The Black Swan – Story Possibilities (Part IV)

             We have spent a few posts looking at Black Swans in economics and politics. Look at them as possible story lines or back story items. This can be either in world building or single situations. Can the reader see it if seen from the correct angle? For example, one can see a Black Swan if one is the Thanksgiving turkey (see Part I – Are We Unknowingly the Turkey) but there really isn’t any Black Swan from the farmers standpoint. The turkey is dumbfounded but the farmer is full and satisfied. Is the reader the turkey or the farmer?

             L.E. Modesitt, Jr.’s series titled The Ecolitan Matter consists of four books; The Ecolitan Operation, The Ecologic Secession, The Ecologic Envoy and The Ecolitan Enigma. These books explore economic, political and ecologic ideas and concepts. I highly recommend all four as a good example of economic and political ideas. The books were written from 1986 through 1997, during a time of several stock market crashes (1987, 1992 and 1997), political upheaval and a renewed concern for the environment. I will admit it is not hard to write books during times of stock market crashes since they tend to happen every four to eight years. Modesitt does a masterful job of including economic and political problems into his stories. I find Modesitt’s use of economic and political principles very well done and very true to form. Notice how he leaves much of the material as back story or world building materials but enough is in the stories to make it easy to follow and enjoy. He doesn’t burden the reader with too much detail.

             Remember, economics and social sciences are full of Black Swans. It is their very nature to be uncertain and unpredictable. Review The Black Swan’s Mask (Part II) to see how we rationalize our incorrect or missed predictions. Can a story be developed from looking backwards through our missed prediction to a situation (reverse the process by creating an outcome and looking backwards through a false prediction to the original situation- which may be incorrect). Remember every world is full of floods that happen only once in a 1,000 years. In The Black Swan – but I saw that Coming (Part III) we looked at the outlier and the uncertain or unknown nature of such.  Again, the most important point is that economics and political science are not true sciences in the way we think of science as being measurable and predictable. Both are full of Black Swans, the unknown and unknowable. Use that to your advantage.

The Black Swan – But I Saw That Coming (Part III)

           We have spent a couple of posts looking at the problem of the Black Swan – the impact of the highly improbable. We have discussed the turkey and the Thanksgiving feast in part 1 of this set. One doesn’t want to be a surprised turkey. We have looked at the problem of induction or inductive knowledge which includes how can we logically go from specific instances to reach general conclusions. According to Nassim Taleb there are traps built into any kind of knowledge gained from observation. He also suggests that those who believe in the unconditional benefits of past experience cannot project into the future. Remember back to our turkey example, was the farmer surprised by the outcome?

           Having made the above observation, I will say there are some situations where we can use past experiences to draw conclusions about future observations. Suppose you are asked to find the average height of the all men in the United States. You could take a sample of say 10,000 men and draw some fairly detailed conclusions. You would be able to take that data and make some conclusions regarding height of men in general. Now if you were to measure one more man from the population in general your estimate of his height would likely be within the parameters you had established. The same would be true for weight. Another way to state this is, one more observation will not significantly impact the predicted results. Now suppose you sample people who are worth more than $10 million. Let’s suppose that your sample does not include Bill Gates. Your sample size may be quite large, relatively speaking, but if it doesn’t include Bill Gates then as soon as Bill Gates is included in the analysis we have a Black Swan situation. A deviation so large that it blows up the study. So, you decide that Bill Gates must be an aberration… (sorry, let me be specific, in the data only), and toss that data point out. Then the next data point you sample includes Steve Job’s estate. The difference between sampling height and let’s say millionaires is one set of data follows a bell curve (predictable or regular) or a variation of such things and one doesn’t. Many who have studied this feel that economics and social sciences cannot be defined by bell curves and its like. Many in econometrics feel that the world can be defined by regular occurring events or activities. Taleb suggests that “a nerd is someone who thinks exceedingly inside the box” or is blind to Black Swans.

           Some other themes arise from our blindness to the Black Swan. Again I turn to Taleb and his book, The Black Swan the Impact of the Highly Improbable. He suggests the following ideas. We tend to focus on preselected segments of the seen and generalize from it to the unseen. We fool ourselves with stories that cater to our thirst for distinct patterns. We behave as if the Black Swan does not exist, human nature is not programmed for Black Swans. What we see is not necessarily all that is there. History hides Black Swans from us and gives us a mistaken idea about the odds of these events. We “tunnel”, that is we focus on a few well-defined sources of uncertainty at the expense of the others that do not easily come to mind.

           As you listen to the news and look at economic projections remember that economists and their associates are working in a world full of Black Swans or full of Bill Gates type situations. It is important to realize that studies done on how successful economists have been in their predictions have shown economists have an exceptionally poor track record of being able to predict things. Just because an economist is able to show past data to support his position may have little or no relationship to future events. It all depends on where the Black Swans are.

The Black Swan’s Mask (problems in induction) Part II

           The marvels (for me anyway) of technology and the benefits of a good internet connection make it possible for me to be in Arizona visiting my grandchildren and their parents. We spent the afternoon at Pima Air Museum where I listened to a marvelous docent, Mr. Miller, tell stories and share experiences from his time in the air service and relating stories of others from earlier times. I marvel again at the willingness of our service people to lay their lives on the line for our great country. I am grateful for their service and sacrifice. I was thinking how it must have felt to live during 1937 – 1939 and watch the world unfold. From our standpoint now in history we know that Germany was going to war, Italy and Japan were gearing up for war and the world was set for an awful time to come. I remember reading that the correspondent William L. Shirer who wrote what is considered by many to be one of the definitive works on Germany’s Third Reich, The Rise and Fall of the Third Reich, was living in Germany during much of the 1930s. If I remember correctly he said that even for those living during that time in Germany and who had a grasp of world events such as a print journalist like himself, didn’t fully grasp what was happening. He and his associates didn’t predict war any better than the others in government, economics or any other branch of science or social science. History tends to look back and say, how could you have missed that. All the signs were there?

           I experienced the lead up and the effects of the recession of 2007 – 2009 from a unique standpoint. I am directly involved in investment banking and many feel that this industry is a big part of the problems that caused that recession. I think the sentiment has some validity. However, most of the leaders or men of knowledge in economics and investment banking never saw it coming. Again, there are some who did see something and made a lot of money on the fact that they felt something was out of alignment in the economy. Again, if one looks at much of the literature on this recession we see individuals drawing conclusions and wondering how we could have missed it. I was in the thick of the information so to speak and I didn’t see it coming. Government leaders, economists, most investment bankers and Wall Street types didn’t see it. We now have Frank-Dodd legislation which runs into hundreds of thousands of words and is so convoluted that we as a people will never fully understand what it does nor do the writers of the legislation really understand its workings or impact. This is supposed to guarantee that we won’t have another financial situation like this happen again. Trust me on this one, it will happen again

           Let’s look at how we rationalize our incorrect prediction (or missed predictions). This is how we protect our self-esteem according to Taleb in his book The Black Swan, where he suggests four methods of rationalization. (1) Tell yourself that you were playing a different game. It is not your skills that are to blame. There is some hidden information or element that if you had known you would have been right. (2) You invoke the outlier. (This is what is generally used by the economists and math guys to explain the recession of 2007 – 2009.) Something happened that was outside the system. Given that it was not predictable you are not responsible. Hey, it was a 1,000 year flood, of course I couldn’t predict it. (3) The “almost right” defense. By looking backwards we assign values after the fact to ideas or events thus applying more or less importance to things, activities, happenings or events. After the fact we say this piece of information is important and this is not. (4) The hedgehog and the fox from Isaiah Berlin and Aesop’s Fables. The hedgehog knows only one thing and tends to exclude all other thoughts and ideas. It may be a single consequential but improbable event. This helps make us susceptible to Black Swans. The fox knows many things and is not married to one idea or course of action. The fox has an open mind (not empty but open) and tends not to get married to one idea. The fox knows history will be full of improbable events but just don’t know what the events will be.

           So, be a fox with an open mind.

Are We Unknowingly the Turkey (the problem of induction) - Part I

           The next couple of posts will explore the idea of how to learn from the turkey or the problem of induction or inductive knowledge as discussed by Nassim Nicholas Taleb in his book, The Black Swan The Impact of the Highly Improbable. I have referred to this book before as it has what I consider some highly insightful and provocative concepts, thoughts, and commentary relating directly to economics and finance. This problem also directly relates to the Black Swan phenomena as discussed by Taleb in his book mentioned above.

           The problem  of the turkey can be seen in the following story. Suppose you are a turkey and today the farmer comes to your pen and feeds you. Initially you think to yourself, this is interesting I wonder what is going to happen tomorrow? By the 14^th day of feeding you are thinking this is pretty good. By the 50^th day of the same activity you think this feeding thing is really great. I am going to brag to my friends about the farmer. By the 250^th day you have forgotten that you ever worried about food. By the 350^th day you feel you are entitled to being feed. You can look back on a long history of consistent feedings, it has always happened. No change, no difference. You expect tomorrow to be just the same as every other day, why wouldn’t it be? Tomorrow comes. The farmer has an ax- it is the day before Thanksgiving. You were not expecting that! The consequences of underestimating the impact is significant for you (the turkey). This is the problem of induction. Do past experiences or histories allow us to predict future events and activities? How do we know that what has been observed will be sufficient to enable us to figure out the properties of what we have been observing? Taleb poses several questions including; one, “how can we know the future, given knowledge of the past; or, more generally, how can we figure out properties of the unknown based on the known?”, two, “how can we logically go from specific instances to reach general conclusions?” and three, “How do we know what we know?”

           As I write this I am listening to the song “Russians” by Sting from Dream of the Blue Turtles album. The lyrics discuss the problem of believing what the Russians and President Regan say regarding the atomic bomb. At the time this was released in 1985 nuclear annihilation was a great concern. Both governments had the ability to destroy all humanity several times over. I remember being in school in the late 60’s and having air raid drills where we got under our desks. However, just four years after the song was released in 1989 the Berlin Wall was breached and by 1990 was torn down. By 1991, Mikhail Gorbachev had overseen the dissolution of the Soviet Union. Who predicted from past Soviet actions culminating in 1985 that six years later there would no longer be a Soviet Union, as such? No one. In 1973 I was studying military tactics in ROTC which included the most effective ways of destroying Russian tanks. In 2003 my son Daniel served an LDS church mission in Rostov, Russia, the place where they built the tanks I learned how to destroy in 1973. I never imagined in my wildest dreams in 1973 that one of my children would be in Russia on a religious assignment teaching the peaceable elements of Christianity in a former Communist country. This is a positive induction problem.

           Let’s further consider the problem of the turkey. Was the farmer suffering from a problem of induction? No, of course not. He knew exactly what was happening. Such problems can be very one-sided and it is critical which side we are on. In the following posts we will look at some specific examples of the problem of induction relating to recent financial and economic problems and some ideas for handling the problems. Additionally, I think there are some applications for world building that I hope will be interesting and helpful.