Thursday, July 26, 2012

Lions eat Black Swans

There was a period there after the crashes of 20o7 when everyone started talking about “Black Swan events.” These were random events happening out of the blue that take everyone by surprise.

It was suddenly all the rage to talk about Black Swans. According to the hype, we were now living through one of these Black Swan events . (Even ACT's Heather Roy got caught up in the hype, before one came up and nipped her in the arse.)

But guess what, people. The crash, the recession, the credit crisis … none of these were Black Swans. A Black Swan event is something truly random and unable to be foreseen.  And plenty of people did foresee the crash; they just weren’t listened to.  Then, or now.

Commentator John Mauldin reckons a more apt analogy is Lions in the Grass—dangers apparently unseen but which with sufficient foresight can be foreseen.

It is natural to the human condition to focus on the apparent dangers in front of us. That is part of our evolutionary heritage from the time when humans were first dodging lions and chasing antelopes on the African savannah. But we soon learned that if we were to survive it was not enough to walk away from and around the lions we could see. We also had to make sure we didn’t walk into a lion hidden in the grass. It is the hidden lions that can spring on us suddenly and take an arm or a leg.

imageWhile most may not spot them, a hunter or an antelope grows adept at spotting the lions hidden in the grass. * So too do those trained in more rational economics than is doled out at most universities.

As Frederic Bastiat noted, it is the skilled economist who looks for the effects that are hidden, the surprises that are unseen. It should be a habit to look at the potential second- and third-order consequences of what we can see happening before our eyes. That way, we not only avoid the lurking lions, we also turn what would hunt us and do us harm into the hunted. Sometimes, the dangers themselves can be turned into a very nice trophy indeed, if you can see and respond in time…

Everyone now knows that there are lions roaming all over Europe… but the lion that lies hidden in the
European grass is France…

France is the imminently sick man of Europe, even without Hollande at the helm—and arms and legs (ad fortunes) are going to be lost betting against it, reckons Mauldin.

Mauldin has another analogy too. One he reserves for disasters so imminent only folk with “the economic understanding that God gave a goose” could fail to see them. And he reserves this analogy for Japan.

Japan is a bug in search of a windshield – but it keeps dodging. Japan has a debt-to-GDP ratio that is approaching 230% (at a rate of increase of 8-10% a year!). The savings rate is declining rapidly and will soon go negative. At that point, the thought is, Japan will need to seek out foreign investors to buy its bonds. And who will buy a Japanese bond at 1% for ten years? If rates rise only 2%, then Japan would be spending almost 80% of tax revenues on just the interest on its bonds. I would submit that that is not a workable business model.

The question with Japan is not, “will this bug hit the windshield?” That disaster is unavoidable. The real question now is “what happens when it does?”  This (to really mix metaphors now) is the real Lion in the Grass.

Because at this point you need more than just economic nous—you need historical knowledge.

What will happen when Japan melts down—a resource-poor country in a world in which borders are being closed and resources are more difficult to buy?  Will it hunker down and accept the fate it has delivered itself. Or will it do, or try to do, what it’s done before?  Historian Scott Powell puts the question:

As its economy falters and its demographic situation becomes desperate in the 21st century, how will its bankrupt government and people react? A distinct possibility exists that Japan will return to being one of America’s [and NZ’s]greatest enemies.

These are questions that can only be answered with knowledge of what’s gone before. Which is why I’d encourage you to look at signing up to Scott Powell’s online Japanese History course—for which Mauldin’s newsletter quoted above is assigned reading.

* * * * 

* Can you see the “hidden lion” in the photograph above? Give up?  Then head to John Mauldin’s newsletter for the answer.

Labels: , ,

4 Comments:

Blogger Kiwiwit said...

In the world to come, relations between countries will be as relations between primitive tribes - brutish and cannabalistic. I wouldn't just be wary of Japan, but also much of Europe and even, given the way Obama has been speaking of late, the USA.

7/26/2012 06:00:00 pm  
Anonymous Falafulu Fisi said...

PC said...
A Black Swan event is something truly random and unable to be foreseen.

Black Swan is connected to Spontaneous order. So, black swan is embedded in the spontaneous order notion of Hayek. They are not exactly the same thing but the connection is there. The specific event may be anticipated, but the question of when it is going to take place is the mystery that no one can answer. This is where randomness comes in.

I know that it will rain sometime this year if I start anticipating the event from now on. To state specifically when it is going to rain, say in weeks ahead, is when randomness comes in? Then Ken Ring's prediction is as accurate as NIWA's prediction. We already anticipated that the event will take place with some prior probability but to pinpoint exactly when, is a different story.

Similarly, Austrian economists had always & rightly anticipated the financial crashes over the last 100 years. But to pinpoint exactly of when that tsunami hits, is a completely different story.

The probability distribution in black-swan is different from probability distribution that is heavily used by financial analysts in evaluating risks. Black-Swan is a power-law probability distribution, where it is non-symmetric. Most analysts still use the normal distribution (symmetric bell-curve), which in reality the markets don't conform to probability distribution law. This is not what Falafulu says. Just grab any big financial data from the net and run the distribution of that data on Excel spreadsheet and you see that it is not symmetric. It fits a non-symmetric power-law rather than a bell-curve.

7/27/2012 11:33:00 am  
Anonymous Maurice Winn said...

Cannonballistic? People are not cannibalistic these days. Countries and people are not like the "good old days" when lebensraum and conquest were normally sought for tribal alpha male dominance hierarchy hunter gatherer territorial purposes for Malthusian breeding and megalomania satisfaction.

Now we have about 7 billion people surging and cerfing in Cyberspace. The world is not just quantitatively different, it's qualitatively very different from 100 years ago.

A few qualitative differences: the Flynn Effect, A380s, Cyberspace, Vaccinations, contraceptives, globalized trade, fairly universal democracy. Here comes genetic engineering.

Japan is doing fine. They do not have a demographic disaster. They are doing well with a uniform age distribution and GDP per person near the best in a country of 100 million with no oil or other found wealth. They are also very civilized. I have no idea why they should become an enemy of the USA or NZ.

There is a fairly uniform disaster/catastrophe/calamity alarmist doomster philosophy almost uniformly accepted as given these days. In fact the world has never been so good and it is getting better at an absurd rate and accelerating as 6 billion people support now millions of creative individuals who have created a leap-frogging technology race driven by $trillions into the Cyberspace era.

The Cyberspace is making all that has gone before look like chimps squabbling in the jungle with the invention of the stick and stone as major achievements. The industrial revolution was good at the time, but insignificantly trivial compared with the Cyberspace revolution.

7/29/2012 02:25:00 am  
Anonymous Maurice Winn said...

How many people now owe their economic existence to Cyberspace? My guess is that there are now more people directly dependent on Cyberspace income than the population of some fairly large countries. At a guess, I'd say 10 million people get their pay cheques [digital deposits] directly from what they produce in Cyberspace. Then there are all those hordes who are dependent on Cyberspace for their business to function. For example, airlines, motels and others very much depend on Cyberspace to run their businesses, find and supply customers.

7/29/2012 02:40:00 am  

Post a Comment

Respond with a polite and intelligent comment. (Both will be applauded.)

Say what you mean, and mean what you say. (Do others the courtesy of being honest.)

Please put a name to your comments. (If you're prepared to give voice, then back it up with a name.)

And don't troll. Please. (Contemplate doing something more productive with your time, and ours.)

<< Home