Taleb highlights fragility of complex world
The world is more fragile than ever because of its ever-increasing complexity and connectedness, according to Nassim Nicholas Taleb.
Mr Taleb, a renowned thinker on the nature of risk and author of the New York Times bestseller The Black Swan, gave a 90-minute presentation to an insurance-industry audience in Bermuda yesterday.
By its very nature the next “black swan” to strike will be entirely unpredictable, but Mr Taleb offered some advice on how to survive and thrive after the resulting disorder with the concept of “antifragility”.
He was speaking to more than 200 delegates at the Bermuda International Long-Term Insurers and Reinsurers (Biltir) Conference at the Fairmont Southampton hotel.
The rapid rise of technology and connectivity made the world more fragile, said Mr Taleb, who was a quantitative trader for 21 years before he ventured into writing and academia.
“Fragility can’t decrease, because the future will be more complex and interconnected, so it will look more stable, but in reality it will be more fragile,” he said. “Shocks will go deeper.”
He said in the 1980s, when he was studying for an MBA, the average time a stock stayed in the S&P 500 Index was about 60 years — now it was 10 to 12 years.
The economic environment should bode well for the insurance business, he added, as there would be “more GDP to insure and more arbitrages”.
He added that the lack of volatility seen in financial markets in recent times was not making the market more stable — rather it was more fragile and vulnerable to a major shock.
Mr Taleb, distinguished professor of risk engineering at New York University’s Tandon School of Engineering, made his point by comparing a cat and a washing machine, a concept featured in his latest book Antifragile: Things That Gain From Disorder.
“The cat, or anything organic, requires some kind of stressors — otherwise it dies,” he said. “But you don’t want stress for the washing machine.
“The big mistake that [former US Federal Reserve chairman] Alan Greenspan made was he thought the economy was a washing machine, but it’s a cat.
“You want people to fail early, not late, because that’s when you have big government bailouts.”
The dampening of volatility in the economy was comparable to a forest that had no forest fires for many years, but detritus would accumulate meaning the fire, when it did inevitably happen, would be more destructive.
“Every big problem we have had in finance has come from mistaking risk and volatility,” Mr Taleb added.
He sees problems with the monetary policy of today’s Federal Reserve as well, with its extended period of ultra-low interest rates since the 2008 global financial crisis, saying the economy has been “on Novocaine”, a local anaesthetic drug.
In an interview with The Royal Gazette, he said: “Interest rates are too low and we don’t have a mechanism to bring them back normal levels so we can use them if we need to. Monetary policy can’t operate without them.”
Asked for his advice to regular investors, he said: “Avoid stocks unless you have tail-risk insurance.”
Tail risk is loosely defined as the probability of rare events that could cause a large movement in the value of an investment. The phrase emanates from the tails of a bell curve, which extend with ever-decreasing probabilities.
But how should one hedge against highly improbable events?
“Work out how your investments would fare in a crisis and make sure you don’t have uncle points,” he said. Traders refer to an uncle point as a point when an investor throws in the towel on an investment that appears not to be working.
He said there were three particular ways in which the average investor tended to misunderstand risk.
“First, they think that if you invest in the market, you will get the market return — that doesn’t happen for any individual, who is going in and out,” he said.
“Second, it’s rational to worry about tail risk. And third, low risk and low volatility are not the same thing.”
Bermuda had an advantage because of its small size, he said. Like city states of past and present, such as Phoenicia and Singapore, its lack of natural resources had only helped the island to innovate and create opportunities for itself.
Size could also help Bermuda to respond in times of crisis. For example, if a pandemic were to sweep the globe, Bermuda could simply shut down its airport, which was how Singapore protected itself against the Sars virus.
Bermuda’s adaptability gives it an antifragile characteristic. Fragility applied when there was no upside to random events, such as a china teacup in an earthquake, he said. But antifragility implied a capability of thriving on disorder, such as the mythical Hydra, which, when its head was cut off, grew two more heads.
The all-day Biltir conference continued with sessions on changing accounting standards, the rise of innovation and insurtechs, the complexities of reinsurance treaties and a regulatory update from the Bermuda Monetary Authority.
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