Beware those Black Swans

The bestselling economist Nassim Nicholas Taleb argues that we can’t make the world financial system

After completing my book The Black Swan, I spent some time meditating on the fragility of systems with the illusion of stability. This convinced me that the banking system was the mother of all accidents waiting to happen. I explained in the book that the best teachers of wisdom are the eldest, because they may have picked up invisible tricks that are absent from our epistemic routines and which help them survive in a world more complex than the one we think we understand. So being old implies a higher degree of resistance to "Black Swans" (events with the following three attributes: they lie outside the realm of regular expectations; they carry an extreme impact; and human nature makes us concoct explanations for their occurrence after the fact).

Take Mother Nature, which is clearly a complex system, with webs of interdependence, non-linearities and a robust ecology (otherwise it would have blown up a long time ago). It is a very old person with an impeccable memory. Mother Nature does not develop Alz­heimer's - and there is evidence that even humans would not easily lose brain functions with age if they took long walks, avoided sugar, bread, white rice and stock-market investments, and refrained from taking economics classes or reading the New York Times.

Let me summarise my ideas of how Mother Nature deals with the Black Swan. First, she likes redundancies. Look at the human body. We have two eyes, two lungs, two kidneys, even two brains (with the possible exception of company executives) - and each has more capacity than is needed ordinarily. So redundan­cy equals insurance, and the apparent inefficiencies are associated with the costs of maintain­ing these spare parts and the energy needed to keep them around in spite of their idleness.

The exact opposite of redundancy is naive optimisation. The reason I tell people to avoid attending an (orthodox) economics class and argue that economics will fail us is the following: economics is largely based on notions of naive optimisation, mathematised (poorly) by Paul Samuelson - and these mathematics have contributed massively to the construction of an error-prone society. An economist would find it inefficient to carry two lungs and two kidneys - consider the costs involved in transporting these heavy items across the savannah. Such optimisation would, eventually, kill you, after the first accident, the first "outlier". Also, consider that if we gave Mother Nature to economists, it would dispense with individual kidneys - since we do not need them all the time, it would be more "efficient" if we sold ours and used a central kidney on a time-share basis. You could also lend your eyes at night, since you do not need them to dream.

Almost every major idea in conventional economics fails under the modification of some assumption, or what is called "perturbation", where you change one parameter or take a parameter henceforth assumed to be fixed and stable by the theory, and make it random. Take the notion of comparative advantage, supposedly discovered by David Ricardo, and which has oiled the wheels of globalisation. The idea is that countries should focus on "what they do best". So one country should specialise in wine, another in clothes, even though one of them might be better at both. But consider what would happen to the country if the price of wine fluctuated. A simple perturbation around this assumption leads one to reach the opposite conclusion to Ricardo. Mother Nature does not like overspecialisation, as it limits evolution and weakens the animals.

This explains why I found the current ideas on globalisation (such as those promoted by the journalist Thomas Friedman) too naive, and too dangerous for society - unless one takes into account the side effects. Globalisation might give the appearance of efficiency, but the operating leverage and the degrees of interaction between parts will cause small cracks in one spot to percolate through the entire system.

The debt taboo

The same idea applies to debt: it makes you very fragile under perturbations. We currently learn in business schools to engage in borrowing, against all historical traditions (all Mediterranean cultures developed over time a dogma against debt). "Felix qui nihil debet", goes the Roman proverb: "Happy is he who owes nothing." Grandmothers who survived the Great Depression would have advised doing the exact opposite of getting into debt: have several years of income in cash before any personal risk-taking. Had the banks done the same, and kept high cash reserves while taking more aggressive risks with a smaller portion of their port­folios, there would have been no crisis.

Documents dating back to the Babylonians show the ills of debt, and Near Eastern religions banned it. This tells me that one of the purposes of religious traditions has been to enforce prohibitions to protect people against their own epistemic arrogance. Why? Debt implies a strong statement about the future, and a high degree of reliance on forecasts. If you borrow $100 and invest in a project, you still owe $100 even if you fail in the project (but you do a lot better in case you succeed). So debt is dangerous if you are overconfident about the future and are Black Swan-blind - which we all tend to be. And forecasting is harmful since people (especially governments) borrow in response to a forecast (or use the forecast as a cognitive excuse to borrow). My "Scandal of Prediction" (bogus predictions that seem to be there to satisfy psychological needs) is compounded by the "Scandal of Debt": borrowing makes you more vulnerable to forecast error.

Just as Mother Nature likes redundancies, so she abhors anything that is too big. The largest land animal is the elephant, and there is a reason for that. If I went on a rampage and shot an elephant, I might be put in jail and get yelled at by my mother, but I would hardly disturb the ecology of Mother Nature. On the other hand, my point about banks in my book - that if you shot a large bank, I would "shiver at the consequences" and that "if one falls, they all fall" - was subsequently illustrated by events: one bank failure, Lehman Brothers, in September 2008, brought down the entire edifice.

The crisis of 2008 provides an illustration of the need for robustness. Over the past 2,500 years of recorded ideas, only fools and Platonists have believed in engineered utopias. We shouldn't think that we can correct mistakes and eliminate randomness from social and economic life. The challenge, rather, is to ensure that human mistakes and miscalculations remain confined, and to avoid them spreading through the system - just the way Mother Nature does it. Reducing randomness increases exposure to Black Swans.

My dream is to have a true "epistemocracy"; that is, a society robust against expert errors, forecasting errors and hubris, one that can be resistant to the incompetence of politicians, regulators, economists, central bankers, bank­ers, policy wonks and epidemiologists.Here are ten principles for a Black Swan-robust society.

What is fragile should break early while it's still small: Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks become the biggest.

No socialisation of losses and privatisation of gains: Whatever may need to be bailed out should be nationalised; whatever does not need a bailout should be free, small and risk-bearing. We got ourselves into the worst of capitalism and socialism. In France, in the 1980s, the Socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

People who drove a school bus blindfolded (and crashed it) should never be given a new bus: The economics establishment lost its legitimacy with the failure of the system in 2008. Find the smart people whose hands are clean to get us out of this mess.

Don't let someone making an "incentive" bonus manage a nuclear plant - or your financial risks: Odds are he would cut every corner on safety to show "profits" from these savings while claiming to be "conservative". Bonuses don't accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives.

Time to definancialise

Compensate complexity with simplicity: Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. Complex systems survive thanks to slack and redundancy, not debt and optimisation.

Do not give children sticks of dynamite, even if they come with a warning label: Complex financial products need to be banned because nobody understands them, and few are rational enough to know it. We need to protect citizens from themselves, from bankers selling them "hedging" products, and from gullible regulators who listen to economic theorists.

Only Ponzi schemes should depend on confidence: Governments should never need to "restore confidence". Cascading rumours are a product of complex systems. Governments cannot stop the rumours. We just need to be able to shrug off rumours, to be robust to them. Do not give an addict more drugs if he has withdrawal pains: Using leverage to cure the problems of too much leverage is not homoeopathy, it's denial. The debt crisis is not a temporary problem, it's a structural one. We need rehab.

Citizens should not depend on financial assets as a repository of value and rely on fallible "expert" advice for their retirement: Economic life should be definancialised. We should learn not to use markets as warehouses of value.

Make an omelette with the broken eggs: The crisis of 2008 was not a problem to fix with makeshift repairs. We will have to remake the system before it does so itself. Let us move voluntarily into a robust economy by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here and teaching people to navigate a world with fewer certainties. Then we will see an economic life closer to our biological environment: smaller firms and no leverage - a world in which entrepreneurs, not bankers, take the risks, and in which companies are born and die every day without making the news.

Extracted from the postscript to "The Black Swan: the Impact of the Highly Improbable" by Nassim Nicholas Taleb (Penguin, £9.99)
© Nassim Nicholas Taleb 2008 penguin.co.uk

This article first appeared in the 05 July 2010 issue of the New Statesman, The cult of the generals

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Happiness is a huge gun: Cold War thrillers and the modern nuclear deterrent

For all that books and films laud Britain's strength, ultimately, they show that our power is interdependent.

Francisco “Pistols” Scaramanga, the ­assassin for hire in Ian Fleming’s 1965 James Bond novel, The Man With the Golden Gun, has invested more than money in his favourite weapon. Bond’s colleagues in the Secret Service have concluded from Freudian analysis that Scaramanga’s golden gun is “a symbol of virility – an extension of the male organ”. It is just one of many phallic weapons in the Bond saga. In Dr No, for instance, Bond reflects on his 15-year “marriage” to his Beretta handgun as he fondly recalls “pumping the cartridges out on to the bedspread in some hotel bedroom somewhere around the world”. Objectively speaking, guns comprise little more than highly engineered metal and springs, but Fleming invests them with an ­extraordinary degree of psychosexual significance.

Size matters in the Bond novels – a point made by a furious Paul Johnson in a review of Dr No for this paper in 1958 (“everything is giant in Dr No – insects, breasts, and gin-and-tonics”). One of the Bond stories’ biggest weapons is a rocket carrying an atomic warhead: the Moonraker, which gives its name to the third Bond novel, published in 1955. The most important thing about the Moonraker is that it is apparently British – a gift to a grateful nation from the plutocrat Sir Hugo Drax. And, like Bond’s Beretta, it is freighted with psychosexual significance. When Bond first lays eyes on it there is no doubt that this is an erotically charged symbol of destructive power. “One of the most beautiful things I’ve ever seen,” Bond says, with a “rapt expression”:

Up through the centre of the shaft, which was about thirty feet wide, soared a pencil of glistening chromium [. . .] nothing marred the silken sheen of the fifty feet of polished chrome steel except the spidery fingers of two light gantries which stood out from the walls and clasped the waist of the rocket between thick pads of foam-rubber.

The guns in the Bond books can be seen as expressions of their bearer’s power – or, as with Scaramanga’s golden gun, compensation for a lack of virility. The Moonraker is equally symbolic, but on a far larger scale: an expression of a nation’s geopolitical power, or compensation for its impotence.

As what is known officially as Britain’s independent nuclear deterrent (“Trident” to everyone else) returns to the top of the political agenda, the cultural dimension of the debate will no doubt continue to be overlooked. Yet culture matters in politics, especially when the issue is a weapon. As the guns in the Bond novels remind us, weapons are not merely tools, they are also symbols. Trident is not just a system comprising nuclear warheads, missiles and four Vanguard-class submarines. Its symbolic meanings are, to a great extent, what this debate is about. Trident stands for Britain itself, and it does so for different people in different ways. Your opinion on whether to cancel or replace it depends to a great extent on what kind of country you think Britain is, or ought to be.

The Cold War British spy thriller is particularly topical because it developed in tandem with Britain’s nuclear programme through the 1950s and 1960s. Moonraker was published just weeks after Churchill’s government announced its intention to build an H-bomb in the 1955 defence white paper, and three years after Britain’s first atomic test on the Montebello Islands, Western Australia. These novels drew on technological reality in their plots concerning the theft of nuclear secrets or the proliferation of nuclear technology, but they influenced reality as well as reflected it, with stories of British power that helped create Britain’s image of itself in a postwar world.

The main theme of the genre is the decline of British power and how the country responded. Atomic or nuclear weapons serve this as symbols and plot devices. Len Deighton’s debut novel, The Ipcress File (1962), for instance, concerns a plan to brainwash British scientists to spy for the Soviet Union, and has as its centrepiece an American neutron-bomb test on a Pacific atoll, observed by a British double agent who is transmitting Allied secrets to an offshore Soviet submarine. The novel’s technical dialogue on nuclear technology, and its appendices providing a fictionalised account of the Soviet Union’s first atomic bomb test and a factual explanation of the neutron bomb, are in the book not merely for verisimilitude: Deighton’s British spies are observers or victims of the nuclear arms race between the US and the USSR, agents with remarkably little agency.

A more dour variation on the theme is John le Carré’s The Looking Glass War (1965), in which the prospect of obtaining information on Soviet nuclear missiles in East Germany provokes “the Department”, a failing military intelligence organisation, to try to regain its wartime glory with an intelligence coup. This hubris leads to tragedy as its amateurish operation unravels to disastrous effect, le Carré’s point being that military and economic might cannot be regained through nostalgic wish-fulfilment. These novels situate British decline in the context of superpower domination; their characters recall the technological and operational successes of the Second World War but seem unable to accept the contemporary reality of military and geopolitical decline. For Deighton and le Carré, Britain simply doesn’t matter as much as it used to, which is why, in le Carré’s later Smiley novels and Deighton’s Game, Set and Match trilogy (1983-85), the spymasters are so desperate to impress the Americans.

Fleming is usually seen as a reactionary, even blimpish writer – his England was “substantially right of centre”, Kingsley Amis remarked – and he signalled his own politics by making a trade unionist the ­villain of his first novel, Casino Royale (1953). So it might seem surprising that he was as concerned as his younger contemporaries Deighton and le Carré with British decline. The historian David Cannadine, for one, emphasises that although Fleming may have been aghast at certain aspects of postwar change such as the welfare state and unionisation (opinions that Bond makes no secret of sharing), he simply refused to believe that Britain was in decline, a refusal embodied in Bond’s very character.

Bond the man is more than the “anonymous, blunt instrument wielded by a ­government department” that Fleming described to the Manchester Guardian in 1958. He is an expression of the British state itself, demonstrating Britain’s toughness while besting its enemies – the Russian agents of SMERSH and, later, the international criminals and terrorists of SPECTRE. He is supported by a formidable apparatus of technological and logistical capability that mythologises British research and development, which had peaked during the Second World War (a point made more obviously in the film franchise when Fleming’s Armourer becomes the white-coated Q, heir to Barnes Wallis and the ingenious technicians of the Special Operations Executive). And, as Cannadine astutely observes, “this comforting, escapist theme of Britain’s continued pre-eminence” is most evident in Bond’s relationship with the United States. The Americans may have more money, but they cannot spy or fight anywhere near as well as Bond, as is made plain when the hapless Felix Leiter, Bond’s friend in the CIA, literally loses an arm and a leg to one of Mr Big’s sharks in Live and Let Die (1954).

Moonraker, however, exposes a more complex and sceptical side to Fleming’s Bond. It is significant that this emerges in a book that is explicitly about Englishness and the Bomb. The rocket is being built atop another symbol: the white cliffs of Dover, prompting some surprisingly lyrical passages on the beauty of South Foreland coast. And yet, though replete with emblems of English tradition and bursting with hatred of ugly, evil-minded foreigners, this novel has an unmistakable political subtext that undermines its apparent confidence in British power. Drax, it turns out, is a patriot – but a patriot of Nazi Germany, which he had served as an SS officer and plans to avenge with a missile that is pointing not, as everyone believes, at a test site in the North Sea, but at central London, the intended Ground Zero being a flat in Ebury Street, Belgravia (the location, incidentally, of Fleming’s own bachelor pad in the 1930s and 1940s). The missile has been designed and built by engineers from Wernher von Braun’s wartime rocket programme, and its atomic warhead has been generously donated by the Soviet Union, which is looking to bring Britain to its knees without having to go through the rigmarole of fighting a war.

The Moonraker, we are told repeatedly, will restore Britain to its rightful place at the global top table after its unfortunate postwar period of retrenchment and austerity. But the rocket is not British, except in being built on British soil, and the aim of the man controlling it is to destroy British power, not project it. The implication is that Britain is not only incapable of looking after its own defences, but also pathetically grateful for the favours bestowed on it. After the missile is fired, its trajectory diverted by Bond back to the original target (thereby fortuitously taking out a Soviet submarine carrying the fleeing Drax), the government decides to cover it all up and allow the public to continue believing that the Moonraker is a genuinely British atomic success.

One of the ironies of the Bond phenomenon is that by examining the myths and realities of British hard power, it became a chief instrument of British soft power. Of the first 18 novels to sell over a million copies in Britain, ten were Bond books, and Moonraker (by no means the most successful instalment of the saga) was approaching the two million mark 20 years after publication. The film franchise continues to offer Cannadine’s “comforting, escapist” image of Britain (the two most recent pictures, directed by Sam Mendes, are especially replete with British icons), but the novels are altogether more uncertain about Britain’s role in the world. Moonraker is full of anxiety that the myth of British power is nothing more than a myth, that Britain lacks the industrial and scientific wherewithal to return to greatness. It even conjures up an image of the apocalypse, reminding readers of the precariousness of those cherished British values and institutions, when the love interest, the improbably named Special Branch detective Gala Brand, imagines the terrible consequences of Drax’s plan:

The crowds in the streets. The Palace. The nursemaids in the park. The birds in the trees. The great bloom of flame a mile wide. And then the mushroom cloud. And nothing left. Nothing. Nothing. Nothing.

***

Even though their plots ensure that apocalypse is averted, Cold War thrillers thus made their own contribution to forcing us to imagine the unimaginable, as did more mainstream post-apocalyptic novels such as William Golding’s Lord of the Flies (1954), Nevil Shute’s bestseller On the Beach (1957) and The Old Men at the Zoo (1961) by Angus Wilson. In Desmond Cory’s Shockwave, first published in 1963 as Hammerhead and featuring the Spanish-British agent Johnny Fedora (whose debut preceded Bond’s by two years), Madrid is saved from destruction by a nuclear bomb that the Soviet master spy Feramontov almost succeeds in delivering to its target. As he contemplates his objective, Feramontov muses that, in the “bomb-haunted world of the Sixties”, death in a nuclear fireball “might even come as a release, like the snapping of an overtautened string; and after the rains of death had flooded the Earth, those who survived in the sodden ruins might think of him as a benefactor of the race”.

But where the post-apocalyptic dystopias might be viewed as an argument for nuclear disarmament, later Cold War thrillers such as Cory’s usually accepted the fact of mutually assured destruction – and that British peace and prosperity were guaranteed by US nuclear firepower. Nowhere is this more apparent than Frederick Forsyth’s 1984 bestseller, The Fourth Protocol, which turns the Labour Party’s famously unilateralist 1983 election manifesto into a uniquely party-political espionage plot. In it, the general secretary of the Soviet Union conspires with the elderly Kim Philby to smuggle into Britain a small, self-assembly nuclear bomb that a KGB “illegal” will put together and ­detonate at a US air force base in East Anglia.

Unlike in Moonraker and Shockwave, however, the objective is not to provoke hostilities or prompt military capitulation, but to persuade the British public to vote Labour – by provoking horror and outrage at the risks of US nuclear weapons remaining on British soil. However, the new and moderate Labour leader, Neil Kinnock, will have a scant few hours in Downing Street, as a hard-left rival under Soviet control (such as a certain Ken Livingstone, whom Philby describes as “a nondescript, instantly forgettable little fellow with a nasal voice”) will at once usurp Kinnock and reinstate a policy of unilateral disarmament, leading to the removal of the US missiles.

The ideological force of Forsyth’s novel is clear enough: Britain is beset by enemies within and without, and must arm itself morally and politically against communism. But although this is an insistently, even tiresomely patriotic novel, its plot makes no attempt to conceal Britain’s relative military weakness and dependence on the United States, though disaster is averted by the combined brilliance of MI5, MI6 and the SAS. The Fourth Protocol thus becomes an allegory of this country’s world-leading “niche capabilities”, which maintain Britain’s prestige and relevance despite its declining military and economic might.

Today, the political argument remains on much the same terms as at the start of the Cold War. Whichever way you look at it, Trident symbolises Britain. To its supporters, it is symbolic of Britain’s talent for “punching above its weight”, and its responsibility to protect freedom and keep the global peace. To its opponents, it is an emblem of economic folly, militaristic excess, and a misunderstanding of contemporary strategic threats; it is an expression not of British confidence but of a misplaced machismo, a way for Britons to feel good about themselves that fails to address the real threats to the nation. One academic, Nick Ritchie of York University, argues that Britain’s nuclear policy discourse “is underpinned by powerful ideas about masculinity in international politics in which nuclear weapons are associated with ideas of virility, strength, autonomy and rationality”.

In 1945, shortly after Hiroshima became a byword for mass destruction, George ­Orwell predicted in his essay “You and the Atom Bomb” that nuclear weapons would bring about what he was the first to call a “cold war”. Because an atomic bomb “is a rare and costly object as difficult to produce as a battleship”, it could be produced at scale only by countries with vast industrial capacity; this would lead to the emergence of two or three superpowers, confronting each other in a “peace that is no peace”.

Orwell’s point about industrial capacity helps explain why Trident is totemic: it is proof that our industrial might has not entirely vanished. Alternatively, it can be seen as a consolation for industrial decline. This may be why the huge cost of the Successor programme – one of the main arguments wielded by Trident’s opponents against replacement – appears to be a source of pride for the government: the Strategic Defence and Security Review proclaims that, at £31bn, with a further £10bn for contingencies, Successor will be “one of the largest government investment programmes”.

Clearly, size matters today as much as it did when Fleming was writing. But Moonraker again helps us see that all is not what it seems. Just as the Moonraker is a German missile with a Soviet warhead, even if it is being built in Kent, so the missiles carried by the Vanguard-class submarines are, in fact, made in California, Britain having given up missile production in the 1960s. The Trident warheads are made in Berkshire – but by a privatised government agency part-owned by two American firms. Trident may be British, but only in the way Manchester United or a James Bond movie are British.

The Cold War spy thriller presciently suggests that true independence is an illusion. Britain may consume the most destructive weapons yet invented, but it can no longer produce them or deliver them without America’s industrial might. British power is interdependent, not independent: that is the Cold War thriller’s most politically prescient message.

Andrew Glazzard is a senior research fellow at the Royal United Services Institute and the author of “Conrad’s Popular Fictions: Secret Histories and Sensational Novels” (Palgrave Macmillan)

This article first appeared in the 21 July 2016 issue of the New Statesman, The English Revolt