Wednesday, March 19, 2008

True Believers hiding Black Swans

Before the discovery of Australia, Europeans thought that all swans were white, and it would have been considered completely unreasonable to imagine swans of any other color. The first sighting of a black swan in Australia, where black swans are, in fact, rather common, shattered that notion. The moral of this story is that there are exceptions out there, hidden away from our eyes and imagination, waiting to be discovered by complete accident. What I call a "Black Swan" is an exceptional unpredictable event that, unlike the bird, carries a huge impact. Nassim Taleb

One of the books I read during my absence from the screen was Nassim Taleb's, The Black Swan: The Impact of the Highly Improbable. I enjoyed the read, and found it thought provoking, but felt the theme of the book, expressed above in the author's words, a bit too blameless.

True ignorance, to which Taleb refers, while as disastrous in effect as the more pernicious ignorances, seems rarely to be man's problem these days. It isn't, it seems to me, what we truly don't know that bedevils us, but what our forefathers once knew, which we have forgotten, or simply not learned.

That is, to work within Taleb's analogy, the problem is not that we don't know there are black swans, but rather that we used to know of their existence, but no longer believe because that belief stands in the way of the promised land, be it peace on earth or permanent prosperity. The black swans are not waiting to be discovered in some far off land. They are here, but hidden. Their existence is denied.

Who would hide a black swan, and leave others to believe the improbable, impossible? The true believer, who, as described so well by Eric Hoffer, interposes a "fact-proof screen between him and reality."

A recent revistation with Hoffer's The True Believer: Thoughts on the Nature of Mass Movements reminded me of an exchange between Ron Suskind and a senior advisor to President George W. Bush:

......he told me something that at the time I didn't fully comprehend -- but which I now believe gets to the very heart of the Bush presidency.

The aide said that guys like me were ''in what we call the reality-based community,'' which he defined as people who ''believe that solutions emerge from your judicious study of discernible reality.'' I nodded and murmured something about enlightenment principles and empiricism. He cut me off. ''That's not the way the world really works anymore,'' he continued. ''We're an empire now, and when we act, we create our own reality. And while you're studying that reality -- judiciously, as you will -- we'll act again, creating other new realities, which you can study too, and that's how things will sort out. We're history's actors . . . and you, all of you, will be left to just study what we do.''

"It is," Hoffer wrote more than half a century ago, "the true believer's ability to shut his eyes and stop his ears to facts which in his own mind deserve never to be seen nor heard which is the source of his unequalled fortitude and consistency." The new reality to which this aide referred is not a larger or grander vision of the world, but, as time seems to have made clear, a lesser one, a diminution of the world as it is, with the negatives removed, with the black swans hidden away.

Alan Greenspan exhibits characteristics of true believer thinking in The Age of Turbulence. Commenting on Bill Clinton's dalliance with an intern, Greenspan writes, As the scandal unfolded and details of their alleged encounters appeared in the press, I was incredulous. "There is no way these stories could be correct," I told my friends.

Talk about hiding black swans from one's eyes. Not only did Greenspan forget about the tendencies of powerful men, he forgot about Clinton's own past. Did he forget about Gennifer Flowers, whose tale of an affair with Clinton almost cost him the Presidency? Did he forget about Paula Jones, whose lawsuit led to the unveiling of his dalliance with Ms. Lewinsky?

In the words of Dick Morris, "You had to be a moron to believe this guy after his past record."

But the past, for Greenspan, is but something to be paved over by "creative destruction" as he relates by way of a dialogue with his wife, Andrea Mitchell, while visiting Venice:

I asked Andrea, "What is the value-added produced in this city."

"You're asking the wrong question," she replied, and burst out laughing.

"But this entire city is a museum. Just think of what goes into keeping it up."

Despite noting that Venice was for centuries a center of commerce, the lesson that being such a place comes and goes, was lost on Greenspan. Managing that reality is what men like Greenspan should do, but don't because they'd prefer such reminders to be forgotten.

I'll close with another excerpt from Greenspan's book that may be viewed in the future as quite ironic:

Korea's central bank was also sitting on $25B in dollar reserves- ample protection against the Asian contagion, or so we thought.

What we didn't know, but soon discovered, was that the government had played games with those reserves. It had quietly sold or lent the dollars to South Korean commercial banks, which in turn had used them to shore up bad loans.

I wonder how much Gold the Fed actually has, and whether this will be the next hidden black swan to emerge.

3 comments:

STS said...

This is great. The 'natural accident' -- an emergent property of complex systems of coupled variables -- is a much more deserving object of our analytical attention than the 'black swan'. Fat tails arise because such systems simply do not meet the hypotheses of the central limit theorem. Kudos to Taleb for playing gadfly, but he seems to underestimate how much we could -- even *ought* -- to be able to anticipate about the realized distribution of events.

The 'Greenspan in Venice' anecdote is priceless. If I had more time, I'd start spinning an analogy to Thomas Mann's 'Death in Venice' ... but an easier and probably better point to make was the one you began to outline: economics has lost all touch with history and politics and functions as a patsy for market manipulators of many stripes.

Volcker on Charlie Rose the other day repeated a popular notion now current: this crisis is all about quants who didn't understand markets. That's superficially true, but at a deeper level is actually precisely backwards. The quants were working for people who 'knew' markets all too well and discouraged (through arrogance and self-interested ignorance) their more serious intellectual tendencies. The quants believed the markets behaved according to the stated rules and the explanations printed in the textbooks and research articles -- or at least the code they designed and/or coded to guide their trading reflected such belief, whether real or affected. Meanwhile their poker-playing 'betters' continued their usual game until it became time to 'run'.

Have you had time to locate a copy of Eichengreen yet? I want to understand whether we need simply to restore the New Deal regulatory regime with merely technical adjustments to contemporary circumstances or if there -- at long last -- might be something genuinely better available. A serious consideration of a well-functioning gold standard, especially it's political pre-requisites is essential to that.

STS said...

Sorry, typing with thumbs and in haste. I'm thinking of course, of normal accidents.

Shillelagh said...

Dude,

I always enjoy reading your blog but I have to say that this a particularly outstanding and insighful piece of work!

I see the same mentality in the company I work for. Once you get over the outrage of it all, there's actually no shortage of savage amusement to be had simply by observing. While I usually refrain from playing armchair psychologist (though it is entertaining), there are likely many pathologies that lead to the same sort of flaws. The one I see most often amongst senior leadership where I work is best characterized as an unchecked ego combined with a basic lack of understanding of the details of the business - operating in an environment of psychophants. A poisonous stew of incompetence and dysfunction. If a correct decision is made by these people you can most usually be assured that it's likely due to the principle that "even a monkey will eventually type a word", than it is from engaging in any deep thinking or moments of profound insight.

Darwin would probably have scrapped his "Survival of the Fittest" ideas had he observed much of this for very long...

Keep up the good work - it takes the sting out of this past week's Gold beatdown - which I am certain was precipitated by my recent augmentation of a long position in Gold Miners...the Bernanke Vulcan Mind Meld got me again...