Why Central Planning Leads To Instability. Bass Reads Taleb

During his recent lengthy discussion on the broad topic of global central bankers, optical backstops, and our coordinated cognitive dissonance, Kyle Bass, of Hayman Advisors, suggested everyone read "The Black Swan Of Cairo" penned by no less a tail-risk philosopher than Nassim Taleb (and Mark Blyth). The Foreign Affairs article from June 2011 brings into clear prose the fascinating dichotomy between the centrally planned smoothing efforts of world bankers and politicians and the inevitable (and much larger) instabilities that spring from this suppression.

It is both misguided and dangerous to push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability “tail risks” to disappear from policymakers’ fields of observation.

With freedom comes some unpredictable fluctuation. This is one of life's packages: there is no freedom without noise - and no stability without volatility.

Foreign Affairs: How Suppressing Volatility Makes The World Less Predictable and More Dangerous (annotated)

 

Why is surprise the permanent condition of the U.S. political and economic elite? In 2007-8, when the global ?nancial system imploded, the cry that no one could have seen this coming was heard everywhere, despite the existence of numerous analyses showing that a crisis was unavoidable. It is no surprise that one hears precisely the same response today regarding the current turmoil in the Middle East. The critical issue in both cases is the arti?cial suppression of volatility -- the ups and downs of life -- in the name of stability. It is both misguided and dangerous to push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability "tail risks" to disappear from policymakers' ?elds of observation. What the world is witnessing in Tunisia, Egypt, and Libya is simply what happens when highly constrained systems explode.

 

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These arti?cially constrained systems become prone to "Black Swans" -- that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.

 

Such environments eventually experience massive blowups, catching everyone off-guard and undoing years of stability or, in some cases, ending up far worse than they were in their initial volatile state. Indeed, the longer it takes for the blowup to occur, the worse the resulting harm in both economic and political systems.

 

Seeking to restrict variability seems to be good policy (who does not prefer stability to chaos?), so it is with very good intentions that policymakers unwittingly increase the risk of major blowups. And it is the same misperception of the properties of natural systems that led to both the economic crisis of 2007-8 and the current turmoil in the Arab world. The policy implications are identical: to make systems robust, all risks must be visible and out in the open -- fluctuat nec mergitur (it fluctuates but does not sink) goes the Latin saying.

 

As Jean-Jacques Rousseau put it, "A little bit of agitation gives motivation to the soul, and what really makes the species prosper is not peace so much as freedom." With freedom comes some unpredictable fluctuation. This is one of life's packages: there is no freedom without noise - and no stability without volatility.

 

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