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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When heritage becomes hate: why my home town of Charlottesville needs to address its complex past

After an invasion of white supremacists, we need to see what our history means today.

Watching a tragedy happening in slow motion, without any way to stop it - that’s how it has felt to be from Charlottesville, Virginia in the summer of 2017. A city that used to always get voted “happiest town in the USA” when I was growing up was the target this weekend of an ugly white supremacist movement whose roots spread far from the city.

It was a huge surprise when we won the lottery of Nazi flags, with our stupid old statues that have become icons of international fascism, with a park named after a distantly forgotten old man becoming a site of struggle for an attempted racist coup of the United States. Our first reaction is: they aren´t from here. Our second: make them go away. Our third: a realisation we need to examine the way that our own ways of life, which we thought so harmless, have inspired such horrible feelings in strangers.

Maybe for my African-American classmates at high school the statue of Confederate general Robert E Lee, and the park when it was still named after him rather than Emancipation Park, always meant violence. Pulling the statue down says no more about the historical Lee than tearing down Lenin in '89 says about socialism. We've been invaded by people pretending to protect us from invasion, and the symbols of our past will never matter as much as living people do.

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The invaders picked our town, probably, because Virginia was a confederate state, and was in fact where the southern gentry used to live. Lee exemplified this tradition. He was son of Lighthorse Harry Lee, a hero of the revolutionary war and governor of Virginia, and is a descendant of one of “Virginia’s first families,” the aristocratic Englishmen who emigrated to Virginia when it was a British colony. He is part of Charlottesville's heritage, and perhaps not even all that shameful a part. He opposed the secession of the confederacy, supported the reconstruction after the war, including giving rights to recently freed slaves. Not exactly woke, but for a confederate general, not as bad as some.

We were taught at Venable Elementary School that he fought only reluctantly, to defend his land, not slavery. In the version we learned, one would imagine Lee being very opposed to people from the Midwest coming to Virginia in cars with Ohio license plates to murder Virginians. Many non-racist Virginians, including quite a few friends, respect Lee deeply - the same is true in towns like New Orleans where other Lee statues are being taken down. Yet if once we could fool ourselves into thinking that the statue didn't represent hatred and racial hierarchies, we can't anymore. The discussion of local history has turned into one of national identity. The statue should be gone by Christmas. 

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The real hero of Charlottesville is the town’s founder, Thomas Jefferson, who was among the most enigmatic of the founding fathers, idealistic and hypocritical - a real American, in other words. His idea of the gentleman farmer is also part of our heritage. It was an alternative to Hamiltonian industrial capitalism, but lost out in the tustle to shape American history. Much like English contemporaries such as William Cobbett, Jefferson believed in a rural ideal, reading poetry by morning, farming by afternoon, playing the harpsichord by night. His thought is also present in our beautiful "academical village" of the University of Virginia which he also founded. It is one of UNESCO’s few world heritage sites in the United States, so I guess it is part fo the globe's heritage as well, and it is also where the white supremacists stomped around with their tiki torches.

It’s time for us to stop being romantic about Jefferson, too. The statue in our minds needs to come down. We can recognize the great parts of his work, of his thought, in Charlottesville today, but we can also recognise that he allowed himself to use violence to dominate others, that he owned slaves and raped them. And we can recognise that equivalent scenarios continue to play out today, and will continue to play out until we are willing to face the truth.

There can be no more excuses. It’s not about Jefferson, or Lee, after all. We use monuments, statues, heroes, to inspire ourselves. In the end, the “truth” about Jefferson or Lee is a matter of trivia and history. Today, for every white male in America, we need to deconstruct the parts of our identity built on the graves of others. It’s not easy.

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Jefferson's gentleman farmer was the forerunner of the people who populate the gentrified Charlottesville that exists today of expensive coffee-shops and celebrity-filled suburbs. This romantic idea, much like the lifestyles of the American and English elite today, seems to engender a lot of resentment from those who can only watch helplessly, and are often gentrified out. It’s not only immigrants or, in the United States, African-Americans, who are denied access to America's Williamsburgs and Charlottesvilles, London's Shoreditches and Oxfords. In Charlottesville, descendants of white sharecroppers and black slaves alike are unable to afford $15 glasses of local Virginia wine.

The paradox implicit in Jefferson’s beautiful idea is that in the end, it’s impossible to sustain this chilled-out and happy lifestyle without the labor being done by others, be they slaves, sharecroppers, or factory workers in China. If America is in trouble now, the conflict comes precisely from the fact that our universalist ideas of freedom, equality, and liberty correspond to an economy that is anything but universal. We actually did it, keep doing it, and unless we can use these ridiculous men dancing through our streets iin Halloween costumes as a funhouse mirror to make us see ourselves as we are, we’ll probably keep doing it.

I resent Jefferson for his hypocrisy, because in truth, I would love it if America looked more like Charlottesville than the industrialized and nasty-looking Interstate 95 highway that leads up the East Coast, the aftermath of Hamiltonian industrial-revolution factory America. The New Jersey towns, the gas stations, what we contemptuously call “McMansions,” suburban Northern Virginia... none of it is really authentic enough. Parallel to the rich and ugly suburbs, are poor and ugly towns, the sort of places with unemployment and discounts on cereal that tastes like sugary trash in the supermarket.

The residents of these towns don’t hate the residents of more gentrified towns for our organic granola, they hate the world for the structures of oppression that they can’t escape, even as an international class, an educated class, a well-meaning class, escapes without even needing to. We coexisted in the same place but not the same set of opportunities, and we glided on to new and bigger worlds of possibility, ones denied to those of different class backgrounds, regardless of their ethnicity.

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Some of my African-American classmates at Charlottesville High School were likely descendants of Jefferson’s slaves, coming from poorer neighbourhoods and housing projects and taking "standard" level classes, with honors and AP classes for students whose parents worked in the University (very liberal, of course), a genteel place where every year, some kid wears blackface or a Nazi outfit to a party - as a joke, of course. While my classmates in AP and Honors classes got help from our teachers in applying to Ivy League schools, the general level classes saw black and white students who shared poorer backgrounds acting out to get attention from harried teachers. This was public school, but Charlottesville’s many excellent private schools, of course, didn’t even have the general level students at all.

Despite some southerners such as Lee supporting the post-war “reconstruction,” white resistance to racial equality led to a Jim Crow system that wasn’t much better than slavery, and an American South which dozed in sweaty decline while the rest of the country industrialised and modernized. From 1865 to 1965, not much happened in the South. True, there were intellectual movements like the Agrarians, whose 1920s manifesto “I’ll Take My Stand” I found one high school afternoon in the local bookstore, we had our Faulkners, our occasional geniuses. But as a society, it was stagnant. 

It was only when the civil rights movement began that the south began to actually rise again. UVa went from being a minor regional school to being a world-class one. Charlottesville went from being a mediocre gentleman’s club to a place that people of all backgrounds could make lives for themselves in the public service. And we, the public, gained so much - that’s why my family chose to live there.

I remember as a child strolling the beautiful downtown mall to go to dinner al fresco with my parents, my father pointed out a man in a turban; it was Satyendra Huja, a Sikh professor at the university who had planned the downtown mall, and made a useless street into one of the nicest places to congregate in town. In 2012, Huja became the mayor. I guess the former mayor of Charlottesville who single-handedly made Charlottesville one of the most charming towns in the country often gets told to “go home,” as if that's somewhere else.

Martin Luther King Jr.’s birthday is a national holiday in the United States, but in Virginia it used to be “Lee/King/Jackson” day, with two confederate officers added in just as a reminder. That’s not really our heritage, and as students, we were grateful for the day but always laughed at how immature it was that the powers that be needed to block out Dr. King’s achievements so much.

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Charlottesville is a southern town true to and even obsessed with our heritage - a place filled with museums, historians, bookstores - which wants to dissect that heritage to remove the parts of our forefathers (and mothers) lives that we can’t accept, like a sandwich that you open up, take the pickles out of, and then keep on eating. We love our heritage in Virginia. We read about it, celebrate it, live it every day. But heritage isn’t a static thing, fixed in time, and the walls between myth and history are thin. In fact, perhaps knowing about your heritage is the ultimate form of privilege. I doubt that either the descendants of slaves I went to high school  with, or the “redneck” (so-called because they got sunburned by working in the fields - “redneck” is a class slur) descendants of the illiterate sharecroppers of rural Maryland, do. 

What happened this weekend to Charlottesville could happen to any town as long as we those who are deprived of their history and who don’t feel at home in their hometown. But the Charlottesville I remember, and the one it is now, proves that you can go from war and conflict and institutionalised racism to one where people of all races and identities can coexist, for the most part, peacefully and happily. We can, if we try, honor Jefferson for his achievements without forgetting the slaves his beautiful buildings were built by. A “Memorial to Enslaved Laborers” is being built on the campus he founded.

For the first time, every one of my old friends is thinking about racism, white privilege, the origins of violence, and what we can do about it. We can honor Jefferson and General Lee’s memory best by trying to learn from their mistakes. Maybe, if it seems like we are able to solve these problems, I’ll have a child myself. I hope she goes to Venable Elementary School, and I’ll take her to Emancipation Park afterwards.

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