Ever behind the curve, I read an article a couple of weeks ago about Nassim Nicholas Taleb. This is a bit late in the day, because he has some very important things to say, and he has been on the world stage for some time now.

You should care about what Mr. Taleb has to say for a couple of reasons. First, because he is a very, very clever man who has a lot to say about the global financial crisis. And second, because word on the street is that he has an open line to Cameron and Osborne, and Cameron in particular is buying deep into his philosophy. What he will do with it I do not know.

Nassim Nicholas Taleb is a former derivatives trader turned philosopher, author and professor specializing in mathematics, logic and problems of probability and uncertainty, which includes decision-making under incomplete information and understanding. His work covers both technical and philosophical problems with probability, including issues of political stability, statistical mechanics, fragility of systems, psychological biases, and systems of ethics.

He was born in the Lebanon in 1960. His parents were Greek Orthodox Lebanese with French citizenship. When he was 15 Lebanon erupted in civil war. Taleb studied for several years in the basement of his parents’ home.

Taleb received his bachelor and master in science degrees from the University of Paris. He holds an MBA from the Wharton School at the University of Pennsylvania and a PhD in Management Science (his thesis was on the mathematics of derivatives pricing).

He has a literary fluency in English, French, and classical Arabic; a conversational fluency in Italian and Spanish; and can read classical texts in Greek, Latin, Aramaic, and ancient Hebrew, as well as the Canaanite script.

Mr. Taleb is currently Distinguished Professor of Risk Engineering at New York University’s Polytechnic Institute and a Visiting Research Scholar at Oxford University (his full list of academic credits, including Professorships of Mathematics at New York University is too long to repeat). In his spare time he is an advisor to the International Monetary Fund.

He has not always been an academic. He is a self made millionaire. Mr. Taleb was a New York arbitrage trader in the 1980’s. He became very wealthy in the crash of 1987, and multi, multi millionaire in the recent financial crisis.

He is the author of books including Dynamic Hedging, Fooled by Randomness (the name of his personal website too), and The Black Swan.

The Black Swan was credited in the Sunday Times being one of the twelve most influential books since World War II.

[Ed: At this point it’s worth saying that the article is long so you might want to set aside some time to read it properly]

Right…

Mr. Taleb is clearly a man of some substance. In the article I read he expressed some disdain for the Gordon Brown’s approach to the management of the economy as illogical and doomed to failure, particularly Brown’s taste for micro managing things which he appeared to consider intellectually and philosophically unsound.

I decided to try and find out more, and promptly ordered a copy of the said book.

I have to say that I found it very hard going. You know when Gordon Brown used to make all those rambling speeches full of economic bullshit jargon (who can forget all that mumbo jumbo about zero percent growth?).

Well, Mr. Taleb is a hard read, but it is not like that. The book is an intense fusion of logic, mathematical theory, metaphor and analysis of the philosophy of risk, the issue of uncertainty, the nature of what “knowledge” is, and where the boundaries of what we know, what we think we know and what we can’t know lie. Whereas I could understand too well that Gordon was talking utter bollocks and could happily just switch off the TV, Taleb’s book is much more disconcerting because I can tell he knows exactly what he is on about, it’s just that he is on another intellectual planet to me.

Fortunately Mr. Taleb is a rather engaging character with a gentle funny side when he speaks and is a lot easier to listen to than to read, and so I have provided some youtube links below.

I cannot say that I can do The Black Swan justice, but this is my understanding.

The term “Black Swan” is borrowed from and old English expression or metaphor for something which cannot logically exist because it has never been known before. Therefore it is assumed that it cannot ever exist at all. Until, of course, one is discovered.

A Black Swan event has two or perhaps three attributes as Mr. Taleb explains here (4min).

First, it is outside the scope of regular expectations, because nothing in the past can point to it being a possibility.

Second, it must be an event which has a major impact on human behaviour.

The third attribute (although it may be a description of the human nature rather than the event itself) is that in spite of the fact that in reality it was a random and wholly unpredictable event, human nature makes us concoct rational explanations for its occurrence after the event with benefit of hindsight.

His claim is that almost all consequential events in history come from the unexpected — yet humans later convince themselves that these events are explainable in hindsight. To that extent, historians and economists are practicing little more than voodoo when they seek to impose structured analyses of events ex post facto.

Taleb says that it is a small number of Black Swan events rather than the millions of mundane events are what actually shape both society and our personal lives.

I think I can attest to that. I well remember a phone call out of the blue, totally unpredictable and seemingly innocuous, in 1998, the consequences of which were to utterly turn my world upside down and shape the rest of my life….

According to Mr. Taleb, thinkers who came before him who dealt with the notion of the improbable, such as Hume, Mill, and Popper focused on the problem of induction in logic, specifically that of drawing general conclusions from specific observations. But this is to look in the wrong place for significance. The unique attribute of Taleb’s Black Swan event is high impact.

Here is a quote from The Black Swan dealing with his explanation about why the normal is not important, it is the exceptional which matters:

“I don’t particularly care about the usual. If you want to get an idea of a friend’s temperament, ethics, and personal elegance, you need to look at him under the tests of severe circumstances, not under the regular rosy glow of daily life. Can you assess the danger a criminal poses by examining only what he does on an ordinary day? Can we understand health without considering wild diseases and epidemics? Indeed the normal is often irrelevant. Almost everything in social life is produced by rare but consequential shocks and jumps; all the while almost everything studied about social life focuses on the “normal,” particularly with “bell curve” methods of inference that tell you close to nothing. Why? Because the bell curve ignores large deviations, cannot handle them, yet makes us confident that we have tamed uncertainty. Its nickname in this book is GIF, Great Intellectual Fraud.”

Wow.

Taleb cites some funny and some interesting examples of Black Swan events. The invention of the tie, for example. A thousand years ago who could have predicted that we would all attend meetings with a rope round our neck, ready to hang ourselves? Harry Potter is a Black Swan phenomenon, as is the rise of any new religion.

Taleb cites World War I (and as he correctly describes it, its “second installment” World War II) and the September 11 attacks as Black Swan events. Who would have predicted on September 11th 2001 that airplanes would be flown into the Twin Towers and the War on Terror with all its ramifications begin?

The great financial and banking crisis is a Black Swan event. Even as Gordon Brown was predicting the end of boom and bust, the edifice was ready to topple. Although it is not the only cause, in an interview I heard with the acutely astute and brilliant novelist Robert Harris, Harris observed that in researching his latest novel “The Fear Index”, he found that the hugely powerful hedge fund computers, activating algorithm based trades day and night 24/7, were unable to comprehend that there could be a crash in certain US housing markets.

That had never happened before, and therefore it could not happen. So they kept on trading in the stocks even when it did. A true Black Swan event.

Now I have to confess that I find Mr.Taleb’s book a bit of a hard read. In fact I have not made a great deal of progress with the book itself. It is a dense and very intense work, weaving many strands of philosophical analysis and reasoning. I have read around it and dipped in and out.

I hope I am not doing him a disservice, but to my limited mind (I have no talent for mathematics or logic) I think what he is saying is that is that governments, politicians and philosophers and particularly economists do not understand the way in which the world works. They want it to be logical and capable of prediction and crucially management (by them), but however much you think you can control it, well: s**t happens. It happens because there is certain randomness to life.

Hence the incredible hubris and indeed philosophical stupidity of Gordon Brown’s claim that boom and bust were over. Because of course, s**t just happens. So what you need to do is not pretend that it will not happen, but build a system which is as robust as possible, because there will be a cataclysm sooner or later.

Many religions would take the same view. What is that parable about the seven fat cows and the seven lean cows?

As I mentioned above, Mr. Taleb was a Wall Street trader in the 1980’s and 90’s. And he had been predicting a global financial meltdown for years.

As I understand it, as a trader he pioneered something called “tail risk hedging” in which investors were insured against extreme market moves. At the same time he managed to be able to take positions which profited from them when they happened.

He noted that the global financial markets and institutions were creating products and forms of investment of ever increasing risk and complexity which they claimed they could manage. They produced and endless scheme of propaganda from their “economists” and “analysts” which explained they had mastered the art of “risk management”, insulating them from any problems.

It seems to me that Mr. Taleb understood both in philosophical and practical terms that this was complete and utter rubbish. They were creating systems with risks that they did not, in fact, understand anyway and which (importantly in his philosophy) they could never predict, because the nature of reality is that involves sudden, unpredictable and catastrophic events which we simply cannot. These may be a good thing (he says evolution and change are driven by them) or they may be a bad thing. But they WILL happen. As I understand it Mr. Taleb took up a long term position in the market which anticipated disaster. He was right, and he made many millions…

Of course, Gordon Brown claimed to be “an economist”. Mr. Taleb berates “economists” as witch doctors who have sold illogical lies dressed up as “analysis” and “forecasts” for years, paving the way for the criminally reckless strategies of the banks. These were based on “risk analyses” which were fundamentally intellectually flawed. Watch Mr. Taleb getting angry with idiot economists, bankers and theoreticians (6min).

I have tried to go further and understand what Taleb’s philosophical analyses mean in terms of hard economic policies, but I have found it hard. As I mentioned above, I find him much easier to listen to than read. Here are some of my very limited conclusions.

He takes the view that many economic policies are driven by warped logic. For example, I think we may see the influence of Taleb in the recent cut in the top rate of tax. Look at it this way, he says. I have done well. I have made a lot of money. So I am doing and have been doing something right. So should I pay a higher rate of tax? You want to penalise me for doing it right and take less off the people who have been doing it wrong? How is that logical?

Put like that, I can see his point.

I am afraid he takes the view that in the long terms the present state of capitalism and the banks is unsustainable. One of the reasons for this is that capitalism has been warped. He takes the issue of bankers bonuses as a clear example. He says that there are bonuses, but there has to be another side to the ledger (“malices”) if things go wrong. In short the one way nature of the way banks pay, and the way banks are then supported when they fail, warps the correct operation of the system and logically must lead to the situation in which we now are, because there is no payback on the people involved. This is asymmetrical and cannot be sustained.

He does not seem to be a fan of Obama’s economic policies, which he says are like giving a man with cancer pain killers, which whilst alleviating the pain, neglect to treat the disease itself. A clip is here (6min).

He says that that central banks and politicians are too reliant on the sanctity of “forecasts”, but the real word they are peddling hokum about as useful as my copy of Old Moore’s Almanac.

He says that you cannot micro manage and economy (or a life) or protect it from shocks. The shocks will come whatever you do. So all you can do is devise robust systems which can deal better with the shocks. In the world of banks I think that means having smaller banks which are allowed to go to the wall if they fail, but don’t take us all to hell in a hand cart with them.

I am sure I have not done justice to Mr. Taleb’s insight. I do not have the intellectual hard drive to do so. But on a purely instinctive level he seems a deeply thoughtful, hugely intelligent and rather charming polymath, who I can only admire. Unlike Gordon Brown, who just struck me as someone churning out jargon to mask dogma and lack of intellectual rigour, Mr. Taleb is a man who strikes me as a hugely intelligent and deeply insightful man. He also seems rather modest and engaging.

Brown and his heir apparent Balls take the intellectual view that they understand what is going on and can control it. The hugely intellectually superior Mr. Taleb takes the opposite view. As he says in one of the clips above, he wakes up everyday and realizes he doesn’t understand most of what is happening. What a wise man.

If others out there can explain more of what he stands for, and why he might be right or wrong, I would be glad to be better informed.

In the meantime, I shall carefully follow what the extraordinary Mr. Taleb has to say.

Gildas the Monk

Mark (the one in Mayenne)
June 12, 2012 at 08:19

In this general context, it’s a general truth that the more severly optimised a system is, the less robust it is to shocks.

Our farming, healthcare, financial systems are greatly optimised for the status quo, and not very stable.

Brian
June 12, 2012 at 17:05

Hence the poor resilience of just in time manufacturing after the Thai floods and Japanese tsunami/nuclear incidents.
I laugh at the idiot management experts who cut organisations down to the bone and then wonder why they get endless colds, flu and injuries like the most superfit athletes. It’s the same with thoroughbred racehorses, very high maintenance is required for high output.
Perhaps we should be content with Welsh Cob economics.

Engineer
June 12, 2012 at 21:26

It does depend a bit on what your competitors are doing. If their products are as good as yours, but they can make them cheaper, they’ll drive you out of business. So you either make far better products than they can, possibly for a niche market, or you cut your costs so that you can compete with them on price. The prize if you succeed is profit for a few more years. Then technology marches on in some way, and you have to run to catch up again.

All these ‘management theories’ are flavour of the month for a while. At some point, ‘lean’ will be superceded by another theory that addresses its flaws; that will be flawed in some way too, and in it’s turn will be superceded.

Mark (the one in Mayenne)
June 13, 2012 at 12:09

Well yes, in the competitive market, there are clear rewards for being efficient and optimised. The problem is that this leads to a lack of resilience. Whereas this can mean that individual companies can go down in a local systemic shock, in an optimised global economy the whole of civilisation is in play.

Engineer
June 14, 2012 at 21:45

Well, if there are still people around needing things (food, clothing and so on), there will still be someone producing it, optimised or not.

Chris Hadrill
June 12, 2012 at 08:54

A podcast you may have missed (1 hour)

http://www.econtalk.org/archives/2010/05/taleb_on_black_1.html

GildasTheMonk
June 12, 2012 at 09:21

Thanks. I am glad to be pointed in the direction of more info on this topic

General Pyston Broak
June 12, 2012 at 09:38

Never mind Taleb, more on your Black Swan phone call in 1998 please.

GildasTheMonk
June 12, 2012 at 11:08

Well, that is a matter which is rather sensitive General, suffice to say that someone looked me up who changed the direction of my life forever

General Pyston Broak
June 12, 2012 at 16:11

Oh we’ve all had one of those. Mine was “General, I’m pregnant, you’re the father” from a saucy young thing whose, erm, charms I fell for one cold October evening.

Single Acts of Tyranny
June 13, 2012 at 18:02

I know of a similar story, but the DNA test said no.

Thomas Hall
June 12, 2012 at 10:17

I’m not sure that the financial crisis was a black swan event at all- you say yourself, Taleb was predicting it for ages beforehand. It was entirely predictable, and followed a long line of similar crashes based on credit bubbles for land speculative purposes. The severity of this one was only because new players were allowed to take part in fueling the bubble through the use of securitied loan derivatives- rated by the credit rating agencies and marketed to the big buy side market players.
The philosophical use of the black swan is simply to show the fallacy of inductive logic. Just because you have a million (or whatever) instances of a swan being white, you cannot prove that ALL swans are white. Scientists are left in a conundrum, as in many cases, it is not possible to have any prove above inductive logical proofs- so various philosphers have tried to quantify the likeliness of something being correct based on induction…

Hysteria
June 12, 2012 at 10:22

His book “Fooled by Randomness” is somewhat more readable.

I think the thesis of Black Swan is interesting – (and yes, it’s heavy going) – but there were people predicting a major event , with the US housing market being the trigger.

I wonder what the trigger will be for the final denouement in the Euro Zone?

alan
June 12, 2012 at 14:43

Sterling will collapse before the Euro Zone, may even be the trigger for a Euro collapse.

Macheath
June 12, 2012 at 19:10

Whatever it is, I’d be willing to bet the BBC’s Robert Peston will have something to do with it.

Remember his gleeful reports from beside the Northern Rock queues? Or the ill-disguised delight with which he fronted the News 24 ‘Downturn’ animated arrow, spouting his market-shaking opinions on a nightly basis?

The man is an apocoholic – a financial pyromaniac to whom his position with the BBC has presented a metaphorical box of matches.

“He used to burn down houses just to watch the glow,
And nothing could be done because he was the Mayor’s son*…”
(Tom Lehrer: ‘My Home Town’)

*Or in this case, son of Labour peer and economist Baron Peston

Jeremy Poynton
June 12, 2012 at 11:48

I think what he is saying is this.

Shit happens. Sometimes, out of the blue, really BIG shit happens which changes things.

SadButMadLad
June 12, 2012 at 12:11

And when really BIG shit happens, don’t change everything to cope with it. Don’t forget about it though, so that you can understand the event better if it does happen again. It’s an unusual occurrence and probably will not happen again for a really long time so take appropriate action.