Risk Assessment

Three things stand out in my mind showing that as a species we are very bad at estimating risk in the modern world.

Credit agencies proved to be very bad at assessing the risk of CDOs, if they were trying at all. This ended up starting the financial panic and leading to the recession. Worst case scenarios tend to get discredited. In any given period of time they might be "unlikely" to happen, but that doesn't mean they are impossible. Yes it was possible for entire swaths of the real estate market to see large value declines.

Then we come to the Deepwater Horizon oil spill. Oil companies had assured the government they had plans for worst case scenarios. Their worst case, just wasn't as bad as what reality had in store for them. The industry took risks that lead to the accident, and then once it had occurred, it was clear there was no plan to deal with the resulting damage to the oil wellhead.

This brings us to the Fukushima nuclear plant problems. At the current time it appears that a major nuclear disaster has been averted. However the cause of the problem was underestimating the maximum intensity of an earthquake affecting the area, and the size of the resulting tsunami. The knocking out of backup generators by the tsunami did more damage than the earthquake, at least in terms of limiting the ability of plant workers to cool the rods and waste pools.

As I think about this issue I could name many other examples, but these are easily the ones that have received the most press in recent years.

For our civilization to survive we need to find ways of being better at this. One thing we must also learn to do is balance the chance that something goes wrong with the level of damage caused if it does. We are not capable of this naturally, it is something that we will have to work at.

Fear of Inflation

Again as the price of oil goes up, and the price of all things that depend on it climb as well, I see politicians and central bankers crying out about inflation. At the moment there is little need for inflation controls outside of a handful of developing economies (for instance China).

Yes the price of oil is going up. But this time almost everyone agrees the reason is temporary in the long term. Yes this drives up the costs of transportation and many commodities. But what inflation hawks don't seem to take into account is that by diverting more capital to fuel costs the rise in oil prices already acts as a brake on the economy. Companies and people alike will have to adjust their budgets to deal with the rise in fuel costs, and that will slow demand on other resources cooling the economy. The market will handle this.

I am glad to see that at least Bernanke agrees. This is not the time to apply panic braking to the economy in the developed world. Raising interest rates at the moment would be like pulling the emergency break on the economy.