Why am I so cautious this year? In the past, beginning in 1988,
when I first started these forecasts of risk issues for the
coming year, I felt a sense of optimism, the thought that we
would make progress in the following twelve months. Re-reading
my January issues over the past six years, I find the entry
of a nagging caution and pessimism. Perhaps it’s the natural
result of growing older, but I sense that many of the potential
opportunities in today’s world are over-weighted by a fear of
downside consequences. So caution becomes the watchword for
Back in the utopian days of early 2000, having seen the millennium
arrive (one year early, to the mathematically inclined) without
the feared Y2K disaster, but with a financial bubble still hanging
overhead, I suggested a hard look at the condition of our financial
institutions and forecast that trust would be a major issue.
In 2001, I warned for the fourth successive year about that
bubble (it finally erupted with a bang in April). I also suggested
that governance and the role of risk management were the year’s
major issues, specifically focused on structure, leadership
and communication. After April’s financial collapse and the
events of September 11, 2001, my 2002 issues were the restoration
of credibility, resilience and a long-term perspective in organizations.
Last year, I ran a summary of critical global, market, operational
and public policy risks, decrying the growth of the “precautionary
principle,” an approach that cripples innovation and progress
and creates excessive risk aversion.
This January, I slip back toward caution. The global political
situation is poised on edge. With luck, we could make progress
in the current hot spots in the Middle East, Africa, and Asia:
a constitution in Afghanistan; a constitution, new government
and the start of the trial of Saddam Hussein in Iraq; the beginning
of an Israeli-Palestinian rapprochement; a quiescent North Korea;
and the departure of Robert Mugabe in Zimbabwe. The cards could
as easily fall in the opposite direction, with greater chaos
in the Middle East, requiring a hasty U.S. pullout, renewed
India-Pakistan warfare, a full Israeli re-occupation of the
West Bank and Gaza, and a North Korea taking advantage of US
preoccupation elsewhere. Add to that the U.S. presidential election
in November of 2004 and we have a truly unpredictable situation.
But have things really changed? Do we now face “. . .
a political force committed fanatically to the belief that with
the U.S. there can be no permanent modus vivendi, that it is
desirable and necessary that the internal harmony of our society
be disrupted, our traditional way of life be destroyed, the
international authority of our state be broken?” George F. Kennan
wrote those words in 1946 describing the Soviet regime (as quoted
in Princeton Alumni Weekly, December 17, 2003). They
apply equally to the threat of Islamic fanatic terrorism today.
Perhaps matters have not changed as much as we think.
The economic scene is even more disturbing. In the Europe,
Japan, and the US we face the explosion of entitlements in aging
societies. In the U.S., our problems are a bloated national
budget deficit, negligible national savings and an escalating
trade deficit. All three threaten the position of the U.S. dollar.
Peter Bernstein calls it “an accident waiting to happen,” one
in which “all hopes hang on an orderly decline in the dollar.”
(Economics and Portfolio Strategy, Nov. 1, 2003 and
Dec. 1, 2003). Given the slow recovery in the US and the faster
economic growth in Europe, Asia and South America, it is inevitable
that investors will turn from financing the US deficits to more
attractive returns elsewhere.
At the same time, we continue to hear disquieting news about our
financial markets. A real estate bubble, supported by low interest rates
and the loss of faith in stock investments, seems poised for puncture.
Mutual funds are tarred with allegations of market timing and late trading
frauds. And the foreign exchange market is tainted by claims of kickbacks
and bogus trades.
This makes the U.S. dollar the most critical risk
management issue for 2004. It calls for the creation of a variety of economic
and political scenarios for which every organization must be prepared
financially and emotionally. A lower dollar means that U.S. goods and
services will be more affordable outside this country. It also means that
others who sell to the U.S. will face higher costs as well as more U.S.
protectionism. Interest rates in the U.S. will creep up to attract foreign
investment to finance the U.S. debt, but this in turn will hamper the
nascent U.S. economic recovery, something the politicians want to avoid.
Last year the biggest issue was re-establishing organizational
credibility after the recent public disasters of such organizations as
Enron, Tyco, WorldCom, Adelphia, the New York Stock Exchange, Hollinger,
HIH, News Corp, Parmalat, Royal Ahold and Elan, where uncontrolled greed
crippled stakeholder confidence. The Harvard Business Review
quoted Judith Martin in its December 2003 issue: “When I look in my mail,
it’s clear that the number one problem facing American society today is
greed.” She really should not have been that surprised about the persistence
of greed: it’s a human instinct that has been and will always be with
us. The issue is to stifle it through the right combination of internal
culture, controls, penalties, and resulting publicity. New laws, rules
of governance, and leadership have started this process and organizations
worldwide are on the path to correcting the imbalance.
Today, besides the U.S. dollar, the related issue is flexibility,
the capability of any organization to rebound from whatever contingencies
may occur in the next twelve to twenty-four months. Can a nonprofit sustain
a 20% reduction in donations and continue its beneficial work? Can a local,
state, or provincial government survive a 20% drop in tax revenues? Can
a profit-making corporation take advantage of a 20% drop in the value
of the dollar and expand its sales outside the U.S.? Will outsourcing
bite back with substantially higher costs from non-U.S. operations?
It is in enhanced organizational flexibility that risk management
can make its greatest contribution. First, it can use the technique of
scenario analysis to undertake broad and integrated risk assessments,
particularly for organizational strategic planners. These scenarios will
incorporate both quantitative and qualitative estimates. Second, risk
management can encourage senior management to be prepared for all
contingencies, however remote. Think about those events that fall outside
the 95.5% estimate of probability. These “outliers” and their consequences
must be incorporated into planning. And third, it can stimulate the creation
and use of enhanced financial reserves, using a combination of savings,
credit, derivatives and insurance to assure adequate financing whatever
occurs. That financing should be directed not only to recovering what
might be lost but also to taking advantage of the new opportunities that
present themselves in a rapidly-changing environment.
Building and maintaining maximum flexibility in uncertain times means
that organizations will have the natural resilience to overcome negative
events and build on positive ones. After all, that is the real goal of
solid risk management: to build and maintain the confidence of all stakeholders
in the organization.
Is it thy fatal destiny, or influence of the stars, that would
put an end to thy so enjoyed ease and rest? For all things have
their end and period, so as that, when they are come to the superlative
point of their greatest height, they are in a trice tumbled down
again, as not being able to abide long in that state. This is
the conclusion and end of those who cannot, by reason and temperance,
moderate their fortunes and prosperities.
François Rabelais, Gargantua and Pantagruel,
Books 1 and 2 (1532), Urquhart- Lemotteux translation, Henry Regnery Company,
Chicago 1949´s Adventures of Maqroll,
New York Review of Books, New York 2002