Groupthink is when too many people think alike, as compared to a more diversified spread of 
views. In contrast, fat-tailed risks are low probability high-octane events that fundamentally 
catch everyone out, when they surprise us by actually happening. 

There is plenty of both risks around at present, potentially giving us endless surprise in the 
coming year or two. Especially if both type of risks were to be globally activated together. 

One fine example of groupthink is that the Dollar will experience a huge correction next year 
on account of the growing global imbalances (centered on the US trade deficit). The other 
example is that Anglo-Saxon housing markets are heading for a fall after having achieved 
‘bubble’ status.

Potentially there are many examples of fat-tailed risk: 

An Asian flu epidemic more virulent than the Spanish variety of 1918 (in which 5% of the world 
population died within months). 
Another major global atrocity, this time not with dynamite, but either with biochemical or 
nuclear means, and far more horrific than seen so far. 
A major financial crisis, in which innovation, excessive risk-taking and corporate bankruptcy 
will again feature centrally (with the global derivatives market fingered with suspicion 
by the BIS). 
An environmental disaster of possibly unprecedented proportions. With all this climatic change 
business going on, watch out for the slow variety (super drought) or the intensely furious 
(super storms), catching not only the locals badly, but devastating global reinsurance as a 
business proposition. 

So what if any (never mind all) of this comes to pass?

For South Africa it would be hugely important, as it would be for many other countries. The two 
identified groupthink risks give quite a different playout for the economy next year. 

The present consensus globally seems united in its unshaken conviction that the US will not be 
able to escape the consequences of its steadily expanding trade deficit. Currently projected at 
$700bn annually, it will grow to $1 trillion by 2009, with foreigners by then holding most 
US Treasury bonds, if nothing deflects these tendencies from their present course. As these 
numbers boggle the mind in absolute terms, there is deep conviction that global appetite for 
US assets will dry up long before then, forcing adjustment. 

After the briefest hiccups in the course of 2005, renewed Dollar adjustment will come, pushing 
it at least back towards 1.35-1.40:€ next year (if not by late this year). 

This kind of thinking (unconsciously) divides the recent past and immediate future into three 
stages.

First, there came 2001-2004 during which US interest rates were forced to record low levels, 
Fedfunds falling to 1%, a level it had last seen in the late 1950s. In the process the Dollar 
declined by 60% against free-floaters such as the Euro, but much less against the Yen, and 
minimally against many emerging market currencies, which today represent a very large part of 
US foreign trade. 

As a consequence, the Dollar on trade-weighted barely declined 20% before correction took hold 
from early 2005. This turned out to be stage two, driven by growing economic and financial 
differentials in favour of the US that allegedly took global market focus (momentarily) off the 
structural issues.

US growth has outperformed Europe and Japan, its main regional competitors, throughout recent 
years without saving the Dollar, but it served to keep alive a mental picture of America’s 
attraction as a dynamic investment outlet (even as foreign direct investment flows slumped for 
a while). 

More important was the fact that European and Japanese bond yields were steadily being eroded 
by a global surplus of investable funds (due to under-consumption and/or under-investment), 
with underperforming equity markets (on account of prior overvaluations) and ageing demographics
favouring fixed-income bonds at a time of shrinking supply.

This trend has been underway for some years, even as the US falling bond yield sharply reversed 
direction as of mid-2003, once the Fed had sounded the all clear on the then perceived deflation
threat. However, instead of rapidly rising from its low point of 3.1% towards 5%-6% in line with
a tightening Fed policy firmly underway (as widely expected), the US 10-year yield got stuck at 
4%, with a downward bias, even as Fedfunds was steadily raised towards this level as well, 
flattening the US yield curve and sending out all sorts of conflicting information.

It certainly didn’t herald an imminent recession (robust trend growth continued unchecked, not 
least because of this arrested bond correction). It also didn’t signal the imminent collapse of 
US inflation (it was steadily rising, in part egged on by commodity prices - oil). 

What it did seem to reflect was focused global appetite, according to which 4% US bonds were 
now considered ‘high-yield’, as compared to 3% German and 2% Japanese yields. The overwhelming 
weight of the global savings surplus, the counterweight to US deficits, were becoming channeled 
into US bond markets to such an extent that they outweighed Fed actions (raising Fedfunds 
steadily). 

With both Fedfunds and US long bond yields now comfortably higher than comparable European and 
Japanese offerings (by as much as 1% to 3%), and with especially emerging market supersavers 
(in Asia) preferring risk-averse destinations (America primarily, strangely enough, offering 
the deepest liquid markets), the stage was set for very large, increasingly public sector 
capital inflows into the US.

In 2005 this would increasingly anchor US long bond yields, as described, while starting a 
Dollar revival against free-floaters, rising beyond 1.20:€ recently.

Groupthink globally considers this 2005 development as an aberration. In so many words, it is 
understandable (now that it has happened), but nonetheless unreal, considering the gigantic 
global imbalances that have come into being and are still expanding, traditionally eventually 
giving rise to fundamental currency realignments.

And this is where the rub is. Projecting past experience uncritically and unchangingly into the 
future, without considering that despite the scale of these things there have been even bigger 
changes in the world at large, in whose context these large trade imbalances actually are still 
insignificant (at least for now). Fed chairman Greenspan has been one of the few who on this 
score keeps on muttering about the wider relevance of deepening globalization and what it means 
for financial markets.

In contrast, groupthink declares that once the global overreaction to recent European political 
and economic problems corrects (as it will, with political changes and more reform coming), and 
the US growth differentials stabilize or erode (as they will as well), the current relative 
attraction of US assets will wane and concern regarding expanding imbalances will come back 
into focus. 

That would be the moment for entering stage three, in which the Dollar can expect another major 
depreciation, and in which incidentally long-term US bond yields may finally move higher, 
surrendering to the Fed’s lead.

Perhaps this will happen. But perhaps not. 

What if the global savings and spending imbalances are more durable than believed, with savings 
surpluses continuing to grow in Europe, Japan and especially parts of emerging Asia? With the 
US continuing unchecked as willing deficit outlet, obligingly saving less, spending more, 
raising debt levels and generally having the time of its life? Unthinkable? Hardly.

If such global spending and saving behaviour has a certain momentum behind it, because Europe 
and Japan won’t reform quickly, emerging Asia won’t change its development focus soon, and the 
US remains a willing debtor-of-last-resort, the implied imbalances may have some way to go, as 
all concerned willingly participate in keeping the feedback loops alive and expanding. 

That way greater global savings imbalances, larger capital inflows into the US, and support for 
the Dollar remains in effect. It would also incidentally anchor US long-term bond yields, 
indeed still erode them towards European and Japanese levels, especially if inflation could 
peak out and subside. 

Rising energy prices and an US economy performing at potential suggest that US inflation won’t 
be that obliging. On the other hand, it isn’t a total given that the US economy will outperform. 
Corporate behaviour still suggests less than robust job growth and cash flow use. Though not as 
bad as elsewhere in the world, even the US economy continues to show hints that inflation may 
subside again cyclically ere long. 

Which brings us to that other groupthink fixation of the moment, non-sustainable housing booms.
The playout suggested above, in which global imbalances continue to expand and in which the 
Dollar remains supported, implicitly also includes ongoing ammunition for the US housing boom, 
if US bond yields remain low (or even erode lower), taking fixed-mortgage rates within them. 
The US homeowner is yet to be financially challenged, with his paper wealth rising in leaps and 
bounds, even as his financing remains neutrally anchored.

Thus financial leverage remains strongly biased in favour of more rather than less US property 
speculation. And this shows daily. 

The US property boom still seems to be gathering momentum, gathering speed (price changes) as 
well as spread and depth (more locations becoming inflamed, and the happiness spreading to 
commercial property as well). 

Only a Lone Ranger attitude from the Fed might finally unnerve this market, if the Fed were to 
keep pushing Fedfunds higher once Greenspan is gone, determined to end this debt madness and 
speculative excess, and the growing feedback interference from the global system in American 
monetary affairs. 

As discussed elsewhere this week, this would be an historic moment, if it were to arrive, 
reminding most of Fed chairman Paul Volcker and his Saturday night massacre back in 1981 when 
he declared total war on inflation. 

But could the other Anglo-Saxon property markets also face another lease on life for their 
bubble conditions, Aussie and the UK foremost, Canada less so?

The key problem is the same as for the US condition. If the central problem globally is under-
spending and excess savings, with governments and central banks dedicated to keeping inflation 
low, but also ensuring as far as possible full employment, then the bias remains in favour of 
excess cyclical liquidity, falling yields and another cyclical downswing in global interest 
rates (potentially to new global lows).

This has already commenced in Sweden, may shortly spread to the UK (and Aussie), may eventually 
pull in Europe (though it is already at low, frightening levels of 2%) and lastly may again 
pull in the US. 

If the global macro-economic condition of its own volition doesn’t engineer this, financial 
events along the way may still contribute in doing so. An equity market scare in the autumn 
(this year or next year in response to Fed forcefulness) or a global financial crisis (as 
bankruptcy finally overtakes excessively innovative derivative risk-taking) could abruptly 
force central banks to show their hands. So far, the global culture has been one of capitulation
whenever financial collapse, deflation or economic underperformance loomed.

It has been fashionable in recent years to speak of a supercycle for commodities with the advent
of China as consumer-of-last-resort. Is it time to start speaking of a supercycle for global 
property prices, too, in which overvaluations are driven way beyond historical norms, also 
reflective of these deep global imbalances so far discussed?

Aussie property prices have been falling for a year, in Britain the national index is down 1% 
and London leads with –2% to –5%. The outlook is for a cumulative –10% to –20% over the next 
five years, after prices have doubled in recent years, with financial leverage today 
overexploited to the hilt and in need of correction as first time buyers have largely dried up.

Under ‘normal’ global conditions this would indeed be a likely scenario. It may still come to 
pass, especially if global growth turns out stronger than here assumed (and of which there are 
at present some early signs, such as the beginning of an inventory-driven turn around in 
industrial production worldwide).

However, global conditions are anything but normal of late, may continue ‘abnormal’ for quite a 
while, with no fixed idea as to where this will end. 

Meanwhile the short-term consequences of relative under-spending and over-saving globally, with 
or without excessive central bank accommodation, could be yet more erosion of global bond yields,
the beginning of a down cycle in short rates, ongoing support for the Dollar (rather than seeing
it sunk) and potentially a supercycle stage for already heavily overvalued global housing markets,
especially Anglo-Saxon ones.

Projecting into this outlook some of the fat-tailed risks mentioned earlier merely stacks the 
cards even scarier on the downside. 

For consider a virulent Asian bird-based flu hitting the global economy (with the latest issue 
of Foreign Affairs dedicated to this question). Death tally could be 10%. Rich countries might 
succeed to protect themselves imperfectly with costly inoculations (‘only’ 20 million deaths in 
the US alone), but certain parts of the world (Africa, China, India foremost among them) wouldn’t
stand a change. This would be Black Death plague stuff, and far outrank the HIV/Aids pandemic 
as a disaster. 

A major urban atrocity, this time wiping out a whole city or large portion thereof, could 
greatly shock the global financial system, depending on which city was targeted. It was rather 
telling that one response to the 7/7 London outrage was that it thankfully wasn’t biochemical 
(or nuclear). More than anything else, that tells us the nature of one major fat-tailed risk in 
our global midst.

We have historically more experience with financial shock (default). Environmental super events 
on the scale suggested would be new.

But all of them would have the same consequence. Shock. Economic decline. Policy intervention. 
Liquidity expansion. Interest rate and yield declines. Risk aversion. Safe haven preference. 

Obviously, a commodity supercycle is dependent on good demand growth being maintained. If events
overwhelm even the China factor (or it becomes embroiled in a downward spiral as well), the 
commodity supercycle would experience a quick death.

Similarly for a supercycle in housing overvaluation. If shock population loss, or financial 
default causing massive risk aversion, were to be unleashed, no amount of liquidity might save 
the exposed homeowners of the world. Only increased inflation might do the trick. As Japan has 
shown these past 15 years, it isn’t simple to crawl out of a deflation hole once you are in it. 

What is the likelihood of any of this?

The chances could be high that global groupthink is going to be found out. The next stage after 
all may not be another major Dollar depreciation in response to global imbalances. Instead, the 
imbalances may continue to expand, in the process supporting the Dollar, and rather incidentally
giving us a supercycle in global housing overvaluation. 

Some of the fat-tailed risk may be much less fat-tailed than generally assumed. These are by 
their very nature still high-octane events, but perhaps with a much higher probability of 
coming about than conventionally allowed. 

The biggest threat staring us in the face is bird flu. Scientifically, we are apparently being 
invited to consider it inevitable, a matter of time, with rich countries already preparing to 
annual stockpile large quantities of inoculation stocks. 

The world is used to financial crises happening with a certain historic episodic regularity. 
Indeed, we may already be overdue for another big one reckoned according to Greenspan’s seven-
year itch scale. 

Geopolitical atrocity on an expanded scale looms, it being only a matter of technology and time.
As to climatic disasters, as with falling meteorites, that may have a somewhat longer fuse. 

What does all this hold for South Africa? 

If the Dollar heads south, as groupthink suggests, renewed Rand firmness will come roaring back.
Prepare to ‘survive at five’ in 2006. It would also mean more CPIX inflation suppression 
(despite high priced oil), a few more interest rate cuts, continuation of the domestic spending 
boom, and substantially more overvaluation in our housing market than seen so far.

On the other hand, if global imbalances remain in the driver’s seat and the Dollar reasonably 
supported, the Rand will be less pressured in the 6.50-8.00:$ range, giving yet more balance to 
our ongoing economic boom as exporters will also participate more joyfully. Global capital may 
continue to favour us as much as the US and other emerging recipients, given our now impressive 
4% GDP growth (and 6% spending growth) and still high-yield status. The main explanation, though,
would be ongoing high global liquidity seeking deficit outlets of quality. 

With interest rates likely easing globally into the next cycle, and the SARB initially holding 
out in response to our 4%-5% inflation and strong economy, the Rand will be prevented from 
declining towards much weaker levels. 

Indeed, some kind of Rand firmness may well survive as global players could decide to challenge 
the SARB’s policy stance by punting the Rand (potentially aggressively – remembering past such 
events in a global world financially-challenged and starved for yield and seeking speculative 
opportunity wherever it can find it).

Imported deflation, despite high priced oil, may still over time erode our inflation rate enough
for the SARB to follow through with more interest rate easing. 

This suggests that South Africa could also still experience somewhat of a supercycle in housing 
overvaluation, provided fat-tailed risk as enumerated doesn’t floor us.

An exciting future for all awaits, with so much risk on the table, and the world clearly 
confused about what comes next, and saying so loudly. Have fun and don’t get caught by whatever 
it is that is going to hit us shortly. 

References: Comment, “Housing Booms: What Next?”, 14 July 2005: Comment, “A Historic Moment 
Looms”, 19 July 2005: Opinion, “Global Confusion Reigns”, 20 July 2005, by Cees Bruggemans, 
Chief Economist of First National Bank, obtainable at www.fnb.co.za/economics 

Source: Weekly Comment by Dr Cees Bruggemans, Chief Economist First National Bank  
21 July 2005. Cees Bruggemans is Chief Economist of First National Bank. Register for his free 
e-mail articles on www.fnb.co.za/economics1