Today in the financial world, it is becoming more and more complex to draw the dividing line between risk and uncertainty. To familiarize, risk is an outcome of an event which is likely to happen with a probability which is not difficult to observe or calculate. Uncertainty is outcome an event where in the first place all the outcomes are unknown and even if it did there is no way to calculate the probabilities of such outcomes.
Take the current economic history of China. After achieving extremely phenomenal growth over several decades, it is currently stalling. At this point in time, the financial analysts believe that 6.5 – 7% annual GDP growth as an optimistic possibility. What has changed? Is this change due to internal or external factors? Will China come for a hard or a soft landing or they will pull out from the trough? Finally will China devalue their currency to perk up the external demand? What will they do with their present excess capacity? Lots of foreign money is believed to be leaving the country due to a host of reasons such as the foreigners exiting the Chinese bond and stock market and residents converting a part of their savings to US dollars. (China allows its citizens to keep upto $ 50000 US with them) or through over invoicing and other means the Chinese businessman move their funds out of mainland.
How do you calculate the probabilities for all these events? The confusion is about the event itself one may ask a question as to why what is happening in China is more relevant than say what is happening in Brazil and Russia. One simple answer is that the market thinks so and for a variety of reasons. Some of which are as follows
Ms. Christine Laggard, IMF chairperson has stated in her forecast that this year global economic growth will be much lower than last year. This is a sobering thought.
Now let us revert to the heading will the current situation force them to devalue their currency? It is not at all clear whether the will do so and even if they did by how much will be question in our lips. As an Indian stock investor I wish I knew clearly. Their devaluation will be somewhat equivalent to the subprime crisis of the US. At that time our Sensex dropped from 21000 to 8000. As an investor one must have the uncanny ability of forseeing what the Chinese authorities are likely to do. As a wealth manager I must build an exit strategy for this possibility. Will my knowledge of statistics help? Perhaps I should revisit the min max theory to see how best I can exit the market. In the case of China, the dividing line has disappeared. So let us not look for a probability when there is none.
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