Tuesday, February 28, 2012

Tackling the Black Swan Theory (Problem)

According to author, Nassim Nicholas Taleb, the "Black Swan Theory" is a theory explaining an unexpected event or series of events, which are highly improbable and unpredictable, that impact our lives severely and at a post-mortem analysis, deemed preventable if resources have been dedicated to identifying the symptoms which were right before our eyes.

The "Black Swan Theory" can be said for any major unexpected crisis (eg Earthquakes, tsunamis, financial system breakdown, political coups and even wars).

Let us first take a look at natural calamities such as earthquakes, tsunamis, typhoons and hurricanes.

As we understand more about science, we began to record information and statistics constantly so that when incidents happens, we are able to look back at the records to see if there are any consistent patterns leading to the incident. By identifying certain record patterns that occur prior to the incident, we can then expect the unexpected to happen ( knowing well that we are unable to stop certain occurrence of Nature )

So with our technologies and people, various agencies are set up around the world to chart seismic, thermal and meteorological data. Mathematicians analyse the statistics information from these data to try their best in predicting the next natural calamity. But by knowing them, it does not mean that we can stop them.

Our efforts in finding out the next calamity only allows us to better prepare for it. We still have to let it happen as we do not have control over it happening. We can evacuate and minimize the loss of human lives and perhaps invest lesser in the infrastructure at the location where it is predicted to strike.

The signs of science becomes easier to spot with years of accumulated records and occurrences of such calamities. With each incident, we evolve, with better technology and coordination, in handling the evacuation and recovery.

Natural calamities cannot be prevented with Science and Mathematics, but it can be detected early to reduce losses of the affected area. Thus we can somewhat prevent the Black Swan Theory by being able to predict the event and minimize the impact.

Now if we are to look at induced calamities such as wars, terrorism and politics using the same Black Swan Theory.

To deny the fact that political tension is a sign of instability, is to welcome the "Black Swan" with open arms and the only predicted expectation will be to suffer the impact of the resulting incident.

Similar to gathering data for the natural occurring incidences, intelligence agencies are set up located all over the world, to collect information and statistics, that leads to each "Black Swan" incident that have occurred. That being said, even if a certain predicted outcome is bound to happen, these agencies may not be able to prevent them from happening.


Having read Malcom Gladwell's "What the Dog Saw", one will know that the outcome of a "Black Swan" incident will cause an unexpected financial dive of the system of the affected region. While some bank their money on gradually increasing economies with stable but minimal returns, there are some whom bet against the expected growth pattern, banking on the collapse of the system as an outcome of the "Black Swan" incident. The returns from betting against the system arising from the collapse, far outweighs the accumulated earnings from betting on constant growth.

This means that if an individual whom invests a one time $100,000 to earn $1000 yearly dividend, by banking on constant growth for 20 years, gets $20,000, at the end of the 20 year term. (Read: Longing the market)

This holds true for any investment, provided that there are no Black Swan incident during term period of that investment.

However, if a Black Swan incident do occur on the 10th year, he may lose more that what he was trying to earn (ie the principal value to $100,000 may be reduced drastically to $50,000 for example).

On the other hand, for those predicting the Black Swan incident, by banking against the constant growth pattern, his $10,000 investment may just turn into millions overnight. (Read: Shorting the market)

So now that one is armed with the knowledge that there are significant importance about knowing the Black Swan Theory and the signs that are leading to a Black Swan incident......

Would you prevent it or let it happen as an unexpected incident with a outcome that has severe impact (which if known, can allow you to make millions from mere thousands) ?

Did you know that at any moment in time, currency is a zero sum game?  (Read: Zero Sum Game)
i.e. If a certain currency is gaining value, that will mean that some other currencies is losing value.

In actual fact, the amount of money in our world do increase, but not because they just print additional zeros in everyone's bank account. It is due to the increase of debts owed to the central banks. And with these debts, interests and "favours" are earned. (Read: Central Banks and their roles)

With owed favours and due debt interests, debtor countries constantly struggle with keeping up and eventually have to comply with creditors(Central Banks) requests. Such requests may come in the form of mining rights, prime property, tax breaks, etc.

I find an interesting line in Wikipedia which describes one of the Central Bank formidable prowess:

With accumulated debts and constant favouring that allows external Central Banks to reap the benefits, instead of its own people, it is inevitable that the locals can no longer afford a better life within their countries. Those whom can afford, would leave for a better life elsewhere. And those whom cannot afford, will have no choice but to stay poor and helpless. And it is inevitable that the poor and helpless, will one day, come to realize that their land is sowed and reap for rewards by foreigners. 

When you have nothing to live for, you have everything to fight for

Knowing the "Human Condition", the Black Swan incident becomes a cycle. Easier to predict with each occurrence and with shorter cycle periods.

The truth is, we cannot tackle the Black Swan Problem. 
The rewards of the dip due to the Black Swan Incident far outweighs the constant pattern of growth. Our entire capitalist financial system thrives on greed. No matter how much we loathe this system of greed, it is the only system we know that will guarantee continuity and productivity.

Those whom have the resources to record the statistics and able to predict the next Black Swan Incident, can only minimize the adverse impact on themselves. And similar to a natural calamity, they can only let it happen.

I wrote the above article after reading the article on Today Papers (Singapore) by Simon Tay.

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