Tuesday, October 4, 2022

Out of the box risks

Policy Tensor on the consequences of a Russian nuke (HT Marginal Revolution) was very interesting: 

Consider the least escalatory option, that of a “demonstration detonation”: Russian forces air-burst (to avoid the nuclear fallout that results from a ground detonation) a tactical nuclear weapon with sub-kiloton yield (ie, no bigger than a big conventional weapon) over uninhabited territory somewhere in south-eastern Ukraine. This would be consistent with Russia’s “escalate-to-deescalate” doctrine ... What happens then?

Precisely because it is such a dramatic break with precedent, even a demonstration detonation would radically change the character of the Russo-Western conflict over Ukraine. New Yorkers and Berliners etc, are likely to flee the cities. Everywhere, in Europe and America, supermarkets would likely empty within hours. Many local authorities may institute civil defense measures, even as federal governments everywhere urge calm. A widespread breakdown of law and order would be a real possibility; especially in America, where it would be attended by partisan passions and finger-pointing....

Not to bash a hobby horse, but the Fed, SEC, FDIC and so forth are now obsessed with climate risk to the financial system. Chatting with colleagues at the Fed, it is astonishing how much and how detailed the research is in to climate (really weather) scenarios, much of this directed by higher-ups. 

Today I will not criticize that effort. Maybe pianos do fall from the sky.  What is striking to me, verified in every conversation I have with people in these institutions (please prove me wrong!) is that nobody at these institutions is doing any analysis of any other risk. 

This seems like a useful one, for example. Any nuclear explosion is going to make the ATMs go dark. Is anyone at the Fed gaming this out? What if (when) China blockades Taiwan? What about a massive cyberattack on the banking system, a deliberate attempt to cause a run (Russian disinformation that a major bank has had all its account information wiped out, get your cash now)? A new pandemic that looks more like 1350 than the flu?  

So a positive suggestion: Let the climate risk to the financial system efforts continue, but broaden them to all out of the box shocks to the financial system. Game them out, then let's assign some probability. I would guess this one at 5% or so. It's certainly worth asking, "are we ready?" 

I do not worry so much about the massive climate financial risk effort. If they do it honestly, I suspect they will only produce careful qualitative refutation that says climate, for all its problems, is not a risk to the financial system. A lot of time gets wasted in central bank research anyway. But a good worry about climate-financial risk taking over all the attention is that nobody is paying any attention to far more likely scenarios. As the UK was not watching plain old collateral in derivatives contracts, and we'll see about whether the rest of Europe managed to oversee plain old borrow short lend long risk. 

(To clarify, after some comments. Yes, economists are writing papers about this sort of thing. But it is not even conceived of in central bank risk analysis and systemic stress tests.) 

BTW, on a game theory note, I'm less persuaded  by the rest of Policy Tensor's argument that the Russian nuclear step is quite so likely. Look one more step down the game tree. The goal is to restore Russia's status as world power. But losing a war in Ukraine that can only be stopped by a demonstrated resort to nuclear terrorism is not a long-run strategy to be a great power. It would be a Pearl-Harbor wake up to the West. And Russia would be even more a pariah, and in fact show even more evidently how utterly powerless it is in any other way. The goal of great-power respect would not be achieved. It would only become absolutely everybody's enemy. 


Correction. There is in fact a good deal of attention to cybersecurity risks. There is for example an Office of Cybersecurity and Critical Infrastructure Protection at the Department of Treasury. There is no need to overstate the issue. Thanks to correspondent. 


  1. Geopolitical risk is a serious concern not the least because conflicts tend to unfold in fairly unpredictable manner. I'm surprised you have not heard anyone looking into this sort of problem.

    I know someone who majored in political science who once got offered a job to monitor geopolitical risk, so that's clearly something people do in financial markets to manage their risk exposure, but it's a little worrying you didn't hear of anyone think about it from the point of view of systemic risk to the entire financial system of a country -- or the world.

  2. I'm skeptical that people would flee Western cities if a small nuke was detonated in Ukraine. More likely more of "Don't Look Up".

    1. Believe me, if the threat of nuclear war starts to ever look like even a 1-2% probability, the cities will empty.

  3. "Policy Tensor" is engaged in a gedankenexperiment. An air-burst tactical nuclear weapon demonstration over S.E. Ukraine (presumed 'empty') would be de facto a declaration of war by the Russian Federation on the U.S. And, it would be considered as such. The conflict so far has been waged with conventional weapons, mass maneouver and the loss and re-gaining of territory. Stepping up to nuclear weapons, brings in nuclear weapons and counter-measures to further use of nuclear weapons. There is no half-way measure -- it's all or nothing. The alternative is to wipe-out the leadership of the Russian Federation, root and branch.

    The more likely scenario is more in the vein of the disabling of Nordstream I and II. Stealth measures that cripple critical infrastructure in Western states. Strikes against Nordstream I and II were a fore-taste of this practical form of attack. NATO has responded with a counter-threat of its own, the credibility of which is doubtful. Too much area to cover, too many cables and pipelines to protect. One or two deniable attacks would be sufficient. The question would be "What is the mode of retaliation that would put an immediate stop to this form of attack?"

    The FRB is seeking answers to a philosophical question: "If global temperatures rise on average by two degrees Kelvin, how many commercial banks and investment banks in the U.S. will fail by the year 2100?"

    The answer is this: "The number of failures of U.S. commercial banks and investment banks is independent of the global temperature rise, on average."

    It keeps theoretical economists and econometricians employed who would otherwise be sweeping the floors of the major stock and options exchanges; to that extent, the FRB's inquiry is useful. Sweeping the floors of the major stock and options exchanges was made obsolescent with the introduction of the all-electronic virtual exchange boards.

    If Putin uses nuclear weapons over Ukraine, or any other western european state, then he and his cohort die. There is no second way or third way or fourth way. Xi and Kim need to be made aware of this. In no uncertain terms.

    1. and you die also….what a deal

    2. "And, we all fall down!" Children's song chorus describing the 'Dance of Death' that was commonly put on during the bubonic plague years in Europe. We all die eventually. If you recall the battle slogan, "Give me Liberty! Or, give me Death!" Or, from Duke Frederich of Prussia before the gates of Vienna as his Teutonic knights prepared to repulse the Turk, "Hunde! Willst du ewig leben?"

  4. With how digitized the modern banking system is, knock out the power and the generators, and walla, you've got mass panic. Fewer people carry cash nowadays.

    As far as game theory with Russia, it did surprise me that after 30 years of sanctions being a failure in conflicts they actually worked. I think it's simply due to the Georgia conflict occurred, the West under George W. Bush and company did nothing. Crimea occurred, the West under Barack Obama and company did nothing. He took a 3rd slice of the pie and suddenly they woke up. I'm just wondering where these balls from the U.S. President and the Europeans were with Yugoslavia, Iraq, Iran, Syria, Georgia, Crimea, Afghanistan.

  5. It is unfortunate that the primary approach to climate disruption is the interdiction of supply and distribution -- The War on Drugs approach. The cheap energy entitlement appears to be too tough of an obstacle for policy makers to overcome.

    A simple way of resolving the climate crisis would be a limited, regional nuclear war. That would in essence, replace one climate problem with another.

    In such a scenario perhaps one third of North Americans would get sick and most of those would eventually die due to poor health outcomes.

    1. I had that thought regards to Covid. In addition to the short-term reduction in use of energy from more people staying home, less travel, etc., there should be a long-term reduction in according to official numbers 6.55 million, according to more realistic numbers probably 10 million people dying prematurely.

  6. So a GDP lower than Italy and per capita par with Mexico wants to be a world power? And, a country with 11 time zones wants a tiny sliver of a 3 times poorer country (Ukraine is the poorest country in Europe and sometimes poorer than Sri Lanka and Sudan on a per capita basis) to show it's global tessellations??

  7. if the Russians lose badly the war, as they consider the eastern part of Ukraine part of Russia and cannot accept Ukraine in NATO. they will go nuclear. They are not as logical and rational as Prof Cochrane, unfortunately.

  8. Ah, but wait, it’s a twofer; an air burst will send an even larger contaminated air plume worldwide. See, it was a weather risk the whole time; er excuse my wokeness climate delta.

  9. I don't see anyone in Washington worrying about failure of the electrical grid due to a huge solar flare, i.e., a repeat of the Carrington Event of 1859. This would paralyze the country

  10. The City Journal has published a comprehensive review of the contradictions inherent in the so-called "green" movement to transform society's energy infrastructure from 'fossil' fuels to so-called "clean" energy sources.

    The Green War on Clean Energy -- Radical environmentalists fight against the very technologies that would cut carbon emissions. James B. Meigs, City Journal, Summer 2022.

    Navigate to:


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