Black Swans Are A Myth, Government Intervention Is The Only Black Swan
(click here for access)
By John Tammy
Forbes, September 21, 2013

"Thankfully for readers eager to understand why the markets and the economy are both a shadow of what they could be, Spitznagel has written an essential new book. Indeed, The Dao of Capital: Austrian Investing in a Distorted World might be one of the most important books of the year, or any year for that matter."

SALT Conference in Singapore (click here for website)
September 24-27, 2013

Keynote:  Nassim Taleb

• New York Times Bestselling Author, "The Black Swan" & Distinguished Scientific Advisor, Universa Investments
• Nassim N. Taleb is a former derivatives trader who became a scholar and philosophical essayist in 2006. Although he is currently Distinguished Professor of Risk Engineering at New York University, he self-funds his research and operates in the manner of independent scholars. He is also Distinguished Scientific Advisor at Universa Investments L.P., an investment manager that specializes in tail hedging as a means to enhance long-term equity returns.
• Mr. Taleb is the author of The Incerto: A Philosophical Essay on Uncertainty, in Four Volumes, which includes The Black Swan (2007) and Antifragile (2012). He is also author of a series of mathematical monographs on Probability and Risk in the Real World. His work focuses on decision-making under opacity and how systems can handle disorder.

Eric Spencer and Brandon Yarckin of Universa will be attending and available for meetings.

This story appears in the August 12, 2013 issue of Forbes.
By Mark Spitznagel of Universa Investments

The U.S. stock market’s return to nominal alltime highs amid artificial zero interest rates is sending yield-hungry investors down a dangerous path, one they hope will continue to lead to quick and easy returns. Such pursuits ignore a reality grounded in some of the oldest human wisdom, dating back 25 centuries to the Daoist sages of ancient China, who eschewed the direct in favor of the indirect–the roundabout that leads to better strategic advantage.

This is the Daoist concept of shi, of avoiding the immediate and decisive clash (what they called li ) with its high risk of loss (the parallel to today’s top-heavy market should be obvious) in order to move decisively later from a stronger position against an enemy vanquished by its overextension. The preeminent industrialists, economists (specifically the Austrians) and military strategists (most notably Sun Tzu of The Art of War and the oft misunderstood Carl von Clausewitz of On War ) have all embraced the roundabout of “going right in order to go left.”

In most strategic human undertakings, particularly in investing, the circuitous is, paradoxically, the superior route–the central point of my book, The Dao of Capital: Austrian Investing in a Distorted World . Indeed, as Austrian economics forefather Eugen von Bohm-Bawerk observed, it is often the only way. The Austrians taught that this is the map of civilization’s progress, forgoing consumption to amass more roundabout capital structures that subsequently result in greater efficiency and productivity.

Yet, for investors, it remains counterintuitive, uncomfortable and often downright foolish to sit on the sidelines during heady times, waiting for better opportunities to come while others rack up easy gains. (Though one never knows precisely when, history shows this artificial-liquidity-fueled rally will end badly.) The roundabout goads us beyond the immediate to adopt a depth-of-field perspective comprised of a series of forward “now” moments and to avoid that which would undermine the opportunities in those forward nows.

Fortunately, we have role models from nature: The leitmotif of The Dao of Capital is the conifer, the towering success story of our planet, which once ruled uncontested (save for the herbaceous dinosaurs) until some 65 million years ago, when aggressive angiosperms (grasses and deciduous trees) emerged and overtook them. To survive, conifer trees developed an adaptive niche, retreating to the unpopular places where the competition couldn’t grow. Even today, in their roundabout growth, they slowly amass the necessary “capital” of thick bark, efficient roots, needled leaves and a tall canopy, gaining strategic shi advantages. Thus the conifer “tortoises” accelerate their growth, eventually exceeding that of the angiosperm “hares” (and even taking their land after wildfires rage).

Great entrepreneurs, too, walk this circuitous path by reinvesting their profits rather than consuming them as dividends or as unproductive cash. Henry Ford, the quintessential example, plowed profits back into operations in an autocatalytic process of tools begetting more tools (steelmaking and foundries to produce parts for the assembly line economically). This is what Bohm-Bawerk called Produktionsumweg, which requires hefty immediate investment costs that often feel like setbacks, wherein the yield-hungry marketplace metes out punishment for the shrinking short-term profits that follow. But this is the very foundation for the capital structures that are the means to higher, though later, production and profit.

No matter how appealing the direct path, it will likely not best take us where we want to go. Most often it leads only to loss–the hare ultimately loses to the accelerating, roundabout tortoise. Thus we must invest like the triumphant, roundabout conifer–and the illustrious entrepreneur. Investors (and policymakers) ignore this universal logic of growth at grave risk to themselves–and to the progress of civilization itself.

Project Syndicate
By Mark Spitznagel, Universa Investments
August 6, 2013


As Detroit begins to sort through the ill-begotten public liabilities that have driven it to bankruptcy, an important opportunity is at hand to revitalize the city that was once the epicenter of American entrepreneurship and manufacturing, while setting an example for other municipal governments that appear to be headed toward a similar fate. Here is an “Austrian moment” in the making, a potential libertarian awakening guided by the market-oriented, non-interventionist principles of the Austrian school of economics.
This illustration is by Pedro Molina and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.Illustration by Pedro Molina

For years, Detroit’s expenditures vastly exceeded its revenues. With the tax base eroding, owing to a declining population and diminishing private-sector jobs, efforts to boost revenue by raising taxes would have been futile. (Detroit’s 2012 income-tax rate of 2.45% and its property taxes, which are among the country’s highest, are inexplicable, given the inadequacy of basic public services.) In this context, Detroit’s “Ponzi”-like fiscal situation would have continued to deteriorate, with no options other than to borrow more.

But, as long as investors were willing to purchase risky bonds, neither politicians nor unions would admit how unsustainable Detroit’s situation was. With the Federal Reserve’s near-zero interest-rate policy and purchases of trillions of dollars in long-term securities driving demand for such bonds, Detroit’s leaders were able to delay public-sector reform for far too long (a situation that is frighteningly similar to the federal government’s today). Detroit’s bankruptcy is thus exactly what the financial system needs.

Before any tears are shed for the bondholders, it is important to consider the fundamental differences between private and public debt. Private debt is an inter-temporal, contract-based exchange between two entities: the debtor, who needs capital, and the creditor, who is willing to provide that capital in exchange for a sufficient rate of return.

When it comes to public debt, however, creditors receive returns not from the governments to which they have lent money, but from taxpayers, who may be reluctant to cover the costs incurred by a contract to which they never really agreed. Given that the people who borrow and disburse government funds (typically, as in Detroit’s case, an entrenched political elite) are rarely the ones from whom revenues are later collected, public debt does not entail a willing inter-temporal exchange.

As the Austrian-school economist Murray Rothbard pointed out more than two decades ago, deficit spending and public debt represent “a growing and intolerable burden on the society and economy,” given that they transfer “resources from the productive [private sector] to the parasitic, counterproductive public sector.” Detroit’s predicament clearly demonstrates the need to reduce this burden, even if that means enduring a painful adjustment period.

In fact, public debt and deficit spending can be compared to a forest that has become choked with overgrowth, giving the false – and, ultimately, damaging – impression of an abundance of resources. In the forest, natural correcting mechanisms, such as small wildfires, might be suppressed by external actors with an interest in preserving the illusion of plenty, regardless of its potential consequences.

Likewise, rather than allow market forces to correct the problems of mounting public debt and deficit spending, policymakers manipulate interest rates to create excess liquidity and encourage investors to chase yield in a risky environment. Such interventions support unhealthy, distorted, and destabilizing growth, causing the debt burden to grow and, eventually, triggering systemic collapse.

The good news is that, as Rothbard noted, such a collapse “is the ‘recovery’ process,” and, “far from being an evil scourge, is the necessary and beneficial return,” whether in a forest or an economy, to “optimum efficiency.” Given this, purging Detroit’s balance sheet (specifically, the disproportionate unfunded liabilities that have plunged it deep into the red) is the best – maybe even the only – available path to renewal. The long-term benefits would more than offset the short-term costs.

Detroit can correct its past public-sector ineptitude and abuses by unleashing the private sector’s vast potential, rooted in the metropolitan region’s vibrant entrepreneurial and manufacturing culture, skilled workforce, and a robust technology base nurtured by world-class institutions like the University of Michigan. The city’s position on an important border crossing and access to an enormous fresh-water supply from the Great Lakes, not to mention the business community’s unrelenting support, enhance its prospects further. (In fact, in the wider metropolitan region, the private sector is realizing its potential even today, despite the barriers that Detroit’s dysfunctional public sector has erected.)

The time has come to free Detroit’s entrepreneurial spirit from the legacy of government mismanagement. Guided by the Austrian school’s libertarian principles, Detroit can transform itself from an example of municipal failure into a symbol of restoration and source of economic dynamism, the likes of which the US has never seen.

Financial Post
by Philip Cross, Special to Financial Post | August 7, 2013

Nassim Taleb, author of the best sellers The Black Swan and Anti-Fragile, formalized his searing critique of economists and statisticians in ‘A Brief Exposition of Violations of Scientific Rigor In Current Economic Modelling,’ presented at a conference in France in July. Most of this paper is drawn from a longer treatise on ‘Fat Tails and (Anti)Fragility,’ available free on the web, which presents 160 pages of the dense mathematics behind the ideas promulgated in his recent books (you’ve been warned, this isn’t light summertime reading).

The crux of his papers is how the occurrence of rare but high-impact events undermines much of the standard statistical theory used in fields ranging from economics to portfolio investment theory. Some of the criticism is well-founded. As a life-long student of business cycles, I have witnessed the consequences of economists both underestimating the risks of booms and busts and overestimating human rationality; the two are related, as shown by the formation of recurring bubbles in financial and housing markets. Economics, like transportation safety (Taleb’s analogy, not mine), should first of all be based on avoiding catastrophe.

These ‘Black Swan’ events are central to his analysis. They lurk unseen in the ‘tails’ of the probability distribution of what may occur. They cannot be modeled, they distort the measurement of the median, and they result in the underestimation of risk. Risk lies in the future, not in the past, and risk management based on the study of history invariably is erroneous in the long-term. This is because history itself is only one sample from many alternative scenarios that could have happened, which distorts our estimates of the probability that an event may happen. But since we are part of that sample, it is very difficult for people to grasp this concept.

Mathematics has an ambiguous impact on economics. In the words of Robert Heilbroner, the famed popularizer of economics, “Mathematics has given economics rigour, but alas, also mortis.” Exposure to its rigour makes some economists formidable debaters in the public arena, cowing other social scientists who lack its logical discipline. However, mathematics is about certainty, the opposite of probability which allows for a range of uncertain outcomes. An over-reliance on abstract mathematical models leads to a view of economics that ignores the risks that exist in the real world.

Economists are not always consistent in applying logic. We are all instructed in econometrics class that, when applying standard statistical techniques, you should reflect on whether the data have a normal distribution. For over a decade, it has been a crusade of Taleb’s that once you introduce skewness, which applies to almost all economic phenomenon, it is erroneous to assume the data have a normal distribution, on which the most common statistical techniques depend. This may be why econometrics has never been decisive in settling any economic question of consequence, according to Larry Summers, widely-touted as possibly the next head of the Federal Reserve Board.

One reason social scientists are so wedded to the normal distribution is it validates results drawn from small samples. A recent paper on the challenging topic of intergenerational mobility had only 13 sample points to support its main conclusion. But small samples likely don’t include the rare events that preoccupy much of Taleb’s thinking. By his standards, research based on small samples is little more than anecdotes; “Social scientists need to have a clear idea of the difference between science and journalism, or the one between empiricism and anecdotal statements. Science is not about making claims about a sample, but using a sample to make general claims and discuss properties that apply outside the sample.”

Still, society should not dismiss economics any more than it should be in thrall to it. Economics has had great triumphs since the 1970s, wrestling the inflation dragon to the ground in developed countries while lighting the path out of poverty for much of the developing world. It is still notable that the success in controlling inflation and boosting growth in developed countries owed more to heuristics and tinkering than to modelling.

The risks of basing policy on econometrics are on display in the sluggish recovery of Europe and the U.S. In Europe, the IMF recently admitted its estimates of the multiplier effects of fiscal policy were too low, leading it to underestimate the drag on growth from fiscal austerity. In the U.S., quantitative easing by the Federal Reserve Board has had the desired impact of boosting prices for assets such as stocks, bonds and even housing of late, but the stimulus from this wealth on spending has been lower than what models predicted. Having a head of the Federal Reserve who shares this skepticism about models could improve its performance.

Philip Cross is Research Coordinator at the Macdonald-Laurier Institute and former Chief Economic Analyst at Statistics Canada.