Nassim Taleb: "The Government Debt Is Becoming A Pure Ponzi Scheme"

Tyler Durden's picture

In an interview conducted with Business Week, Nassim Taleb discusses his view of the biggest black swan in the market currently, and isn't shy to call government debt a "Pure Ponzi scheme." - When asked where he the biggest potential source of systemic fragility is, he responds: "The massive one is government deficits. As an analogy: You often have planes landing two hours late. In some cases, when you have volcanos, you can land two or three weeks late. How often have you landed two hours early? Never. It's the same with deficits. The errors tend to go one way rather than the other. When I wrote The Black Swan, I realized there was a huge bias in the way people estimate deficits and make forecasts. Typically things costs more, which is chronic. Governments that try to shoot for a surplus hardly ever reach it. The problem is getting runaway. It's becoming a pure Ponzi scheme. It's very nonlinear: You need more and more debt just to stay where you are. And what broke Madoff is going to break governments. They need to find new suckers all the time. And unfortunately the world has run out of suckers." Alas, Taleb is wrong: Ponzi or not, today's UST auction will likely once again come at a multi year high Bid To Cover as the suckers (especially those who recycle Fed discount window money) just refuse to go away.

Some other excerpts:

Q: The new edition of The Black Swan includes
what you call "10 principles for a Black-Swan robust society." One of
them is: "Citizens should not depend on financial assets as a
repository of value and should not rely on fallible 'expert' advice for
their retirement." Can you explain what you mean?

Taleb:
The problem is that citizens are being led to invest in securities they
don't understand by people who themselves don't quite understand the
risks involved. The stock market is probably the best thing in the
world, but the true risks of the stock market are vastly greater than
the representations. And this leads to extremely strange situations in
which, say, someone has a bakery, is extremely paranoid about
suppliers, very careful about risks, and protects his business with
appropriate insurance. Then, at some point, he puts his $122,000 in
savings in a fund that he knows nothing about, based on risk measures
he knows nothing about, in companies very few people know much about.

People
use "risk measures," but you're really not measuring anything like you
measure temperature or distance. You are making a speculative
assessment of a future event. That's not measuring, that's estimating.
And as we saw with BP, with the banking system, and with Toyota,
companies themselves are hiding risks from the security analysts.
They're cutting corners. Companies have a tendency to hide risks.

So
someone extremely careful and prudent in the management of his own
affairs will be completely careless with the half of his savings
invested in the stock market. I'm saying: Don't use the stock market as
a repository of value. It has vastly more risks than you think.

I
was at an investment conference last week with mutual fund managers and
financial advisers. There were a surprising number of mentions of the
possibility of "Black Swans," and your name came up. Do you think those
people understand the concept?

No, they don't get it.
My Black Swan idea is very different: There are events that you can't
forecast, and you need to be robust to these events. If I think that
someone doesn't understand Black Swans, I'm sure that whatever bad news
happens to him will be Black Swans for him but "white swans" for me.

What should you do with your savings?

We
have this culture of financialization. People think they need to make
money with their savings rather with their own business. So you end up
with dentists who are more traders than dentists. A dentist should
drill teeth and use whatever he does in the stock market for
entertainment.

People should have three sources of variation in
their income. The first one is their own business that they understand
rather well. Focus on that. The second one is their savings. Make sure
you preserve them. The third portion is the speculative portion:
Whatever you are willing to lose, you can invest in whatever you want.

In
the second category—preservation of value—you should have the
consciousness that there is something called inflation. You should
avoid some classes of investments that are very fragile.

What are are potential sources of fragility or danger that you're keeping an eye on?

The
massive one is government deficits. As an analogy: You often have
planes landing two hours late. In some cases, when you have volcanos,
you can land two or three weeks late. How often have you landed two
hours early? Never. It's the same with deficits. The errors tend to go
one way rather than the other. When I wrote The Black Swan,
I realized there was a huge bias in the way people estimate deficits
and make forecasts. Typically things costs more, which is chronic.
Governments that try to shoot for a surplus hardly ever reach it.

The
problem is getting runaway. It's becoming a pure Ponzi scheme. It's
very nonlinear: You need more and more debt just to stay where you are.
And what broke Madoff is going to break
governments. They need to find new suckers all the time. And
unfortunately the world has run out of suckers.

You're saying that what is supposed to be the safest place to invest, government debt, is in some ways the most dangerous?

Unless
you invest in your own home currency in very short-term Treasury bills.
Because governments can print more of their own currency, the risk
comes from a rise in interest rates rather than a government default.
When you have hyperinflation, deficits, or debt problems, with
short-term bills you can catch higher interest rates to compensate you
for the inflation or whatever return you've missed.

I
think some people get confused about Black Swans and think you're
saying that you can't predict what's going to happen. But you can see
some big consequential events coming down the road.

A
Black Swan for the turkey is not a Black Swan for the butcher. For
someone very naïve, some events may be Black Swans. For someone warned,
they're not going to be Black Swans if you know they can be possible
and you hedge against them.

Do you have any thoughts on the U.S. financial reform package?

I
don't like complicated regulation. I think we should not need financial
reform. What we need is definancialization. What we need to do is break
the financial community's grip on society. And you can do it very
easily by transformation of debt into equity. Banks have an interest in
building debt, but equity in society is vastly more stable than debt.

So
the problems have not been addressed. They're making something that was
complicated even more complicated. We need some fundamental reforms
rather than a very, very precise guideline on how you should behave.

What are you working on now?

My next [book] is about beliefs, mostly. How we are suckers and how to live in a world we don't understand.