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Weekend reading: Black Swan blues

Weekend reading

Excellent reading from the Worldy Wise Web.

Once upon a time, Black Swans were rarer than golden geese. But then Nicholas Taleb wrote his bestseller The Black Swan (not to be confused with the pouting Natalie Portman vehicle) and Black Swans have ever since been ruffling feathers everywhere.

I have nothing against Taleb’s dark tome, although I prefer his earlier Fooled by Randomness, which could genuinely change your investing life.

But I do object to the ceaseless reaching for the Black Swan metaphor whenever anything happens that someone doesn’t like the look of.

  • “A nuclear reactor has blown up – it’s a Black Swan event!”
  • “Reckitt Benckiser’s CEO resigns – another Black Swan!”
  • “The market is down today – Black Swan! Black Swan!”
  • “Why knew ISA rates would fall to 3%? Talk about Black Swans.”

No, please don’t talk about Black Swans, not until you can tell one from a duck.

Anyway, The Motley Fool ran such an excellent piece on spotting Black Swans versus red herrings that I’m making it today’s post of the week.

The author, Vincent Scheurer, writes:

The rule that all swans are white was never logically provable. However, the first person to see a real black swan (in 1697) immediately knew that the rule that all swans are white was wrong.

The point about the “Black Swan” in the modern sense of the word — the unexpected event with terrible consequences — is that it cannot be predicted in advance, which means that we as a society must take steps to ensure that its impact is minimised rather than spending all of our resources trying to stop it from happening in the first place.

That, in a nutshell, is why most of the efforts going into financial re-regulation are a waste of time.

Something else will go wrong, anyway. And we don’t yet know what.

From the blogs

Money Maven roundup

Mainstream media on money

  • The real housewives of Wall Street… – Rolling Stone
  • …the author also takes on Wall Street in this CNN video – via Ian Fraser
  • Good news on UK jobs – Flanders/BBC
  • DRIP your way to wealth – Motley Fool
  • Investors urged to check they understand ETFs – FT
  • What shares are value investors buying? – FT
  • The bullish case for gold, again – Merryn/FT
  • Investors now have £860 billion in ETFs – Telegraph
  • Britons ignore debt until it hits £10,000 – Telegraph
  • Tweet your complaint to get a result – Telegraph
  • UK economy to be monitored by the IMF – Independent
  • New fund highlights opportunities in oil – Independent
  • A bank has the right to raid your cash – Independent
  • Is sugar toxic? [Not investing-related, but probably right]NYT

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{ 8 comments… add one }
  • 1 Yakezie April 16, 2011, 11:48 am

    It is quite interesting that Black Swans happen so often eh?

    It’s all just a marketing gimmick word that sticks!

    Best, Sam

  • 2 ermine April 17, 2011, 10:52 am

    > we as a society must take steps to ensure that its impact is minimised

    We don’t do that very well now. We seek efficiency and drive out redundancy and resilience. We craft long supply lines orchestrated by just-in-time management systems that assume tomorrow will be like yesterday. We hire jumped up bean counters who attempt to drive down costs by cutting contingency.

    Cheap oil has made much of that possible over the last 30 years, aided and abetted by improved communications and information processing. There may be adtvantages to the increasing costs of transportation in shortening our supply chains, hopefully at least for food.

    We are also losing the capability to design for resilience, at any rate in engineering, as product life-cycles become shorter. We expect to replace rather than repair, because it matches the current world of relative abundance. Hopefully that assumption will prevail in future, but if it doesn’t, we will find ourselve ill-equipped to deal with it.

    Part of our problem this time with the credit crunch was that we found the financial system had cross-linked everything so failures propagated. We could discourage that perhaps, so at least an entity that had been black swanned could fall in isolation. Or perhaps we could accept that once is every three-score-years-and-ten the entire financial system self-immolates, at teach our kids that’s just the way the world is, so they don’t get to rely on it.

  • 3 Salis Grano April 17, 2011, 11:08 am

    I agree with ermine that resilience is extremely important. The trouble is that it is often not easy in practice. In my experience in IT, for example, systems are often presented as redundant and fail-safe, but there is often some other hidden SPF introduced to co-ordinate failure modes.

    For me, the way to go is definitely to assume that crashes will happen. In fact, if such assumptions had been made throughout the financial fabric, and not officially discouraged everywhere, we would not be in the current mess.

  • 4 The Investor April 17, 2011, 12:12 pm

    Interesting thoughts chaps. Have you read Black Swan? Taleb is very into redundancy and heterogeneity.

    Really the clue is in natural ecological systems. Stable ecosystems have huge webs enabling lots of mini booms and busts to mop up localized catastrophe.

    A V1 human designed system for a forest would have a shock when the first tree fell on a defecating bear in the woods. The resultant splatter wouldn’t be in the model — it’d be 30 years before the tree was due to be lopped, and what the heck is a bear doing in there anyway? — and there would be nothing to mop up the resultant damage.

    In contrast in nature you’d get scavengers, fungi, bacteria, and so on. It’s one of the innumerable reasons why I fear environmental collapse.

    However I think Ermine’s comments on oil (which we’ve debated before! 🙂 ) highlight the difficulties for our own engineering.

    Ermine considers the end of oil to be a likely catastrophic event for current civilization. I think at least that the jury is still out. We could waste a lot of time and effort re-fitting our society for the end of cheap energy, only to regret it later when we crack nuclear fusion, or cheap PV, or what have you.

    Multiply such redundancy up by 100s of other potential cul-de-sacs, and the argument for ignoring the downside reveals itself. Counter-factuals are as hard to prove in financial markets and science as they are when considering a world where Gaddafi rolled his death squads into Benghazi — or didn’t.

    Tough stuff. Perhaps what oil has really done for our future (the benefits in the past are clear) is increase the risks by putting so much of our bets on black?

  • 5 OldPro April 17, 2011, 12:42 pm

    The Investor — this is why capitalism works, because it disperses decisions across many many entities… the commies with their tractor-committees never stood a chance.

  • 6 The Investor April 17, 2011, 12:55 pm

    A good post I missed on the ‘spillionaires’ who cleaned up after BP’s oil spill:

    http://www.washingtonpost.com/national/spillionaires-are-the-new-rich-after-bp-oil-spill-payouts/2011/04/11/AFjaqsWD_story.html

  • 7 UK Value Investor April 18, 2011, 12:07 pm

    I think there may be a Perfect Storm of Black Swans brewing.

  • 8 ermine April 18, 2011, 11:59 pm

    @TI – man, you’ve picked the more existential fear 😉 At least peak oil is survivable in principle, whereas some of the extremes of environmental collapse aren’t that survivable for humans!

    On the other hand, you’ve made the case for the resilience of natural systems, so unusually I’m on the side of the optimists there!

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