Living With Black Swans

http://knowledge.wharton.upenn.edu/article.cfm?articleid=2755

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"Big picture thinkers are comfortable with ambiguity. They don't try to force every observation or piece of data into pre-formulated mental cubbyholes." (John C. Maxwell)

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Nassim Taleb's April 13 interview at Wharton provides a fresh perspective on his original black swan theory as well as a what he thinks about oil, the economy, the middle east, etc.

It is interesting that Taleb sees himself as having a tough time getting his black swan message across. While Dr. Herring (his interviewer and former teacher) disagrees with Taleb on that (after all, the term "black swan" has become a part of modern business/economic language), Taleb's point is that the true message of the black swan is that there are some environments in which rare events are simply not predictable.

Taleb goes on: "Most people think they can predict the black swan, that with quantitative sophistication they can get answers. They don't get the idea that because we can't predict black swans, then we need to restructure institutions and rethink strategies to be more robust in the face of uncertainty." For Taleb, the real message of black swans is robustness. Build it (robustness) and one will survive black swans.

Taleb doesn't see the events of the Middle East as black swans: maybe "gray swans." These events are possible to anticipate. In his book, he uses Saudi Arabia as a prime case of the calm before the storm and the "Great Moderation" [the perceived end of economic volatility due to the creation of 20th century banking laws] comparably. The fact that Saudi Arabia has kept a lid on any dissent is a prime example of pressure building. Where Italy, for example, has had 60 regime changes since WW II, and nobody takes all of the elegant yelling and screaming seriously, all people in Italy are represented, however disorganized. In Saudi Arabia, between 7 and 15,000 people "own" the country and the class immediately below them (upper middle) resents that. The Saudi situation looks like stability, but it's not: "Once you remove the lid, the thing explodes." So, the same kind of thing happens in finance. Take the portfolio of banks. The environment seemed very placid - the Great Moderation - and then the thing explodes.

So, the idea is not to try to predict the "catalyst" - who could anticipate that a self-immolation in Tunisia would lead to the widespread discontent in North Africa. The "discontent" could be predicted (with 60% of the Arab street under 30 and unemployment rates high), but not the immediate trigger. As Taleb puts it so well with his "bridge" analogy, it can be predicted that a bridge is fragile but it cannot be predicted which truck will break it. So, one looks at the bridge situation in a structural form: what the physicists call the "percolation approach." You study the terrain. You don't study the components. In finance, they study the random walk. Physicists study percolation (everything is dynamic).

And then, as Taleb says, you learn not to try to predict which truck will break the bridge. But, you just look at the bridge and say, "Oh this bridge doesn't have a great foundation. This other one does. And this one needs to be reinforced." So, this goes to finance and the concept of building "robustness." Look for it or build it where we think it's needed.

Turning to the jobless recoveries we seem to have had over the last 10 years, Taleb's position is that we're not in a "recovery" now: "We did not have a recovery. What we had was a massive reliance on the printing press for more money ... So we are fooling ourselves with the numbers ... [this is] sort of like Madoff style growth."

There is much more to this exceptional interview and Taleb's perspectives. Read it and see how much sense it makes to you.