The discussions on how to save the euro were, bizarrely conducted in English, though there were not a Briton in sight. The Sunday Times 14/02/10
According to David Graddol's extensive survey for the British Council, the number of non-native or second language speakers of English now outnumbers those of primary or native speakers. At the same time there is an ever increasing need for speakers of different languages to communicate with each other:
International tourism is growing, but the proportion of encounters involving a native English speaker is declining (1.9). There were around 763 million international travellers in 2004, but nearly three-quarters of visits involved visitors from a non-English-speaking country travelling to a non-English speaking destination. This demonstrates the scale of need for face-to-face international communi- cation and a growing role for global English. English: Global Language FAQ
Nassim Taleb's The Black Swan (2007)puts forward the theory that the most important events are usually impossible to predict. The title refers to the fact that all swans were believed to be white - until a black one was discovered.
This unpredictability is particularly important in relation to finance. A trader can calculate what he thinks is likely to happen in the market, taking into account known contingencies. What can't be predicted is what Donald Rumsfeld called - 'the unknown unknowns',
Taleb puts it like this
The events that impact on our lives most are impossible to predict. After they occur we find rationalisations for them but we should accept that random events may disrupt any model or plan.
What we call here a Black Swan is an event with the following three attributes.
First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.... A small number of Black Swans explain almost everything in our world, from the success of ideas and religions, to the dynamics of historical events, to elements of our own personal lives.
Taleb's idea seemed to be spectacularly realised in the financial crisis of 2008. But what could be done to avoid such a catastrophe in the future? Taleb makes these suggestions
What is fragile should break early while it is still small. Nothing should ever become too big to fail.
No socialisation of losses and privatisation of gains.
People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
Do not let someone making an "incentive" bonus manage a nuclear plant – or your financial risks.
Counter-balance complexity with simplicity.
Do not give children sticks of dynamite, even if they come with a warning.
Only Ponzi schemes should depend on confidence. Governments should never need to "restore confidence".
Do not give an addict more drugs if he has withdrawal pains.
Citizens should not depend on financial assets or fallible "expert" advice for their retirement.
Make an omelette with the broken eggs.
Arguments against Black Swan approach
- markets may react with what Greenspan called 'irrational exuberance' but eventually correct themselves.
- Avoiding risk may also involve losing in the long run. Markets fall and then rise again (60% since September 2008)
- Some risks are unavoidable - terrorist attack, for example. All we can do it reduce them.
- the rejection of the need for 'confidence' is problematic. Is Taleb suggesting that the world economy is so inherently unstable that all investment in it is too risky?
Vocabulary - Ponzi scheme Named after a famous fraud in which investors money was never actually invested but used to pay limited returns to other investors. Everything works fine until investors start trying to withdraw their money. Fallible makes mistakes.
Worksheet: 50 minute activity based on Black Swan Theory
Did you choose Option A for the dilemma in the last post? When the question was put to a group of doctors, the answers were as follows:
Option A: 72% Option B: 28%
It seems logical. Save some lives rather than risk the loss of all of them. But then the researchers offered the same doctors this choice:
The U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows: If program C is adopted, 400 people will die. If program D is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die. Which of the two programs would you favor?
This time the answers were reversed
Option C: 22% Option D: 78%
This seems crazy. The dilemma is essentially the same - only the wording has been changed. So why the reversal?
The key lies in the direct reference to 'deaths'. Rather than accept limited loss the doctors become willing to risk everything.
Psychologists believe that this indicates what they call 'loss aversion'. Because we hat the idea of losing something we make irrational decisions to protect what we have. For example shareholders will often refuse to sell a falling share because they don't want to accept certain loss.
Perhaps Homer Simpson was speaking for us all when he said, 'It is not okay to lose!
Those of you with less than a passing interest in economics will find your eyes closing at the words inflation and deflation. It's worth opening them again for Amity Shales who does a great job of bring the subject to life. She argues against the current orthodox view that deflation (when prices fall) is not necessarily the biggest danger facing the economy.
Deflation, as we hear so often now, hurts good people, strivers who over-borrow. What’s the reality about deflation and inflation? Deflation can cause depressions, as the U.S. saw in the early 1930s, the period Bernanke has studied so intensely. In the Great Depression, there wasn’t enough money around -- literally. Lacking cash, banks collapsed, and good people did lose homes or farms. More banks collapsed. Deflation doesn’t always spell apocalypse. It can coexist with prosperity -- or even perpetuate it. There was deflation in the 1920s. Prices fell in 1923, and 1925 through 1928. The money shortage hit one sector, farming, hard. Overall, the economy grew. Unemployment stayed low. Vigilance on inflation kept prices stable. Stable prices made life easier. As Harvard University’s alumni magazine reported recently, in wonderment, Harvard’s tuition stood at the same level, $150, between 1870 and the beginning of World War II. And when prices are rising? How bad can it get? The most famous example is Germany's hyper-inflation of 1923. We often hear about customers taking wheelbarrows of money to the supermarket. But what was the effect on the German equivalent of Harvard University: “The Department of Canonical Law at the University of Munich had a budget of 2,000 marks in 1922. Yet the subscription price for a single scholarly journal was already 10,000 marks.” In other words the college did not have the money to buy a copy of its own magazine!
So that's why those meetings of the Federal Reserve, the Bank of England and the European Central Bank are so important. They must decide whether to put up interest rates (to control inflation) or down (to avoid possible deflation). At the moment they are doing neither - let's hope they've got it right.
