aspects of the situation, just as it is critical for investors to make a realistic assessment of the economic data, even when it presents bad news, to minimize the probability of worse results later.

If the Facts Change

For investors like ourselves the stakes in a crisis are lower than they are for nuclear power station engineers or front-line health care workers, but the principles are generally the same.

Always think about resilience: Diversify, give yourself flexibility to be nimble when the tail event strikes, do not give in to the “fear of missing out.” When a crisis comes, embrace the discipline of a playbook: Think dispassionately about the possible scenarios and draw up a plan of action for each one, shutting out the noise and focusing on what is critical. Then revisit those scenarios frequently—and if the facts change, change your actions.

As Tolstoy, Einstein and Rosling would have appreciated, this is not a counsel of despair but “factful optimism.” Our old economy is under dire threat. But COVID-19 has made many of us work from home, travel less, appreciate our frontline workers and harness humanity’s medical and technological ingenuity as never before. Perhaps we will make our new economy more sustainable, more equitable, more productive, more resilient, more flexible? There will likely be investment opportunities in doing so.

In the end, the story of Chernobyl, like that of COVID-19, is about the heroic efforts of ordinary workers: people like the engineers on a suicide mission to prevent a devastating steam explosion early in the crisis; the coal miners who tunneled under the plant with a vital heat exchanger; and the 3,000 liquidators, each given a deadly 90 seconds to clear as much reactor debris as they could to make the plant ready for its enormous shelter structure—itself constructed under horrific conditions.

Chernobyl is a fitting tribute to them, and to the spirit of human courage and ingenuity that builds a better future.

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