The Black Swan of Cairo

All the old paintings in the tombs
They do the sand dance don't you know
If they move too quick, oh-way-oh
They're falling down like a domino
--The Bangles

During his recently profiled presentation, Kyle Bass recommended that people in the audience read "The Black Swan of Cairo" (Taleb & Blyth, 2011). The paper is co-authored by Nassim Taleb of previous 'black swan' fame.

Bass is right. This is an insightful piece.

Although written in light of the political unrest taking place in Egypt earlier this year, the article is essentially an argument against the suppression of volatility and an argument for letting natural systems breathe with the inevitable ups and downs that are inherent to them.

The mortgage meltdown in 2007-8 and the current political upheaval in the Middle East share a common trait--they both follow prolonged periods of artificial suppression of volatility by policy makers in the name of 'stability.' Taleb and Blyth (2011) argue that such suppression pushes unobserved risks further into the tails of probability distributions. As the tails 'fatten,' the chances of extreme events grow--although things appear calm on the surface. At some point, however, the highly constrained system explodes in a massive blowup as pent up potential energy turns kinetic.

Paradoxically, actions taken seek to suppress naturally occuring volatility, while possibly well intended, tend to exacerbate volatility in the long run. Some examples:

Living in a super sterile environment...increases potential for disease.
Interest rate manipulation by central banks in the name of price stability...increases potential for big price swings.
Supporting a dictatorship...increases potential for political blowups.
Increasing regulation to reduce risk...motivates people to take more risk (moral hazard).

I find this model very intuitive as it is wholly consistent with principles of natural law. The authors quote Rousseau: "A little bit of agitation gives motivation to the soul, and what really makes the species prosper is not peace but freedom."

A nice insight toward the end of the piece: variation is information. Where there is no variation, there is no information. Thus, an intelligence apparatus seeking to distill info from political behavior in other countries will have a rough go of it when those countries have been manipulated by policies aimed at reducing variation.

The authors wrap it up nicely:

"With freedom comes some unpredictable fluctuation. This is one of life's packages: there is no freedom without noise - and no stability without volatility."

Another way of articulating the fundamental tradeoff between safety and freedom.

Reference

Taleb, N.N. & Blyth, M. 2011. The black swan of Cairo. Foreign Affairs, 90(3): 33-39.