Cross post from Adelia Hallett:

We believe that all swans are white. It never crosses our minds that swans could be any other colour. Then a black swan appears, completely destroying our faith. That’s Black Swan Theory, and it was used by Wall Street trader Nassim Nicholas Taleb in his 2007 book The Black Swan to describe the way in which people – especially those in the money markets– think that the unpredictable won’t happen.

The rise of the Internet and the September 11 attacks are examples of black swans, and now we’ve got another one.  The collapse of US financial institutions that seemed as solid as rock has left traders, investors, politicians and anyone connected to the markets shaking their heads in disbelief. In New Zealand, the words Big Black Swan are being bandied around the trading houses. No-one saw it coming. No-one can believe what is happening. No-one knows what will happen next.

The extent of the reaction to this black swan is highlighted by the Vix, the Chicago Board Options Exchange Volatility Index that measures just how volatile the volatility on the US stock market really is.  It’s also known as the Fear Gauge.  In 2001, after the 9/11 attacks, the Vix reached a high of 48 points; this week, it hit 58 points.  That means that the US markets are more frightened now than they were after 9/11.

Another indicator with a catchy name – the TED Spread – is also in trouble. It measures the relative popularity between short-term US Treasury bills and their commercial counterparts – in other words, by how much more people trust the Government with their hard-earned savings than they do the private sector.  The TED Spread usually sits at around half a per cent, but this week it has hit four per cent – four times higher than it was after the 1987 share-market crash.

What does this mean for ordinary families? That rather than listening to the buy-buy-buy message of the consumer society, we should have been heeding the lessons that our grandparents tried to teach us; live simply within your means, don’t buy on credit, put feeding and housing your family first, tend your vegetable garden.  Why should our grandparents have had more wisdom than we do?  Because they faced their own black swans. The First World War, the Great Depression of the 1930s, and then another World War taught them to base their lives on the fundamentals, and to value what really matters.  And that, no matter what we are told, there are always black swans.