Brexit Raises Risk of Global Recession, Maybe
After Britain voted to leave the EU last week stock markets around the world became very volatile. Two days after the vote $2.5 trillion were wiped from the world’s markets.? To put that into perspective that’s roughly the entire annual economic productivity (GDP) of the United Kingdom.
George Soros, the investor who warned of a 20% devaluation in the British pound now warns the Brexit has “unleashed a crisis similar to the financial panic of 2007 and 2008.” He says that a hard landing in China is “practically unavoidable.” And he is not alone. Most news sites say the Brexit fallout will continue to ripple across the world and put not only Britain but also the U.S. and other countries back into recession.
These commentaries are often portrayed as conventional wisdom, but that doesn’t mean they are necessarily true. In fact, news predictions are often wrong. One day in 1987 stock markets around the world crashed starting in Hong Kong and spreading to Europe and then to North America. The Dow Jones index in the U.S. lost more points in a single day than any prior trading period. This historic event was known as Black Monday. Many analysts and publications at the time warned it was only the beginning of a bear market and that more turmoil would come. A lot of people believed the hype and got out of the market because they were afraid. But those investors didn’t do their own risk assessment. Today, Black Monday is nothing more than a small, insignificant blip in the historical stock market chart. (circled in red below)
The way we perceive risk is not always rooted in reality. An article in the Chicago Sun-Time features a study that demonstrates how conventional wisdom can lead people to the wrong conclusions about risk. Imagine an 8 year old girl has 2 best friends who both live close by but in different homes. The first friend’s parents keep a gun in their home.? The other friend’s household doesn’t have a gun but does have a backyard swimming pool. ?
If you had to choose, which is the safer house for the little girl to go play in? ?
Without any other information most parents would probably think the second friend’s house is safer because guns are perceived to be more dangerous than swimming pools. But in a country such as the United States, there are about 6 million swimming pools, and 550 children under ten years old drown in them each year. However out of roughly 200 million guns in the U.S., only 175 children die each year from guns. In other words, the risk of the girl dying by a pool (1 in 11,000) is much higher than dying by a gun (less than 1 in 1,000,000.) According to the study’s author, most people are “terrible risk assessors.” We often let irrational fears cloud our judgement.