What we know

When you hear analysts talk about the outlook for the economy, they have to base their analysis on actual data. The problem with that is to some extent the fact that future events consist of three types. There is the known, things we know will happen and for which we can prepare. This area carries the least risk. The second category is the known unknowns. These are things we know may happen, but we also know may not happen, so the risk they present is somewhat predictable but dangerous. You can account for these in a strategy and plan for the various possibilities. The final area however are the unknown things we don't know about. Now, we all know things are going to happen that are completely unexpected. How do you plan for them?

You can't. If you think you can, you are clearly moving them into the category of known unknowns. For example, suppose you feel that in every previous economic downturn, new opportunities emerged that were completely unexpected, at least by most people. This is however a known unknown, we know that this type of crisis creates an environment where individuals and companies are forced to consider multiple options. This sort of creativity will result in opportunities, even if those opportunities are currently unknown.

The true unknown unknowns are not predictable. It is this uncertainty that ultimately means all forecasting must include a significant margin of error. Now, these unpredictable events are not necessarily bad, they can go either way. If you want an example of such an event, you could think about the terrorist attack on the World Trade Centers. Now, some might argue that this was more of a known, unknown and a terrorist attack now would fall into that category, but I would argue that prior to the 911 attacks, such an attack was simply not included in anyone's plans.

Now much of the objective of analysis is to eliminate the category of unknown unknowns and at least move them into the category of known unknowns. Of course, just when you think you have accomplished that, a new unknown unknown comes along.