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2 Of black swans and greedy
oilmen By Chan Akya
It
is not often that a school of thought comes along
at exactly the right time that markets, economists
and policymakers are worried about a specific
event or crisis. When a book setting out these new
views does come along, it is usually ignored, then
quietly buried, and then only is quoted by
increasingly esoteric sources until the work is
driven to the point of irrelevance.
Such a
fate is quite likely for two outstanding books
released in 2007 - Black Swan [1] and
Zoom [2] - both of which capture some
original thinking on the state of the markets and
the underlying
economic
structure that supports market mechanisms. While
the authors did not in all probability set out to
collaborate per se, they may have just produced
classically symbiotic tomes.
First, the
books on their own merits.
Nassim Nicholas
Taleb or NNT for short, famously wrote about
planes crashing into buildings in an earlier work
[3] in the months preceding the ugly September 11,
2001, incident. He did not attempt to predict that
planes could be used for this purpose, only that
deterministic probability models are unlikely to
factor in such catastrophes. Thus, when he
published a book on the limitations of probability
models currently employed by market technicians
earlier this year, it was almost the natural order
of things for markets to experience exactly that
type of upheaval.
NNT's book works on a
premise that the human mind fails to adapt
adequately to what it does not know and therefore
assigns irrelevant (not merely incorrect)
probabilities to what it does know. Thus, in the
decades and centuries preceding the discovery of
Australia it was commonly held that all swans were
white, ie the probability of a swan being white
was held at 100%. As the early explorers wandered
in the Australian bush and discovered black swans,
the probability of swans being white suddenly
changed. Note here that the "natural" probability
of swans being white remained unchanged during the
whole period of human existence. What changed was
simply our knowledge set.
This apparently
esoteric philosophical point has much relevance in
markets, especially in what is known as risk
management. The ability to quantify risk is based
on accepting a certain set of data as the only
range of possibilities and assigning a probability
distribution such as Gaussian or bell curve to the
same. There are problems with selecting a
probability distribution based on the available
data because expanding the range of data always
changes the underlying probability distribution.
In effect, what looks like impossible in the
probability distribution (say a one in a million
chance) may actually be a lot more likely once the
underlying data is properly populated.
Choosing the wrong data with the incorrect
probability distribution contributed to the
creation, rating and trading of dangerously
combustible collateralized debt obligations (CDOs)
that referenced subprime mortgages (Annus financialitis Asia
Times Online, December 22, 2007). The range of
defaults actually observed on these securities far
exceeded the thresholds set in place by the
declarative probability models employed by Wall
Street, in turn triggering both price declines and
a wider loss of confidence across the financial
system (In gold we trust) Asia
Times Online, September 8, 2007).
NNT
dismisses the work of Paul Samuelson, the patron
saint of Wall Street, by showing that the lofty
buildings of modern finance taught in the
classrooms across the US and Europe today are
based on foundations of goat’s cheese. He is not
the first one to cross swords with the academic
establishment of today, but as William Poundstone
[4] found to his chagrin a couple of years ago,
obduracy and indifference can undo arguments
faster than mere rebuttals ever could.
Continuing the incendiary tactics of
Black Swan aimed at the world of finance,
Zoom focuses its attention on the car and
oil industries. Much of what is written in the
book is already well known, but to string the
pieces together the way the authors have done must
really have taken significant discipline and
imagination.
Starting with a catchphrase
that "Oil is the problem, cars are the solution",
the authors dismiss any notions of replacing the
current way of life enjoyed by the US and Europe
in the name of global warming. In other words, the
only thing that will change is the how cars are
fueled, rather than the total volume of cars sold
and used on a daily basis. Many of the arguments
laid out by the authors will be familiar to Asia
Times Online readers (How central bankers could save the
world” Asia Times Online, December 8,
2007) but perhaps not to readers of American and
European mainstream publications.
The
insider's view on how oil and car lobbies help to
reverse every tentative step suggested by
governments and consumers, not to mention
discrediting those arguing about climate change,
is alone worth the price of admission on this
book.
By itself, Zoom represents
strong arguments in favor of governments acting
today to properly price the negative economic good
of air pollution caused by the use of fossil
fuels. It lays bare the structure of the oil
industry's lobbies, how the Seven Sisters relate
to the national oil companies and what the most
likely avenues for solving over-dependence on oil
are. For a change, the authors do not assume that
alternative fuels such as wind and solar power can
be taken for granted; indeed they point out that
depletion of proven oil reserves may expand the
use of other fossil fuels such as shale and tar
sands, in turn triggering even higher pollution
from the extraction and refinement processes to
continued use of fossil fuels.
The
behavior of Asian governments and consumers is
paramount in all this. If the billion or so cars
that enter the roads of China and India in the
next three decades are powered by fossil fuels,
the world will be one hot and sooty place. If
instead fuel cells and electric batteries power
them, the outlook improves dramatically. Make no
mistake; Asia is very much the battleground where
the forces pushing or reversing global warming
will need to win.
Where the books
collide Almost serendipitously, the two
books prove to be symbiotic. Over-dependence on
fossil fuels and ignoring the pernicious effects
of global warming are of course central to the
assumption of what constitutes "normal" standards
of living in the US and Europe. The underlying
logic is one of "my dad drove a car offering 10
miles per gallon, and I certainly don't see a
reason to change that because my comfort is more
important the survival of stupid polar bears".
The problem with that view of course is
that no one asked anyone to sacrifice their
comforts for polar bears, only that the price of
gasoline in the US is too low to encourage any
shift to more economical cars (yes, even at
current levels US gasoline is a steal compared to
what it costs). In much the same way as NNT lays
down in his book, underlying assumptions of how
fuels will
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