David Cameron in conversation with Nassim Taleb

thanks a lot it's very nice to be back here I think two and a half years later I remember the first lecture I gave about the Black Swan actually I was 30 pounds heavier was here at the in this room two and a half years ago and my argument was not as convincing as it is today so now it's becoming boring but at a time is more exciting because I was shocking people and so let me make a few points about what I my concerns about a Black Swan people think that Black Swan thinking requires constant paranoia that is not true requires finding out which black swans can really hurt you and which domains are Black Swan prone let me get the same metaphor I gave here two and a half years ago if I randomly gather a thousand people from the world population and put them on a scale maybe today you know and what you know but they actually have you and a half years ago because people who eat a lot of carbs anyway so we have a thousand people you put them on a scale and you add to that sample the heaviest person on the planet that person will represent a few basis points from the total 1.3 percent so you can have exceptions and some domains but these exceptions are not consequential however socioeconomic life is very different if you have a very same sample of thousand people to put them instead of putting them on a scale you add up their net worth and add to that sample the wealthiest person on a planet how much of the total of that person represent not 30 basis points okay he'll be worth 50 billion and the remaining thousand would be worth 1 to 2 million right so you realize that there's some domains in which the exception matters a lot unfortunately socioeconomic life has been much more dominated by exceptions we have to identify well vulnerabilities are what if in a world today that's extremely different than the world we inherited from our parents today we have three times the debt level means you cannot make a mistake three time to that level that we had in 1980 approximately depending on how you count you can no longer make mistakes we have interdependence today a lot of interdependence we come from the internet rumors become planetary so you know what happened there's something are you familiar with this device here commonly called the blackberry a lot of divorces so this bankrupted this Iceland in no time normally when Oh runs on a bank take place you know people take a tube and go wait in line right now you do it during dinner so can I have rumor plan sir so we're much more vulnerable to extreme deviations today than we did in the past because of tools we have in our hands we can no longer make the same mistakes and other things have been happening globalization globalization makes companies very efficient but makes them more fragile so you have operating leverage that's very similar to that lever I mean financial leverage ok mixed company is very vulnerable so economic life is more and more Black Swan prone another prone to huge changes coming from a single event and exception than it ever did before at no time in history have you had such small like imbalances in food supply cause you know that's by these these spikes I mean wheat prices tripled and and it's not like everybody decided to eat a lot more pasta right with prices tripled and response to a little more pick up and demand and and we had supply but supply couldn't catch up small small imbalance that never happened in history so we live in a world that's much more fragile than the past what is it solution solution is very easy very very easy look at mother nature mother nature does not like leverage mother nature does not like too big to fail simple solution if we win and I'm sure it's not very politically correct they decided to shoot the largest animal right the largest mammal a whale ok would be bad would it destroy mother with a destroy nature no but if we went and shopped firm say Lehman Brothers right you know what can happen so you can have interdependence not a big deal but you cannot have too big to fail you want to make sure that something happens that the consequences are manageable right the second thing Mother Nature doesn't like that the opposite of that is redundant I have two lungs I know in the UK everybody has two lungs almost no right so have two lungs one spare kidney a lot of things it's the opposite of that spare parts so if we let you know economists manage mother nature that give one lung to everyone and then you borrow you know your time the reason right to be optimal why do I have to carry along okay so I mean this is a so we have a so Mother Nature does not like the Ricardo concept okay of one country specialize in wine another country specialize in cloth or some other item right because all these concepts that we've inherited from classical economics don't make sense when you still cast aside in other words inject some randomness when I what is the price of wine changes what is people decide not to drink wine anymore or you have shifts while it's not a good idea to specialize in wine so mother nature does something that's opposite to specialization we call it functional redundancy or degeneracy it's doing things that having function doing things that are not efficient are not optimal but they help evolution like for example lips writes that used for a lot of purpose okay mother nature amuse your lips to eat to talk to taste a lot of things right so the the so it's the opposite of over specialization so mother nature can show us how to build a robust system a system that can withstand huge deviations and stay standing it's very simple and that's all I have to say thank you thank you thank you guys see perhaps I could kick off with with a couple of observations and a question before Danny opens it up to two to everyone else and I very much enjoyed Black Swan and I'm trying to come to terms with Black Swan thinking and what it might mean for politics and I wanted to try and ask you to two to tease out some of the consequences of what you call Black Swan thinking if you assume that we are going to be hit by as you call them high impact but low probability events that you you can't always foresee what are what are the consequences for political thinking should it be I would argue that means you've got to have a an attitude that is pragmatic not utopian cautious and skeptical when it comes to regulating things you need to have wise people in good institutions rather than thinking you can write a series of rules for every eventuality but I also want to tease you out on some of the specifics of what your thinking means in terms of the current financial turmoil and some of the specific things that you say what one for instance is I mean I think that in general what what you're saying is that because of the risks of instability you should avoid excessive levels of debt because of events that can come and hit you you need to have very strong and robust societies those would seem to be obvious lessons but going down to the specifics on this issue too big to fail hasn't the recent events taught us that actually some of these really quite small institutions needed to be propped up or helped or or rescued in some way because actually even very small institutions can have a systemic impact on the whole the other thing I wanted to ask you is in your book you seem quite keen on banning a number of things so a lot of your approach is quite of live and let live and yet when it comes to things like I think you're a favor of leverage buyers that leverage buyers should be back this seems are very risky in all circumstances surely there might be some circumstances when some leverage might be a good thing so on as it tease out in some of those specifics the consequences of the very radical thinking that you've been doing but can I say first of all thank you very much for inviting me along letting me come along and bathe in your reflected glory now see there are things that make me conservative okay and in that sense I don't like financial instruments that are new so when when it comes to trading I was a derivatives trader for a long time and I distinguished between two cards derivatives those you learn from other traders there's a chain of transmission traitor - traitor as an apprenticeship and those that require you to go get a and then I also taught mathematical finance for nine years I let's distinguish between brooklyn derivatives sarcone Brooklyn and MIT the rivers alright the Brooklyn derivatives can be taught from fraida to trader and these we know how to deal with them and MIT derivative or case is school piano there's no chain of experiences it's you go in you you you you know you learn from textbook and visibly these are the ones that people blow up on and it was proven right with a recent event okay recent events they blew up the system okay these non non Brooklyn products okay so this is so here is that yes not coming back to debt debt is can be a great thing if you're right but if you're wrong you know it's not a good thing alright so that equates overconfidence that comes is a product of overconfidence alright the more confident you are the less that makes sense for you to issue equity alright and dilute your potential profits and the more it makes sense tomorrow so the the problem of course that we humans cannot be trusted with knowledge because we tend to be over confident we're all and that's sort of the message of the Black Swan so the religions have been you know Judaism they say you know the ecclesiastic doesn't like that right as a religion right Christianity early on did not like that and Islam bent that it's not without a reason and then I looked I realize that you had that true belief that started you know translation of that turmoil coming from that from Babylonian times the Romans had problems debt and wars a lot of wars caused by that so that was not necessarily a good thing now people say well in moderation in moderation but we don't know what moderation means if you ask a you know if you ask if someone at lien Lehman Brothers right if you ask them two years ago if that always says you say oh we have moderate level of that okay we don't know what it means so we have to watch out that is something that's very toxic it can hit you very quickly right so which is why I don't like leveraged buyouts and you need to protect people from themselves but but equity issue equity fine equity buyers equity you can express your overconfidence with equity without harming yourself too much we had an equity problem in 2000 if you remember yeah in Silicon Valley where you know we had a big bubble deflated no big consequences now the debt bubble we have now we're still here or at 10 months later we're still here and nothing changed okay what about the argument that some would say well from from your thinking and writing you definitely say when the economy is is is plain sailing then that is the time to avoid excessive debt because you should be cautious and prudent about the future you don't know what events are going to hit you and this is an argument definitely been proved right because those countries with the greatest levels of indebtedness like Britain worst experiences of recession but then running forward after the recession has hit some would argue well you've got then to have higher levels of debt because you're coping with higher levels of unemployment and low levels of growth and that is just the shock absorbers of a modern economy and don't you need to let that happen you need to wind it down as fast as you can we need to let it happen because the consequences would be worse and what I agreed normally I hate normally it's like saying okay I would borrow if I start all right then your will would have a father-in-law or someone to borrow from okay except that today there's no father-in-law right there's China left I'm not even sure all right about their ability to finance more debt so the problem we have today is that any debt all right any debt that you issue any government issuing debt is facing the risk of inflation because you may have to print it and and we know what happens with with with the pleasure it can run out of control worse now with the with the Internet and interconnectedness and and the speed of information and speed of reactions you can have hyperinflation so so monetary policy if you take their textbooks I did something after the Black Swan I wrote a paper called the fourth quadrant in which I analyzed the errors in economic papers they all use the wrong model so we don't know they don't even know their error rate I I looked at some metrics to show that you cannot use linear regression you can't use any again and anything you learn instead it works beautifully for wait for other things it doesn't work in economics of it and the one the economic value that's the most what I call fat tail all right is the inflation numbers because you know we saw what happened in Germany something going from one to three trillion is there's a Black Swan okay so we have to worry about hyperinflation and I think that the risk of hyperinflation is very high and the risk of hyperinflation is very high it's as the story of nonlinearities is you don't know how much pressure you have to put you know and how you get the ketchup out of the bottle you get nothing you get nothing you got nothing on suddenly you lose you know the the table so the the problem is the problem with with the with with the policy today okay that what to do all right visibly what what Obama is not doing all right from the beginning identifying the problem is that over reliance on forecasts and and and there's got the patient has cancer okay they're given a painkiller if you give it a cancer patient painkillers what's going to happen you know visibly so the cast is going to get worse but he's going to not feel it okay so the problem we have in America is that nobody has addressed the fundamental error okay that over-reliance on forecasts they got Larry Summers who blew up Harvard I mean the forecasts what's going to happen with their endowment visibly he didn't read the rights more and a couple you know was over with expansion plans and now they're down things down by a third that blitz the official number okay if you were tomorrow market private equity be a lot more interesting so he they're going to do the same to the US administration they don't making forecasts of what's going to happen in in 2010/2011 and building government deficit based on that okay this is like the believe in Santa Claus so so you break so what is this what should we do you transform that into equity a very simple example you go to a homeowner who had not been foreclosed but who has been getting hate mail from Chase Manhattan Bank like new labor of mind right hate mail from the bank and it gets longer the letter gets longer and show you how much more you own not for clothing right and the person's frozen right so he gets he knows to avoid the the mailman on the third Wednesday of the unit of the month okay when he gets at that letter so the person's froze everything's frozen right he owes six thousand more every month so what you do is you go to the gentleman tell them you know what pay a thousand a month but we won't half the profits from your house now in transforming data to agree very simple a very simple mechanism okay that would make that person sleep a little better it would look won't look that good on the balance sheet of the bank but with help lips so you're already you're doing something to address the cancer than just giving pain killers now we can give some pain killers there's nothing wrong with pain killers right but let's not give the wrong painkillers Obama has been what I was I was writing against them there's a cash for clunkers program I own a car a car that was fuel-efficient I want to get rid of it to buy bought a mini alright to get rid of your other car all right I can because nobody wants to buy a car and the cash for clunkers program is only for bad cars so if you bought if you made a mistake about the wrong car you get $3,500 from Obama all right but if you bought an intelligent car you get nothing secondly they raise the taxes now I happen to do okay in an environment like this I'm paying more taxes so those who did the right thing how can you have evolution if those who do the right thing have to finance those who did the wrong thing so if you're making money in 2009 physically it means you have a business that's robust to the cycle you paying more taxes to finance and if you're losing money in 2009 you get a bigger tax break all right so you're financing so it is it is a it is the opposite of what you know everything I believe it okay and there are other things of course more reliance on that economic establishment Bernanke let's take Bernanke the central bank you guys are blessed with a good central banker compared to what we have when I was railing against the risks in the system imposed by regulators the regulator's right are the ones who are helping valued people use value at risk something completely bogus okay that did not take into a complex ones that cost banks to take lot more risk and the system was accumulated huge amount of hidden risks okay we were moving into a complex system so you have quieter markets but a lot more risk of explosions right Bernanke pronounced that the system was in a Great Moderation phase and he tried to explain it of course being an economist he found explanations right why we're in Great Moderation right when we're sitting on a maximum right on on on a huge amount of dynamite okay so we these people are still there okay we should do something symbolic to say okay the economic establishment failed us sket new economists someone who did not fail is no effort on his part of Obama's part he took that that all staffed so it looks like it's a reward to those who did the wrong thing and more power to the regulator's who got us here more power to the World Bank and the IMF all right who missed on a crisis okay and and not even make an effort to reward those who saw this warned against it no effort on their part so here we have I think they're going to fail okay and after they failed that had a lot of finger-pointing and so on but we don't need to wait for more failure right so today ten months later we have more debt than before some transformation of private debt into government debt and now we have to look for someone to buy the debt and and there's a big joke in trading circles that unit crash of 1929 there's a gentleman who told his clerk sell everything and his quote kept looking at him and it's all I told you sell everything and the clerk yes but to whom sir at some point government wanting to borrow you to borrow from someone all right it's it's from whom from the future from future children you can't even do it anymore inflation will take care of it I mean this is hyperinflation together so we have a severe problem today we just asked about your evolutionary not your evolutionary suggestion what is the evolutionary purpose that have been fooled by randomness why is it survived and why do we continue to be fooled by randomness if itself serves no evolutionary purpose and and after all if we had no financial instruments 2,000 years ago we wouldn't be where we are you you're very certain that stability is superior but actually the world which has been fooled by randomness has gone through these spurts and these crashes it isn't such a bad world is it no I like crashes I like another great scrap I like crashing I just like to be the world to be robust to them the world is not robust to crash in not in 2000 the world of Silicon Valley was very robust I'm not against finance I'm against some parts of finance all right like for example I'm not against derivatives I'm against complex derivatives I'm not against a vanilla option it's very than awesome as they say the devil is in the nuances or the truth resides in the nuances okay let's all shout and also oh no all right my two heroes right the the nuances is we have to know it's not say oh you know investment banking is good right for example hedge funds 1,800 hedge funds closed for the last period can anyone here in the room name a closed hedge fund everybody's focusing on Lehman Brothers so there is a way to build an ecology right in which people can fail aggressively and start again and fail and start again without bringing down the whole system without being financed by regular Joe's like Citibank all right without having bonuses all right financed like you know Bob Rubin : 20 million dollars and then he said all that was unexpected okay he kept his hundred twenty million dollars and and we taxpayers and you can't clone back okay so the the hedge funds hedge fund our solutions so the nuances okay I'm nuts and not against derivatives I'm against some derivatives and there's a list right there's some derivatives that are very stabilizing so that we can issue that you could issue a sorry equity you can hit that and and actually that's how gross happened this level of that we have today is is new complex derivatives are known are just one more on because what I bonuses then because you're against some derivative you're in favor of normal derivatives we're not complex derivatives I also goes about Elvia is what about bonuses been a big debate in Britain about what we should do about bad bonuses regulation of bonuses how would you reform bonus okay I had and this is a fight that started 13 years ago and 13 years ago I kept talking about my metaphor of someone who sells out of money options so you make money for you know a year two years three years four years five years or you're making pennies okay and then one day you lose dollars and then say okay thank you very much I'm sorry right thank you apology letter all right dear investor surely these events are much of a surprise to you where they are to us okay and you close shop right and that was that what that was that was that where that was a model and meanwhile you have your yacht okay and okay all right so there was a mismatch if you use the metrics at modern finance you would be fooled after a year or two Sharpe ratios Beta Beta Alpha alpha all that stuff you'd be fooled into believing that that person is actually doing the right thing so there was a mismatch between compensation period namely one year and time to reveal the statistical properties in this case nine years okay or eight years and effectively in a black swan III was attacked initially because I said that banks never make money they look very intelligent most of the time and in 1982 banks lost more money center banks in America lost more than ever made the history of banking and they said well exceptional events they did it again 1990-91 okay back in 91 we had a plant and of course recently so I don't need to convince you more more with that meanwhile bankers are rich right so but it's very easy to identify domains in which people play that game it's so easy it's so easy it's not even funny you can figure out if this guy deserves its bonus or not it's so easy if I'm giving a loan all right that is can be hit only by negative black swans they say I don't deserve an annual bonus if I am in venture capital where you lose lose lose lose lose and Wasel might make a lot of money I deserve the bonus if you are in what I say long volatility if you have a if your business model alright its R&D you're going to lose lose lose once the my discover a cure for bad press or something that makes your fortune right then you your statistical properties alright are not masking hidden risk so you should not pay a bonus to someone who has hidden risk that's very simple so it's that's not complicated the things very simple it in my first book dynamic hedging and people start to read I finished it in 93 it took me three years to publish it 96 97 right so now it's what thirteen years later people are started you know III it was very very simple model whereas are you skewed left or skewed right in other words can you lose back everything alright or not if you can lose back everything you don't deserve a bonus it is very simple more so sometimes as small ones small me wants a sub society subsidizing your is taking or not if it's not then super bonus

Channel: RSA

Views: 109,546

Keywords: economics, politics, society, black swan, nassim taleb, david cameron, government, conservative, rsa, the rsa, royal society of arts, Tory, economic crisis, Black Swan

Id: QQAVDg4yqUU

Length: 29min 15sec (1755 seconds)

Published: Wed Feb 24 2010

Reddit Comments

[u/ZiVViZ]

Good insight into Cameron's philosophy on borrowing and economics etc.