Deep Read: Nassim Taleb (The Black Swan Guy) : Planet Money Want to protect yourself from Black Swans? Get rid of debt.

Deep Read: Nassim Taleb (The Black Swan Guy)

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Hello, and welcome to the PLANET MONEY Deep Read. I'm Chana Joffe-Walt.


And I'm Jacob Goldstein. Just a quick refresher - PLANET MONEY Deep Reads are these longish interviews with writers and thinkers. We've been posting them about once a month, and they are special bonus podcasts that we do in addition to our regular Tuesday and Friday shows.

JOFFE-WALT: So today's special bonus podcast is your interview, Jacob, with Nassim Taleb. So Nassim Taleb is a former Wall Street trader. He's often known as the "Black Swan" guy. He wrote a now-famous-ish book called "The Black Swan," and the book came out in 2007 before the financial crisis and basically said that traditional economic models are useless, totally useless because they ignore what Taleb calls black swans, these sort of rare, high-impact events that wind up shaping history. And then, of course, the financial crisis hit, and it was much bigger than most economists with their models predicted. And that made Taleb look really, really smart.

GOLDSTEIN: It did. And, you know, he dined out on that for a few years. And then earlier this year, he released a new edition of the book, and there's this new, long section tacked onto the end of the book. It's called "On Robustness And Fragility," and that's mostly what I talked with him about. Like the rest of the book, the section is quirky. It's erudite. It's arrogant. It's sort of fun and weird. For example, there's this one part in the new section about his exercise habits, which he says are based on human evolution. And apparently, he walks around a lot. And then occasionally he, like, breaks into a really fast sprint. And once in a while, he sort of randomly walks into a gym and lifts the heaviest weights he can over his head.

JOFFE-WALT: OK. And exercise habits aside, this new section is mostly about how to be resilient so you can survive a black swan. And that turns out to involve mostly getting out of debt and building up savings.

GOLDSTEIN: And that's what we talked about mostly in our interview and particularly how it fits with fiscal and monetary policy in the U.S. right now. But we started out talking about something really more fundamental to his argument and to his worldview, and that's the problem with forecasting.

NASSIM TALEB: When you make a statement about the future, you are - about the risks in the future, essentially, you are forecasting, OK? Now, of course, people take forecasting more seriously if it, you know, was pointed out to them that in Semitic languages, forecast equals prophecy. OK. So you're standing...

GOLDSTEIN: Quasi-religious or quasi kind of...

TALEB: Exactly. You're making...

GOLDSTEIN: Quacky or supernatural - yeah.

TALEB: Exactly. You're making a statement about the future, OK? You're talking about something that doesn't exist now, how it will exist in the future. So I focused, then, in "The Black Swan" on forecast error. And I realized because we use the wrong metrics, most things in social science and in what domain I call the complex domain - most forecasts don't work. But people are suckers because of rationalism and narrowly defined theories. You know, they don't know that, OK? But if I take economic papers, the cabdriver predicts better. And the proof is that we have a million economists on a planet, and only a handful predicted the depths of what could have happened. So...

GOLDSTEIN: And the notion is that forecasts don't work because they don't take into account these radical, relatively rare events that end up being the key driver of what happened?

TALEB: Exactly. Exactly. And there's a domain I call the fourth quadrant in which these are dominant, and finance is part of that domain. Economics is part of that domain.

GOLDSTEIN: So you predict what happens 99% of the time or 99.9% of the time, but the remainder is the sort of key historical driver. And that's what's outside of your model, outside of the forecast.

TALEB: Yes. So when I completed the book, in the book, I stated that there is a "Black Swan" effect and stated that there's a domain I call Extremistan in which it takes place (ph). But I realize you can take a horse to water. It's not sufficient. You still have to make the horse drink. I realized that I had to take the idea further and explain to people what domains are fragile, where you should have - you should be very prudent and where you can be aggressive. And typically, people behave in opposite way. They're typically aggressive where they should be prudent and prudent where they should be aggressive. So if you have debt, for example, anything that has high degree of debt requires the more that you have, the more precision you need in your forecasting. And...

GOLDSTEIN: Right. So can you give an example of why that would be the case?

TALEB: Yeah. It's very simple. I borrow - I have a project. I need to invest $100 or want to invest $100 in the project. If I put in $5 of my own and borrow $95, OK, I could do that. And my project doesn't work well while I'm bankrupt, and I have to - you know, I'm wiped out. So I'm...

GOLDSTEIN: Because you can't pay back the $95.

TALEB: Because I can't pay back - I still owe the $95. But on the other hand, if my project is very successful, OK, I want all the money. Most of the money comes to me. So I have massive leverage on the $5 invested. Now, if I...

GOLDSTEIN: Right. So if you double that $100 - you invest $5.

TALEB: Yeah.

GOLDSTEIN: You get to keep $100, and you pay the 95 back.

TALEB: Exactly.

GOLDSTEIN: You make a ton of money.

TALEB: You make a ton of money. OK. But on the other hand, if you issue equity, if I say, OK, I'm going to have $95, if I very successful, unfortunately, my returns would be diluted.

GOLDSTEIN: Because you have to share the profits with all the shareholders.

TALEB: Exactly. I have to share the profits. But the good news is that I also have to share the losses. Debt is different because debt - you still own it. So that's the first problem is debt requires very precise forecasting and illusion of forecasting because - as I said, it's scandalous because government can't forecast unemployment. The government can't forecast anything. So why do they load themselves with debt? OK. And of course, companies are fool enough to - foolish to load themselves with debt. And also, I showed two things - number one, that we are moving into more and more unpredictability because of more and more black swan effects, because of complexity, interdependence - so less predictability of the future - coupled with a quadrupling of debt since 1980. You see? Complexity...

GOLDSTEIN: You're talking about - in total debt held by the U.S. or total - what - quadrupling where...

TALEB: Total level of debt - quadrupling of debt and liabilities, if you count debt, you know, increase of mortgage debt, in the U.S.

GOLDSTEIN: In the U.S. or globally?

TALEB: And worldwide and particularly in the Western world developmentally.

GOLDSTEIN: So essentially, you've had the sort of rising Asia lending more and more to the U.S. and Europe...

TALEB: Or within. Or within. You have more and more people borrowing and mortgages and people storing their, you know, savings in these loans. So you have a rise of debt - OK? - everywhere - individual, corporate, bank, financial institutions and governments, while at the same time, you had a degradation of predictability.

GOLDSTEIN: So, I mean, there is now this very public debate about sovereign debt and sort of timing, right? And should the - should governments in the West continue to spend money, to spend more money than they have...

TALEB: Yeah. That is...

GOLDSTEIN: ...In order to lower unemployment, versus should they cut spending now at the risk of cutting off the recovery, right? That's the way it's framed.

TALEB: OK. My - when the crisis happened, I kept telling anybody who would listen to me that it was not a problem of recession. It was a problem of risk.

GOLDSTEIN: Which means?

TALEB: Which means that it was - the problem was not trying to get out of recession. The problem was getting rid of debt because we had cancer and that if we don't get rid of debt then - or today, in other words - if you don't get rid of debt now, it's going to be worse tomorrow. And every day, it's going to be worse. So people don't understand that the risk of recession is vastly lower overall than the risks of deficits, you see? Because if you tighten your belt - OK, say it happened at an individual level, OK? What would you rather be - have more debt if you've been - you know, have debt, or it's the same thing as a drug addict. What's worse, the period in which he has to suffer withdrawal pain or giving more cocaine or heroin, whatever he's addicted to?

So the - in my opinion, if you presented the problem to an individual and his family, you tell them, this is what you want. Tighten your belt now and have - don't buy a flat-screen TV and delay the purchase of your car and other things or have more debt. So the governments should know that what matters for us is cure the problem, not postpone it. We postponed the problem for two years. The debt has been growing. Employment base is lower.

GOLDSTEIN: I mean, there is the argument that it would have been worse without some spending. I mean, governments can hide...

TALEB: I don't think - I don't like this argument for the following reason. What money we spent we have to repay. You see? And you can only say what happened - OK? - and gauge, really, the consequences when the game is over. You see, it's like Madoff. It would have been - yeah. Had we propped up Madoff by - the government should have lent money to Madoff, and nobody would have suffered.


TALEB: OK? But eventually you suffer up till now. You suffer on a day when Madoff collapsed on a big level.

GOLDSTEIN: So you're basically saying what the government is doing is a Ponzi scheme.

TALEB: It's a bigger Ponzi scheme, biggest in the history of mankind because government represent more and more GDP without anyone noticing. So it's a too-big-to-fail industrial proportion, you know, by the government. And the problem that we have now is that what - I mean, I'm not saying we should not protect the weak. We should, as a matter of fact, have stronger protection of the weak because - make sure that the people who suffer are the ones who - the fools who got us here, not the very weak, who are going to suffer in a contraction of the economy.

GOLDSTEIN: So in practical terms, what does that mean?

TALEB: In the practical terms, I want the bankers to be clawed back for the past profits. I want Robert Rubin to return the 120 million, not some government employee in California to live next month on minimum wage. That's what I want. I want the - like, what people don't understand is that we need both a contraction of economic activity and a - some justice. The...

GOLDSTEIN: Meaning GDP falls the...

TALEB: We have to clean the debt, OK? So at some point, someone would say, oh, it's so unpleasant if we let - if we terminate the Ponzi scheme. But you don't cure a Ponzi scheme with a Ponzi scheme. I'm sorry, Paul Krugman. And when I went into all this logic used behind deficit spending, I realized, No. 1, that Keynes - that's not what he said. That's not (inaudible). And then the other is you look at the models, and like economic - other economic models, they simplify something a little too much, OK? Deficit spending can only work if you have a high certainty of your forecasting of a recovery. We don't have that certainty. So if you inject more uncertainty in the models, you come up with exactly opposite methodology than the one offered today.

GOLDSTEIN: So you're basically saying deficit spending works if things are going to get better in a year, in some amount of time.

TALEB: Well, that's uncertainty, and you have to have a good certainty for...

GOLDSTEIN: And do you want to - I mean, I want to bring up an idea, just want to make sure we get to it. There's this idea you talk about in the new section of your book, redundancy - and redundancy in a way that would seem inefficient in a lot of economic models. Can you talk about that?

TALEB: Well, if I have - if I'm investing my money, you see, it's like - and I have cash on the side, it's like having two kidneys, one you use, and one you have a spare part.

GOLDSTEIN: Just in case.

TALEB: I have - I'm investing 15%. I have 85% in cash.

GOLDSTEIN: So you have mostly spare parts.

TALEB: I have a lot of spare parts, OK? On the other hand, if I borrow, you see, I'm in debt. It's the opposite of redundancy. The different classes of redundancy that I've identified - the first one is spare parts, the second one functional redundancy, and the third one is...

GOLDSTEIN: Functional redundancy is one part that can do some job that is not its primary job?

TALEB: Exactly. And the...

GOLDSTEIN: So what does this idea of redundancy mean specifically in economic life?

TALEB: Well, in economic life, if you specialize in one function, you know...

GOLDSTEIN: Meaning if you have one job, if you do one thing.

TALEB: If you do one thing and you lose your job or you're out of business, you see, if you have more than one function, you are - you do very well.

GOLDSTEIN: And what about the idea of spare parts in economic life?

TALEB: The spare parts is have no debt. The opposite, OK? Or spare parts...

GOLDSTEIN: Have savings.

TALEB: ...Is have savings. Have - for example, if there's a squeeze, spare parts help you a lot. For example, if you have extra oil, you don't need it, but you paid for it - and there's an oil squeeze, then you don't have to pay up for oil particularly when you're big.

Another thing I have been writing about - and I just published a paper in a journal of statistical physics called Physica on why they're too big to fail, why also, in economic life, you shouldn't be too big - because it's more efficient most of the time, except when you hit a snag. For example, if you have a water shortage, an elephant would have to pay up for water over a mouse. And I use examples of squeezes like a bank that discovers an error and has to pay up for the error. So you need to be small, as I said, and you need to be diversified. There's a third thing about redundancy. Redundancy, to me, is insurance, OK? It's money you spent on something that you don't need immediately. One of my rules is that we should not let the manager of a nuclear plant get an incentive bonus. And that's a cause of the crisis that - where we have an agency problem - is that he who gets a bonus wants numbers to look good. And the way you look good is by hiding risk.

GOLDSTEIN: Right. So the head of the nuclear power plant would have a financial incentive to really crank up the plant to kind of make it...

TALEB: Hide them away so that...


TALEB: ...They don't show. And the bank system had a lot of hidden risks and corporations as they become listed, which is why I don't see corporations surviving. And you can look at the data. Corporations don't survive compared to family businesses...


TALEB: ...Which is an exception to specialization that family businesses survive.


TALEB: Let me cut to the...

GOLDSTEIN: Yeah. Sure.

TALEB: The thing is we have two incidents or two severe incidents that illustrate it. No. 1 is Toyota. They cut down - you know, cut corners. And you - when you cut corners to make more money, you cut in the wrong places. And the BP. BP, as you well know about this oil spill, is - OK. And when big corporations are listed in the stock market, they are under pressure to have no redundancy, to have the opposite of redundancy. Cut corners here and there beyond up to the point of blow-up.

GOLDSTEIN: Because it makes them appear to be more efficient.

TALEB: Exactly.

GOLDSTEIN: And it's not some radical event.

TALEB: Exactly. But radical events on large corporations is not a good thing.

GOLDSTEIN: So you mentioned the too-big-to-fail problem. I mean, you were talking about debt, and we have more debt now than we have.

TALEB: Ever.

GOLDSTEIN: And I guess I'm just trying to frame this in terms of, you know, before the crisis and now after the crisis. And we have this bill that's passing. I mean, how is the state of things now compared to the state of things five years ago?

TALEB: We're worse than five years ago.

GOLDSTEIN: In what ways?

TALEB: We're worse than we have ever been in history. We have more debt than - collectively than ever before as a ratio of GDP. We have less consciousness of the problem, except in Europe now. Thank God. After three years - took them two years to understand the problem with that. We have a dangerous individual who not only - it's like someone who crashed the plane who are still there. It's very, very dangerous to have Bernanke, Summers and Geithner around. They crashed the plane. You don't have a pilot to fly the plane again. Their methods don't work. The metrics don't work. They don't have an idea of the core problem.

GOLDSTEIN: So my natural impulse here is to ask you what you think is going to happen, although I realize that there's something ridiculous about...

TALEB: No, no, no, no, no.

GOLDSTEIN: ...Posing that particular question to you.

TALEB: No, you can ask me that question because before the crisis, I said, I can't predict black swans, but I can predict who is vulnerable to black swans. See; that was - my point has only been - I mean, I was a trader. I was making bets on - and I - you know, my bet was as follows. If I see a plane flown by a pilot who thinks he can predict hurricanes when he can't predict hurricanes, you see...

GOLDSTEIN: Bet against that plane.

TALEB: I bet it was probability close to one that that plane will crash one day. And so this is where I tell you that - what I predict will happen is two things. No. 1, that either - well, I mean, you have to clean up the system, OK? You can't live - it's a Madoff thing. Madoff - you can predict that. If you see a Madoff, it eventually is going to collapse. Nothing lasts forever like that - that you're going to have to collapse Madoff in a very smooth, controlled way, as the Europeans are doing now, or you may have to do it the old-fashioned way as Weimar Republic because I think that...

GOLDSTEIN: Meaning print a lot of money.

TALEB: Which is what Obama has been doing.


TALEB: This is how they're financing the deficit. They're financing - they're printing money. They're...

GOLDSTEIN: So the inflation is very low.

TALEB: You know, inflation is very nonlinear. The way - and the way it may happen, it may be too late for them to realize it, you see. So printing, printing may do the job for a while, and then, suddenly, the thing explodes in your hands, OK? This is where their metrics don't work because I've talked about nonlinear domain, OK? Just like before, they're saying the risk was very low when hidden risk were convening on the system. It's very similar. And I thought they would learn, but they don't learn.

We have - thank God - in this country an awareness of the problem at the level of the individuals. We don't have it at the level of leaders too much, particularly not the Obama administration. Probably the worst thing we've had in the history of this country is an administration so out of sync with the core problems, and it is imperative that the American public understands the big divergence that we have between their own personal desire for stability and the hidden agendas of people in the establishment to be Madoff-style.

GOLDSTEIN: When you say hidden agenda...

TALEB: Hidden to themselves, often. And I don't know if this is democracy. This is not democracy. There's something about - in the media, the media transform things by distorting that make people produce decisions that are completely against their own interests.

GOLDSTEIN: I appreciate your time. Thank you so much for coming.

TALEB: Thanks for inviting me. I'm honored to be here.

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