Certainty is a delusion…

To be absolutely certain about something, one must know everything or nothing about it”- Henry Kissinger

As the wry old joke goes: “The only certainties in life are death and taxes”, yet human beings like to extend the aura of certainty to areas in which it has no credible place, with sometimes unfortunate consequences.

Even in “hard” science what are sometimes stated or perceived to be “certain” facts (axioms), turn out to be simply untrue, incomplete, or more nuanced and complex- whether the nature of the cosmos and Earth’s place within it, atomic theory, or Newtonian mechanics. Karl Popper stated that for something to be scientific it must be able to be proven false. If things are falsifiable (able to possibly be proven false) then they can be used in scientific studies and inquiry. In other, words, even “certainties” need constantly to be tested.

This fact was brought to mind recently in reading David Quammen’s excellent book “The Tangled Tree: A Radical New History of Life”, which tells the story, amongst other things, of how as recently as 1977 it was axiomatic that the “tree of life” (popularized by Darwin’s work) had only two main branches from its trunk- for bacteria and for eukaryotes (essentially everything else) and that species only changed vertically through mutation and natural selection over time. That was until a molecular biologist called Carl Woese (who was not even looking for the result), realized that, in fact, there are three branches- the two mentioned previously, and what are now called archaea. Not only that, but genes can be swapped between species- via horizontal gene transfer. So much for the certainties of what you were taught in high school biology. In fact, the “tree” is now considered to look more like a tangled web, so perhaps it should be the Thicket of Life?

When it comes to the world of credit risk analysis and management, it would be wonderful if one could be certain of anything and everything! One could then predict the true risk of loss and one’s pricing would be perfect. Dwight Eisenhower (during World War II) pointed out: “Plans are useless, planning is essential.” Of course we build models and make forecasts. These are an essential component of any financial business. However, any experienced analyst knows that actual outcomes can easily be very different from what was assumed because of some unforeseen or unexpected factor (which is one reason why we are also habitually paranoid). The real world places constraints on possible outcomes, but the number and weighting of the variables that go into assessing, say, the risk of default is inherently probabilistic. The real skill lies in understanding the range and scope of potential outcomes over time, and how to manage and mitigate actual outcomes if they deviate significantly from the range of reasonable expectations- planning, not plans, constantly updated.

History also teaches that seemingly minor variations in decision-making or apparently unconnected events can interact and cascade in ways such that what seemed “certain” and inevitable, turns out very differently. At Dunkirk, in 1940, it seemed certain that the trapped British and French forces would be overrun by the Nazi German Wehrmacht. Yet that did not happen, with the outcome that everyone knows.

So, when someone states that they are certain about something (a 100% probability!), the immediate response should be to ask how and why. At Awbury, we believe (and can demonstrate through outcomes) that our approach to risk analysis, management and mitigation is effective in relative and absolute terms; but we would never be so foolish or arrogant as to state that we are absolutely certain of the outcome on any of our transactions. That would be doing ourselves and our partners a singular dis-service. After all, our business model is founded upon assuming real risks.

The Awbury Team

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It is the Devil’s excrement…

Readers may recall that this sentiment was uttered in the mid-1970s by Juan Alfonso, formerly Minister of Mines and Hydrocarbons of Venezuela, and often called “the Father of OPEC”. In full, it reads: “I call petroleum the devil’s excrement. It brings trouble… Look at this locura [madness]- waste corruption, consumption, our public services falling apart. And debt, we shall have debt for years.”

This was an allusion to the natural resources “curse”, most particularly that caused by the discovery of large oil and gas reserves. A politer term is “Dutch Disease”- namely, the negative impact on an economy of anything that gives rise to a sharp inflow of foreign currency. The currency inflows lead to currency appreciation, making the country’s other products less price competitive on the export market, as well as potentially to the economic and social distortions, endemic mismanagement and corruption to which Alfonso referred. An expectation of future export revenues from oil leads to the avoidance of putting in place sustainable government revenues based upon taxation.

It is a rare country that manages to overcome the “curse”. Canada, Norway and the Netherlands are examples of those that have, albeit with different approaches; while the sheer scale of the US’s economy has muted any material impact over time.

However, the catalogue of the “cursed” is a long one- including Russia, Saudi Arabia, most of the other Gulf states, Iran, Iraq and, of course, Alfonso’s own Venezuela, which is perhaps the most egregious and painful modern example.

In the case of the last, one can argue that it is the archetypal petro-state gone wrong, with oil revenues in the “good times” being used to influence and co-opt potential opposition, as well as to “bribe” the population through a latter-day version of “bread and circuses”. Unfortunately, when the subsequent “bad times” coincided with the demise of a charismatic leader (Chavez) and his replacement by a thuggish plodder (Maduro) desperate to cling to power (and supported by those who had benefitted from the corrupt largesse during the good times- the military, in particular), the result has been one of the most rapid collapses of a still-functioning state into “failed” status in recent history. And entirely self-inflicted.

The sheer scale of the regime’s stupidity beggars belief. No rational government would gut, coerce and starve of investment its primary source of revenues. Yet that is exactly what first Chavez and then Maduro have done to PDVSA, the national oil company (NOC). It used to be axiomatic that, even if the Venezuelan government could barely be trusted to do anything right or rational, it would not jeopardize PDVSA’s ability to produce and deliver oil from Venezuela’s abundant reserves. Nevertheless, that is exactly what has happened, with an end-game of regime change perhaps now in sight.

For underwriters of complex credit risks, such as the Awbury Team, events in Venezuela provide a salutary reminder that one has to judge the outcome of risks that depend on the decisions of others by reference to their track record, incentives and constraints. Assuming that people (and governments, like any other entity, consist of people) will actually act rationally and in their long term interests can prove quite misguided. One should always be willing to factor in the probability that actors and agents will not be rational (by the standards of the person making the assessment).

The Awbury Team

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