Incerto 4

An observation about Nassim Taleb’s Incerto books: Taleb is highly critical and sarcastic in his Incerto books about a lot of “experts” in fields like economics and statistics and risk management and the social sciences and the media. Some readers are put off by his apparent arrogance. I eventually realized he isn’t annoyed at these practitioners because of their errors; he is annoyed at them because of their hubris, because in their arrogance they are so sure they are right.

And more than that, as he makes plain in the last book in the Incerto series, Skin in the Game, he is particularly outraged at how many of these “experts” are personally insulated from any consequences of their errors.  Think, for example, about the Goldman Sachs traders and bankers whose ignorance of risks (or greed) helped set off the 2008 crash, but 953 of them got more than $1 million apiece in bonuses in 2009 from taxpayer bailout money. Or think about the Washington foreign policy experts who set off the Middle East wars, with their millions of casualties and displaced persons, and not only suffered no personal consequences from their errors, but may have even been promoted. In Taleb’s view, it is immoral/unethical to offer “expert” advice to others if one has no exposure to the consequences that may flow from that advice. And I agree with him on this.   

In fact Taleb makes clear in a number of places in his books that he is as susceptible to the errors he describes as anyone else, and has to be constantly on guard against them

Recommended article

Politico online has an interesting article yesterday entitled The Fed’ Doomsday Prophet Has A Dire Warning About Where We Are Headed. Thomas Hoenig is a retired member of the Federal Reserve who, in the early 2000s. opposed the Fed’s loose money policy and was thought at the time a crazy outlier – though events proved him largely right, so perhaps it is worth listening to him this time.

I have written before about my concern with the growing Federal debt, the willingness of both political parties to ignore the deficits in favor of buying votes with popular debt-financed programs, and about the enormous amount of “new” money the Federal Reserve has injected into the economy over the past couple of years.

There is a new theory among some economists and politicians called the “Modern Monetary Policy” which argues that government debt doesn’t really matter for nations that control their own currency; in fact that it is a good thing. A good explanation of it can be found in Stephanie Keltont’s 2021 book The Deficit Myth. Or if reading economics books isn’t your thing, there is a relatively short TED talk by her here. It is an interesting argument, but frankly I find it about as believable as the Laffer curve or Reagan’s voodoo economics. But politicians, especially on the left, love it because it justifies their expensive debt-financed Federal programs.

I try largely to stay away from short-term domestic politics in this blog and attend to things that have longer-term and more global implications.  But a severe economic crisis in the US would have global geopolitical implications, so that is why I occasionally deal with these issues.

Incerto 3

Another subtle concept from Nassim Taleb’s Incerto series:

He invents the concept of “Platonicity” from Plato’s approach to the world. Plato was good at dividing the world into distinct objects and concepts, which made them easier to analyze and discuss and think about. And Plato’s approach has had a profound effect on human thinking and theorizing ever since, especially in the Western world (Joseph Henrich’s 2020 book The WEIRDest People in the World shows that not all cultures do this; many perceive the world in a more wholistic manner. Indeed, we in the West are outliers). The problem is that the world is immensely complex, far more complex than a human mind can encompass, so we perforce must simplify it. We divide it into graspable concepts, models, maps, theories, etc., simple enough for our minds to work with. And this is often useful for practical day-to-day matters, even if we have simplified things a great deal.

But since the real world is really immensely complex, whatever ways we choose to simplify it are in some sense arbitrary. We pick some features to model or embed in a concept or theory or mental construct and ignore many, many others. Which features we choose to include in our concepts and mental constructs, and which we choose to ignore, shape our (distorted and incomplete) view of the world. Beyond that, as physicist Carlo Rovello argues in his most recent book Helgoland, it is often the relationships between objects that really matter, not the objects themselves.

The Platonic fallacy is to begin to believe that our simplified models and theories and concepts are truly comprehensive, to believe that our maps of the terrain are the terrain itself, rather than just a much-simplified representation of some few arbitrarily-selected salient features of the terrain. It leads us to believe that we know far more than we actually know.

 

Recommended: Failure and Ignorance

Dr. Stuart Firestein is chair of the Department of Biological Sciences at Columbia University and professor of neuroscience. He has written two very short but brilliant books, Ignorance: How it Drives Science (2012), and Failure: Why Science Is So Successful (2015). We humans tend to focus on what we (think) we know, but Firestein argues in these books that it is the unknown that is what is really interesting and important, and what really drives progress in science. Highly recommended.

Recommended – The WEIRDest People in the World

Joseph Henrich is a professor of human evolutionary biology at Harvard. His 2020 book, The WEIRDest People in the World: How the West Become Psychologically Peculiar and Particularly Prosperous is a massive 680-page study explaining why most of our studies of psychology and sociology and economics are seriously biased, since our samples typically consist only of Western, Educated, Industrialized, Rich, and Democratic people (and most of them students at that). His point is not only that such people (that’s us) are different, even at a neurological level, from other people, but that they are an outlier in many respects, thoroughly untypical of the human race as a whole.

This is a strong claim, but he backs it up with many studies and much data. And it is important, because the WEIRD world (that’s us again) has the power and wealth these days, and is trying to shape the rest of the world without understanding how different the rest of the world really is, how differently they see things, how different are their values and expectations and cultural norms. This is not a light read, but it is well worth the effort.

Incerto 2 comment

Several people have written me about my Incerto 2 posting yesterday, unsettled perhaps by the observation that professional fund managers, let alone amateur stock pickers, might be doing no better than random. There have been several studies about this. See, for example, the 2014 New York Times article entitled Heads or Tails? Either Way, You Might Beat a Stock Picker.  Or the study the S&P itself did  (referenced in the article) entitled  Does Past Performance Matter: The Persistence Scorecard. If you search, there are also a number of academic studies as well, all of which more or less confirm the conclusion that on average, managed funds and managed stock portfolios do no better than random stock picks over the long run, which is why unmanaged index funds, with much lower fees, have become popular. And then the fact that the market trend has been upward for years now in the U.S., despite the occasional dip, means that almost everyone has made some money in the market long-term.

Of course the price a stock sells for at a particular moment isn’t random. It is determined not only by the real fundamentals of the company it represents, but also by thousands of other factors, from the market rumors, correct or incorrect, circulating about it, the momentary demand for that stock, the momentary mood and individual strategies of thousands of players, big and small, in the market, external worldwide economic and political factors, and even the actions of high-speed trading algorithms detecting the offer and buying ahead to push the price up. So although the price isn’t really random within limits, it is subject to so many unmeasurable momentary forces that for all practical purposes its short-term movement is largely random.

Given these conditions, it is no wonder that funds that do well in one year often do poorly the next. There is a claim by one statistician that anything less than an 11-year history of a fund is meaningless for determining if it is really doing better than average (I don’t know how he got to exactly 11 years, but you see the point). There is even a market strategy that says to sell the highest performing funds each year and buy the lowest performing ones, because of the statistical tendency for them to regress to the mean (meaning that on average the poorer performing funds ought to do better next year, and the better performing ones ought to do worse next year.)   

It is a little hard to actually model this statistically, because funds and fund managers that do poorly for a few years, even if by chance, tend to get eliminated (managers get fired, funds close or are merged with other funds), so there is what is called an “absorbing state” on one tail of the distribution, which muddies the waters a bit statistically.

In any case, given all of this, Taleb’s observation that there is a “survivorship bias” operating when “winning” fund managers claim their strategy is responsible for their success seems reasonable. And of course much the same logic applies to “winning” CEOs who write books about their successes.

Incerto 2

Here is another observation from Nassim Taleb’s Incerto series, this time from his first book, Fooled by Randomness. The main message of that first book, as the title suggests, is that we humans (and he includes himself) often misinterpret purely random results. Here is an example.

There are thousands of CEOs and thousands of fund managers in the world.  If they all made decisions at random, simple chance alone would dictate that a few would be right most of the time, and rise to the top on the basis of their impressive results.  And human nature being what it is, most of these random “winners” will attribute their random success to something they had or did, because they were smarter or because they had a better strategy.  This is called “survivorship bias”.

One might think this would be obvious to most people, but a quick search of Amazon will reveal a mass of books written by “successful” CEOs and fund managers and investment managers and the like, “explaining” how their systems led to their success. And lots of people apparently buy these books and attend their expensive seminars, hoping to learn their “secrets of success”.  It may even be that a few of them actually do owe their success to being smarter or having a better system (or engaging in insider trading), but most are successful due to simple chance. Since most are where they are by simple luck, their “advice” is probably worthless, though it certainly helps their book sales.

Much the same message comes from Michael J. Sandler’s book The Tyranny of Merit, which I recommended a few months ago.  The elites of the world think they are the elites because of something about themselves – that they work harder or are smarter or better educated or come from better blood lines – when in fact they are where they are mostly by pure luck, by having the luck to be born in the right place to the right family with the right connections in the right time with the right genes, and by having the good luck not to have screwed it all up somewhere along the way. 

This applies to history too. As the saying goes, "History is written by the winners".  And of course the winners always think they won due to their superior strategy, when in fact in many (most?) cases, they won primarily through luck. For example, the great victory at Midway in World War II hinged on the fact that an American scout plane was lucky enough to spot the Japanese fleet though the clouds before the Japanese located the American fleet. Of course history also suffers from the "narrative flaw", which we will discuss in a future posting.

China and reality

I have observed that it takes a long time, perhaps a decade or more, for the media and politicians (which one is driving which?) to accommodate to new facts. It took about that long for them to catch on to the fact that China was gaming (cheating on) the WTO (World Trade Organization) membership to support China's economic growth. 

Now we have a general consensus among the U.S. media and politicians that China is a growing economic and military threat.  Chinese propaganda certainly feeds that narrative, and the American press is apparently gullible enough to believe most of the propaganda. 

So let me suggest an alternative view from geopolitical strategist Peter Zeihan, who bases his views on maps and data, rather than ideology or wishful thinking. He has a recent short (12 minute) piece on YouTube entitled How China Is Going To Vanish which is worth listening to, and which gives a different perspective. 

The data Peter presents certainly doesn't mean that China isn't a limited threat right now, especially if the CCP gets desperate. But it does suggest that it will be a diminishing threat over time, not an increasing one as the media seems to think.

Incerto 1

I have been re-reading the books in Nassim Taleb’s “Incerto’ series (Fooled by Randomness, 2001, The Black Swan,2010, The Bed of Procrustes, 2010, Antifragile, 2012, and Skin in the Game, 2018). I am finding it fruitful to read them each several times – there are some profound observations buried in them that one doesn’t easily get on first reading. Here is one:

Beginning in The Black Swan, Taleb makes the useful distinction between things in what he calls “Mediocristan” and things in “Extremistan”.

Think about the average height of humans. Worldwide the average male height is reported to be about 5’9”.  If we lined up 100 random men, we would expect the average of their heights to be around 5’9”. If we found the tallest human who had ever lived and added them to the other 100, it wouldn’t change the average much, because the tallest human who ever lived might be 8’ or even 9’ tall, but wouldn’t be 80’ or 800’ or 8,000’ tall. The same would be true for average human weights, or size of dogs, or variation in outdoor temperature in Chicago, or human lifespans…or….or. These are things in Mediocristan, things for which the most extreme possible outliers don’t deviate all that much from the average.

Now think about wealth. In the US the median net worth these days is reported to be about $120,000. And if we picked 100 random Americans and looked at their median wealth it would probably be around that number. But if we added in the net worth of the wealthiest American living (currently Amazon’s Jeff Bezos at about $177 billion) it would change the average net worth immensely. And in fact there is no theoretical limit to how wealthy the wealthiest American might be. Or think about the size of planetary debris hitting the earth. The average piece of debris is a dust particle, but the largest possible could be the size of a planet larger than earth. These are things in Extremistan, things which have outliers very, very far from the median.

What is the importance of this distinction? It is that Mediocristan doesn’t have black swans, so that our common statistical methods of estimating risk work reasonably well, given enough data points in the history to get a valid feeling for the shape of the underlying distribution. But Extremistan does have black swans, which means that our common statistical methods of estimating risk are meaningless, irrespective of how much historical data we have. The turkey story is illustrative – for 1000 days it gets fed regularly, so from historical data it can reasonably expect to get fed every day, then Thanksgiving arrives…

The difficulty is that too many experts in too many fields think they are working in Mediocristan with their models and theories and risk estimates, when they are really in Extremistan.