Nassim Nicholas Taleb has turned his guns to Alan Greenspan- quite rightly so.
Sitting 17 weeks on the New York Times best-seller list, “Black Swan” outsold former U.S. Federal Reserve Governor Alan Greenspan's “The Age of Turbulence” months ago.
So, how does it feel?
“Greenspan is an empty suit,” he told the Turkish Daily News in Istanbul, one of the latest stops on his lecture tour. “He does not understand economic life and he does not know that he doesn't know. And his book is boring. I despise the man.”
Taleb says the turmoil vindicates him once again. “Greenspan is a man who plays with economic life without understanding its basic structure. In today's world, links between action and consequences are not as visible as they were in the past.”
A major mistake of Greenspan was letting the banking system cluster, he said. “Thus, you end up with a gigantic bank and lose the natural ecology. If a restaurant does not give decent food, the owner goes bust. But banks get clustered. So you end up with one single source of risk and that is JP Morgan!”
“In the U.S., you trade with any bank, you are trading with JP Morgan. I barked about this for years, but then Bear Stearns went bust and JP Morgan ended up taking it,” he said. For Taleb, a system that banks do not go bust means a system that risk is highly concentrated.
He cited an example from another realm. “Which one has more political volatility? Italy or Saudi Arabia? Of course Italy, because they had 62 governments since World War II. But Saudi Arabia has had the same family in power since you guys left them,” he said, referring to the Ottoman Empire. “But Italy has much less risk than Saudi Arabia.”
So, some entities like Bear Stearns do not have volatility but are very risky, while some that are risky do not have volatility. “Greenspan and others do not understand this,” he said. “They never let the banks fail. I want them to fail, because I love the banking system. Finance is too important to be left to U.S. central bankers.”
In his trading days, Taleb was a legend due to a few incredible “hits.” The most legendary of these was in 1987, when he was working for First Boston. At 28 years of age, he made the right bet on Eurodollar futures when nobody else did. On Oct. 19, the Dow Jones Industrial Average declined 22.6 percent, the biggest one-day drop in the United States ever. Eurodollar futures surged after the Fed pumped liquidity into the banking system in a rush, lowering interbank borrowing rates.
Investment choices:
The majority of his personal fortune today is still based on that lucky day. His choice of investing that fortune tells something about Taleb's philosophy. “I like things that are volatile. Instead of investing in medium-risk securities, I invested 90 percent in no-risk government bonds. But my 10 percent is in extremely risky choices.”
“Some businesses, such as biotech, or emerging markets, can benefit from the black swan,” he said. “The problem is, some businesses, like banks in the U.S., have a lot of downside exposure, but no upside exposure.”
The basic rule for Taleb is simple: “If you need a mathematician to understand what you have in your books, you're a blowup.”
“I trained lots of these people,” he continued. “And I tell you, my students were incompetent. I would not give them my car to drive, or even to wash. Mathematics does not work in real life.”
Does “Extremistan” mean the old saying that history repeats itself is not valid anymore? “People tend to learn first order from history. The best example would be the Maginot Line. When Germans came, the French built a wall. What did the Germans do? They went around it,” he continued. “First order thinking is like, ‘Let's make sure we are prepared for a second 22 percent stock market crash.' Because it had never been that worse. But then, the 22 percent crash did not have a predecessor, so history would not have taught you that.”
Taleb has told “the guys at Morgan Stanley” that they are “morons” precisely because of that. “They were doing historical stress testing on their subprime portfolio. But how can you do that when history does not have a predecessor?”
Then he explains his “second order thinking” so rapidly, one might think he cannot repeat these words again: “There is a past, the past's past and the past's future. Then there is today, today's past and today's future. You should work with today's future in relation to today's past the way the past's future worked with the past's past.”
“Simple peasants understand this thinking. But bring in someone with a PhD who works at a bank on risk management, he does not. It's like autism. Thus, the more mathematicians you have in a bank, the more likely it is to blow up.”
From Lebanon to war on terror:
A political “black swan” from Taleb's childhood was the Lebanese civil war. “Nobody saw it coming,” he said. “My father was telling me that it would be over in a week. It went on 17 years. But today, the black swan for Lebanon is peace.”
The black swan takes on another quality if it is spotted. “Anytime you identify a source of randomness, you overestimate its probability and commit mistakes,” Taleb explained. “Today we overestimate terrorism. Give a retard like [George W.] Bush an army and he starts inventing sources of risk.”
The biggest source of risk for humankind is not terrorism but diabetes, which kills 80 million people every year, he argued. “Our reaction to terror causes more people to die than terrorism itself. Nearly 3,000 people died on Sept. 11, 2001. But in the aftermath, many more died due to traffic accidents because they were afraid of flying.” Nearly 600 extra deaths on U.S. and European roads per month after 9/11, he said.
If diabetes is the biggest source of risk today, economists come after it. “We have too many economists,” he said. “The Federal Reserve is dangerous. So is Davos. All pseudo-experts.”
Overoptimization:
Now, this reporter was warned before the interview that Taleb was a “hard one to crack,” and a couple of previous interviews went astray due to colleagues' insistence on asking his prediction on oil prices, the U.S. dollar or the Turkish economy.
This time, Taleb answers without receiving the question in some sort of verbal preemptive strike. “Why did the price of food and oil rise so much?” he said himself. “Because the system is too optimized. A small imbalance of 1 percent in the demand for wheat causes prices to double. But if you look at the facts, demand for wheat is up 2 percent while supply is up 5 percent.”
Such vast price swings tell us that “forecastability in that domain is worse.” So, nobody can guarantee that a barrel of oil will not cost $40 the next day, instead of continuing its rise toward $140. And that is why Taleb is reluctant to predict.
Then, is there an alternative to be paranoid and expect the unexpected? Maybe one has to look at what Karl Marx had said decades ago, a suggestion surprisingly made by prominent businessman İshak Alaton in April.
Taleb strongly disagrees. “According to Marx, the idea is how to turn knowledge into action, and that is pure enlightenment arrogance,” he said. “My point is how to turn absence of knowledge and understanding into action.”
For that, the world has to wait for “Tinkering,” the next book of the trader-turned-philosopher. Until then, ranks of Taleb fans are sure to get more crowded. The world is hungry for new ideas and perspectives, a common phenomenon for times of such deep crises. And that is exactly what Taleb delivers.
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