Nassim Nicholas Taleb to David Cameron

Tuesday, August 18th, 2009

Nassim Nicholas Taleb writes an open letter to David Cameron, leader of Britain’s Conservative party:

We live in an increasingly complex system and complexity causes Black Swans. How? The more interdependent we become, the harder it is to trace the cause of an event and the tougher to forecast accurately, meaning the traditional tools of economics will fail us. And since the spread of the internet, rumours go round the world in minutes. Consider the run on Icelandic banks. It took place at BlackBerry speed. So the economic variables, such as sales, commodity prices, unemployment or GDP growth, are subject to ever more extreme variations. The over-efficiency of the systems means things run smoothly, but are subject to rare but violent blow-ups.

David, you must counter this complexity by lowering indebtedness. We have known since Babylonian times that debt is treacherous and allows no room for mistakes: felix qui nihil debet goes the Roman proverb (“happy is he who owes nothing”). The combination of debt levels swollen from two decades of over-confidence with modern finance’s complex derivatives has been disastrous.

Be careful, too, of the so-called science of economics. Economists have been no better in their predictions than cab drivers. We have an “expert” problem, in which the expert provides you with misplaced confidence, but no information. Because we think, correctly, that the dermatologist, the baker, the chemist are true experts (they know more about their respective subjects than the rest of us), we swallow the canard that the economists at the International Monetary Fund, the World Bank, the Bank of England and the US Federal Reserve are also experts, without checking their record. This reliance on faux experts is, for the most part, what got us here. Now it is continuing with the build-up of government deficit and an increased reliance on flimsy forecasts by the Obama administration.

This problem with experts was particularly acute when it came to the “risk models” on which bankers built those positions that turned sour. So it is that you are coming under pressure to provide more regulation. Alas, the need for more regulation is a myth. I have been fighting risk models both as a Wall Street trader and as a professor and my worst nightmares were the results of regulators. It was they who promoted the reliance on ratings by credit agencies. The “value-at-risk” models regulators promoted made us take more risks.

If we are to have regulators, we need them to operate along conservative lines and conserve the rich knowledge and understanding of risk transmitted through generations of practice, of trial and error. We replaced the heuristics of the elders with arrogant (and incompetent) beliefs, breaking, in the name of science, the chain of knowledge. Old, conservative bankers and traders have been replaced by keen young mathematical analysts, yet anyone who listened to a grandmother who survived the Depression would have been warned against debt and been better prepared than Ben Bernanke and Alan Greenspan, respectively chairman and former chairman of America’s Federal Reserve.

The solution is obvious: build an economy that increases the role of well-tested traditions. Ban financial derivatives that require advanced mathematics rather than trial and error. Look at mother nature. There is a complex system built around sound principles that has insured both evolution and survival. It does not let anything get too big to fail. It breaks things early. I don’t understand why people who stand against tampering with nature accept tampering with the economy that would have organically grown too. Work on building a “robust” society, capable of withstanding errors, in which the role of finance (hence debt) would be minimal. We want a society in which people can make mistakes without risk of total collapse. Silicon Valley offers a good example, where people have the chance to fail fast (and repeatedly).

The best blueprint is the very opposite of the Obama administration’s economic policies (its foreign policy is commendable). It has been administering pain-killers without addressing the cause of disease. Obama is strengthening those who do the wrong thing.

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