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The global tightrope

This article illustrates how Chantell Ilbury and I have developed the scenario-planning technique over the last ten years. We feel that instead of just listing different scenarios as some consultants do, it is much better to present them in a matrix like the one depicted in the article. This allows people to visualise the logical connection between the different scenarios, have a debate around which quadrant the world is in and whether the world is about to move to another quadrant.

Obviously, the choice of the two axes that form the basis of the matrix is crucial. Our advice is that you should list all the key uncertainties surrounding the topic covered by the matrix and then ask yourself which are the ones that are the real driving forces for different futures and which are the ones that people are most interested in. In this case, we felt that the two key issues on people’s minds are whether or not the world economy is going to experience a short-term recovery; and secondly, whether or not the world will stay relatively united in overcoming existing problems or fall apart.

The other two modifications we have made to the scenario process are to identify the flags which we believe indicate movement towards a specific scenario; and then, based on the disposition of the flags, attach a subject probability to the scenario. We have found that our clients are as interested in the flags as they are in the scenarios themselves. We watch the flags all the time and, as you will see later on in the book, adjust the probability of a scenario as soon as we detect a shift in a flag’s position.

In other words, the matrix is dynamic in the way that we interpret it; and of course, over a period of time, we replace the axes with new driving forces and the quadrants with new scenarios. That is what is so fascinating about the future. It is like driving along a road where the countryside gradually alters but occasionally undergoes a sudden transformation. For this reason, no presentation on the future can ever get stale. You are always talking about different surroundings.

If Ben Bernanke were in the circus rather than chairman of the US Federal Reserve Bank, he would be a tightrope walker. On the one hand, he has done everything to stop the Great Recession turning into the Great Depression with his monetary stimulus measures. On the other hand, he wants to avoid stagflation – a condition of low economic growth but rising inflation and hence rising interest rates. In other words, he does not want to repeat the mistake made by Alan Greenspan earlier this century which contributed to the Crash of 2008.

Let us analyse the tightrope on which he is precariously perched in terms of scenarios, flags and probabilities:

On our latest scenario gameboard, Chantell Ilbury and I have chosen two axes. On the left of the horizontal one is a “U“ denoting a long economic slog of at least five years before the world as a whole experiences a sustainable recovery. On the right is a “V“ where 2010 was a year of transition, 2011 will see a mild recovery and 2012 we are truly back in business.

On the top of the vertical axis is a world operating as one unit and, on account of globalisation, sharing a common destiny. At the bottom is a world that is becoming increasingly divided, either because of differing economic prospects or as a result of rising tensions, protectionism or regional strife.

The interaction between these two axes yields four possible scenarios. Going clockwise, the first is “Hard Times“ or a classic “U“ for everybody where unemployment rates remain painfully high for much longer than people anticipate. The second scenario is “New Balls Please“ where Bernanke is the hero of the day, but the economic game is very different in its revived form. Resources are scarce as the East vies with the West for economic supremacy.

“Ultraviolet“ is a two-speed “UV“ world where emerging economies experience a recovery in the short term while advanced economies labour on under a mountain of debt. “Forked Lightning“ is a double-dip repeat of the early 1930s when the Crash of 1932 eclipsed the Crash of 1929.

Currently, we are in the “Ultraviolet“ scenario and it is our favourite over the next five years with a probability of 40%. The flag to indicate we are moving into the universal “Hard Times“ upper-left quadrant is a dip in China‘s economic growth rate below 6%. So many emerging economies in Africa and elsewhere, as well as advanced economies like Germany and Australia, are dependent on China‘s continued success. If China falters, the multiplier effect kicks in. We give “Hard Times“ a 30% probability which is lower than “Ultraviolet“ because it is odds on that the Chinese economic miracle remains in place.

The flags for “New Balls Please“ are a decline in the US unemployment rate below 6% and a general drop in national debt to GDP ratios among advanced economies. The former is still at a historic high around 9½% and the latter are continuing to climb since governments have only just begun to rein in their budget deficits. We therefore accord “New Balls Please“ a 20% probability at this stage, on the grounds that the conditions for sustainable recovery are elusive.

As for “Forked Lightning“, our principal flag is a jump in the ten-year US Government Bond rate above 5%, which would indicate a loss of faith in the dollar as a reserve currency. Other flags are a national default of note in Europe, a trade war erupting between America and China, and a massive conflict in the Middle East or between the two Koreas. Essentially, a gust of wind blows Bernanke off the tightrope and the finely crafted balance he has put together falls apart.

None of these flags is up at the moment and we therefore assign “Forked Lightning“ a 10% wild-card probability. Our advice to clients, however, is to monitor the flags constantly and adjust the probabilities as the flags go up or down. Equally, there may be other flags we have not thought of or even other scenarios. Whatever your preferences, this approach is more sensible than betting the shop on a single forecast. It makes you more nimble when things change.