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BLACK SWAN TWO/Taleb: Government Deficits Could Be the Next ‘Black Swan’

In a new edition of The Black Swan, author Nassim Nicholas Taleb warns against depending “on financial assets as a repository of value”

By Ben Steverman

Finance

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The Black Swan: The Impact of the Highly Improbable is a philosophical treatise on uncertainty that managed both to entertain readers and to predict the financial meltdown of 2008. Nassim Nicholas Taleb—the book’s author, who is also a trader and university professor—has reissued his 2007 best seller in a second edition that includes a new 73-page essay, “On Robustness and Fragility.”

Businessweek.com interviewed Taleb in early July about his views on investing and the dangerous Black Swans—i.e. unpredictable events with big consequences—that could lie in wait for financial markets. Edited excerpts from the conversation follow:

Q: The new edition of The Black Swan includes what you call “10 principles for a Black-Swan robust society.” One of them is: “Citizens should not depend on financial assets as a repository of value and should not rely on fallible ‘expert’ advice for their retirement.” Can you explain what you mean?

Taleb: The problem is that citizens are being led to invest in securities they don’t understand by people who themselves don’t quite understand the risks involved. The stock market is probably the best thing in the world, but the true risks of the stock market are vastly greater than the representations. And this leads to extremely strange situations in which, say, someone has a bakery, is extremely paranoid about suppliers, very careful about risks, and protects his business with appropriate insurance. Then, at some point, he puts his $122,000 in savings in a fund that he knows nothing about, based on risk measures he knows nothing about, in companies very few people know much about.

People use “risk measures,” but you’re really not measuring anything like you measure temperature or distance. You are making a speculative assessment of a future event. That’s not measuring, that’s estimating. And as we saw with BP (BP), with the banking system, and with Toyota (TM), companies themselves are hiding risks from the security analysts. They’re cutting corners. Companies have a tendency to hide risks.

So someone extremely careful and prudent in the management of his own affairs will be completely careless with the half of his savings invested in the stock market. I’m saying: Don’t use the stock market as a repository of value. It has vastly more risks than you think.

I was at an investment conference last week with mutual fund managers and financial advisers. There were a surprising number of mentions of the possibility of “Black Swans,” and your name came up. Do you think those people understand the concept?

No, they don’t get it. My Black Swan idea is very different: There are events that you can’t forecast, and you need to be robust to these events. If I think that someone doesn’t understand Black Swans, I’m sure that whatever bad news happens to him will be Black Swans for him but “white swans” for me.

What should you do with your savings?

We have this culture of financialization. People think they need to make money with their savings rather with their own business. So you end up with dentists who are more traders than dentists. A dentist should drill teeth and use whatever he does in the stock market for entertainment.

People should have three sources of variation in their income. The first one is their own business that they understand rather well. Focus on that. The second one is their savings. Make sure you preserve them. The third portion is the speculative portion: Whatever you are willing to lose, you can invest in whatever you want.

In the second category—preservation of value—you should have the consciousness that there is something called inflation. You should avoid some classes of investments that are very fragile.

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