Taleb on Overstabilisation

It’s nice to know that Taleb is preaching more or less the same gospel that I am.

Via the NYT:

Stabilization, of course, has long been the economic playbook of the United States government; it has kept interest rates low, shored up banks, purchased bad debts and printed money. But the effect is akin to treating metastatic cancer with painkillers. It has not only let deeper problems fester, but also aggravated inequality. Bankers have continued to get rich using taxpayer dollars as both fuel and backstop. And printing money tends to disproportionately benefit a certain class. The rise in asset prices made the superrich even richer, while the median family income has dropped.

Overstabilization also corrects problems that ought not to be corrected and renders the economy more fragile; and in a fragile economy, even small errors can lead to crises and plunge the entire system into chaos. That’s what happened in 2008. More than four years after that financial crisis began, nothing has been done to address its root causes.

Our goal instead should be an antifragile system — one in which mistakes don’t ricochet throughout the economy, but can instead be used to fuel growth. The key elements to such a system are decentralization of decision making and ensuring that all economic and political actors have some “skin in the game.”

Two of the biggest policy mistakes of the past decade resulted from centralized decision making. First, the Iraq war, in addition to its tragic outcomes, cost between 40 and 100 times the original estimates. The second was the 2008 crisis, which I believe resulted from an all-too-powerful Federal Reserve providing cheap money to stifle economic volatility; this, in turn, led to the accumulation of hidden risks in the economic system, which cascaded into a major blowup.

Just as we didn’t forecast these two mistakes and their impact, we’ll miss the next ones unless we confront our error-prone system. Fortunately, the solution can be bipartisan, pleasing both those who decry a large federal government and those who distrust the market.

First, in a decentralized system, errors are by nature smaller. Switzerland is one of the world’s wealthiest and most stable countries. It is also highly decentralized — with 26 cantons that are self-governing and make most of their own budgetary decisions. The absence of a central monopoly on taxation makes them compete for tax and bureaucratic efficiency. And if the Jura canton goes bankrupt, it will not destabilize the entire Swiss economy.

In decentralized systems, problems can be solved early and when they are small; stakeholders are also generally more willing to pay to solve local challenges (like fixing a bridge), which often affect them in a direct way. And when there are terrible failures in economic management — a bankrupt county, a state ill-prepared for its pension obligations — these do not necessarily bring the national economy to its knees. In fact, states and municipalities will learn from the mistakes of others, ultimately making the economy stronger.

It’s a myth that centralization and size bring “efficiency.” Centralized states are deficit-prone precisely because they tend to be gamed by lobbyists and large corporations, which increase their size in order to get the protection of bailouts. No large company should ever be bailed out; it creates a moral hazard.

Consider the difference between Silicon Valley entrepreneurs, who are taught to “fail early and often,” and large corporations that leech off governments and demand bailouts when they’re in trouble on the pretext that they are too big to fail. Entrepreneurs don’t ask for bailouts, and their failures do not destabilize the economy as a whole.

Second, there must be skin in the game across the board, so that nobody can inflict harm on others without first harming himself. Bankers got rich — and are still rich — from transferring risk to taxpayers (and we still haven’t seen clawbacks of executive pay at companies that were bailed out). Likewise, Washington bureaucrats haven’t been exposed to punishment for their errors, whereas officials at the municipal level often have to face the wrath of voters (and neighbors) who are affected by their mistakes.

If we want our economy not to be merely resilient, but to flourish, we must strive for antifragility. It is the difference between something that breaks severely after a policy error, and something that thrives from such mistakes. Since we cannot stop making mistakes and prediction errors, let us make sure their impact is limited and localized, and can in the long term help ensure our prosperity and growth.

27 thoughts on “Taleb on Overstabilisation

  1. I remember you saying you’re on friendly terms with Taleb, Aziz, and just saw him mentioning Switzerland (go to Interlaken if you ever get the chance! – http://en.wikipedia.org/wiki/Interlaken – amazing clear water a very beautiful ducks) and it reminded me of this fascinating book about an infamous Swiss banker – Wilhelm Ropke: Swiss Localist, Global Economist, from the library of Modern Thinkers 😉 http://www.amazon.com/Wilhelm-Ropke-Localist-Economist-Thinkers/dp/1882926676

  2. There are no problems of social structure, including banking, that we can’t solve. After all, some of us created them. The big underlying problem is that most people don’t want to solve them. The ruling classes profit from the way things are, and the masses apparently want to be led by the nose.

    • Or as Milton Friedman said in his book which advocated full reserve banking (“A program for monetary stability”):

      “The vested political interests opposing it are too strong, and the citizens who would benefit both as taxpayers and as participants in economic activity are too unaware of its benefits and too disorganised to have any influence.”

        • Failed to add: This quote applies to EVERY action of government, not just regulation of bank reserves or economic activity.

        • “Friedman was the main proponent of the monetarist school of economics. He maintained that there is a close and stable association between price inflation and the money supply, mainly that price inflation should be regulated with monetary deflation and price deflation with monetary inflation. He famously quipped that price deflation can be fought by “dropping money out of a helicopter.”[36]”


          Yeah if only the 1% are around at the secret location to receive the cash and buy up the “deflated” houses.

          Monetarism is theft, by inflation through access to cheap printed money.

      • Per Wikipedia

        “Friedman was initially unable to find academic employment, so during 1935, he followed his friend W. Allen Wallis to Washington, where Franklin D. Roosevelt’s New Deal was “a lifesaver” for many young economists.[20] At this stage, Friedman said that he and his wife “regarded the job-creation programs such as the WPA, CCC, and PWA appropriate responses to the critical situation,” but not “the price- and wage-fixing measures of the National Recovery Administration and the Agricultural Adjustment Administration.”[21] Foreshadowing his later ideas, he believed price controls interfered with an essential signaling mechanism to help resources be used where they were most valued. Indeed, Friedman later concluded that all government intervention associated with the New Deal was “the wrong cure for the wrong disease,” arguing that the money supply should simply have been expanded, instead of contracted.[22] In the publication Monetary History of the United States by Friedman and Anna Schwartz, they argue that the Great Depression was caused by monetary contraction, which was the consequence of poor policymaking by the Federal reserve and the continuous crises of the banking system.[”

        So there you go, Bernanke is following Freidman’s rules, but the Banks are not playing ball, instead possibly bidding up the casino stock market, instead of lending to innovative business. Note the New Deal was an Economist’s “lifesaver”. Soothsayers dare not rock the boat.

        It would have been better to give the QE to the people (Robbing the 1% and redistributing), and let the money flow to the innovative business men. At least then, goods and services that had utility to the people (Even if their choices were flippant and emotive such as designer jeans or iPhones).

        Instead the market has ramped up from the 2009 lows, when the 1% bought up on the cheap (I am sure they were foretold) and squirreled away in foreign bank accounts. I used to think this stuff is to brazen to be real, but I am convinced there was theft by deception. Hank Paulsen, along with George W. Bush should be jailed as Agents of the 1%. Congress should be sacked for incompetence.

      • I think one of the problems, even for the minority of dissidents, is that we don’t agree on what money is, or should be. Right now what I often read is that printing (or, more accurately, creating credit) ‘works’ or ‘is working’, so whatever is going on is sort of all right. The emperor is wearing clothes; they just happen to be perfectly transparent and kind of light for the weather.

  3. I don’t believe that Taleb gets it at all. He, similar to many others, believing that things are the way they are because people misunderstand, instead of what should be quite obvious at this juncture, which is that things are the way they are because this is EXACTLY the way they are designed to be.

    If you point a loaded .44 at somebody’s head and pull the trigger, it should come as no great surprise that their brains are now splattered on the adjoining wall.

    • Taleb understands the problem of looting very well. People (as in the wider society) do misunderstand and misdesign. The looters understand exactly what they are doing.

      • John, people go into most situations hoping for the best, but deep down inside [where the reality of the situation abides], knowing that the result is going to be not as expected.

        Hope is the ultimate double-edge sword, that which get us through the bad times, while, in the same breath, insuring that the bad times return, time and again.

      • Talib seems to miss the point that inflation is a common law crime. It would be bad enough if the government simply printed up scrip to pay their “workers” with but what is even worse is borrowing to print it up which makes everyone perpetual debt slaves.

        In 1913, Henry Ford paid his production workers $5/day which was equivalent to an ounce and a quarter of gold. Since then productivity has increased by a factor of 11, meaning that same labor should bring about 15 ounces per week. In a free economy, the productivity gains accrue to the workers via the Phillips Curve. America today should be unimaginably prosperous. With inflation, however, the workers are paid in fiat with sharply diluted purchasing power. The scale of the crime cannot be conceived of by the average person. Until this is understood, the people of the world will continue to be slaves.

        • “Since then productivity has increased by a factor of 11, meaning that same labor should bring about 15 ounces per week. In a free economy, the productivity gains accrue to the workers via the Phillips Curve.”

          Actually, productivity gains should be seen in the increasing value of the [sound] currency, and therefore everybody who uses the currency shares in the gain.

          Keep in mind that productivity increases [should] lead to decreasing prices, so margins might/might not increase depending on external factors. Take the modern electronics industry as a good example, as increasing productivity has slashed prices and margins [on the whole].

      • I think that Aziz’s comment about the looters is the best interpretation of what has happened in the US. But the blame ought to centered on the politicians (Dodd, Frank, the Clintons, Obama, et al) more than the Fed or big bankers. In any case, decentralization is truly needed.

        • “But the blame ought to centered on the politicians (Dodd, Frank, the Clintons, Obama, et al) more than the Fed or big bankers. In any case, decentralization is truly needed.”

          I notice you miss out Bush! I think you are too caught up in the false left wing / right wing party politics. All politicians generally in both parties work either for themselves or for the banksters. Even the tiny exceptions that might be sincere are suspect…there to give the impression that there is freedom of choice.

        • Re robc just below: I may be focused too narrowly on the subprime residential real estate tragedy. Republican Speaker Hastert was implicated, as were many others (mostly Democrats) in the congress, Clinton administration and Fannie and Freddie (all Democrats, as I recall). The Bush administration reportedly sent over a dozen cautionary messages to the Democrat controlled congress, which were ignored. BUT Bush did not veto anything!




    It all started when parents made their children wear helmets when riding a bike, then the Government mandated it. Nanny State.

  5. as far as i can tell, the military/defence industry is mainly located in and about US territory, even though it’s a relatively global industry – so you can think that America’s most profitable economic sector will either decide to roll itself back into bankruptcy or else start marketing weapons for self defence on a mass scale around Earth….

  6. Contrary to Taleb’s suggestions, rectifying some of the daft characteristics of current attempts to regulate the economy would not necessarily lead to less stability. For example there is his claim that “printing money tends to disproportionately benefit a certain class.” Not true.

    It is perfectly possible for government and central bank to print and spend new money into the economy in a way that DOES NOT benefit “a certain class”: spend the money on pensions, health, education, etc and/or just leave money in taxpayers’ pockets with the middle and lower earners getting the biggest tax reductions.

  7. “The Fed was largely responsible for converting what might have been a garden-variety recession, although perhaps a fairly severe one, into a major catastrophe. Instead of using its powers to offset the depression, it presided over a decline in the quantity of money by one-third from 1929 to 1933 … Far from the depression being a failure of the free-enterprise system, it was a tragic failure of government.
    —Milton Friedman, Two Lucky People, 233”

    So how was that cheap money in the 20’s then a deliberate pull back causing the crash of 29 compare to 2000’s to 2007 (Hiking rates unnecessarily, then panicking and dropping them, like a underage kid trying to steer a stolen car)

    History Rhymes. Central Banking and Interest rate manipulation is theft and destruction. Leave the setting of interest rates to the market!

  8. Frederick Bastiat despised the patronising socialist nanny state. I doubt he would agree wit overstabilisation. 10 men in a room controlling 5 Billion people’s lives. What arrogance! Bastiat says: “To socialist intellectuals, the relationship between the people and the legislator is the same relationship between the clay and the potter. Socialists envision a utopian society of which they would be the wise leaders. They find ideological support among legislators whom, for the most part, assume themselves to be better than the people and the peoples’ saviors from their own stupidity: “He who would dare to undertake the political creation of a people ought to believe that he can, in a manner of speaking, transform human nature, transform each individual . . . into a mere part of a greater whole from which the individual will henceforth receive his life and being” (Rousseau). “Impartiality in law consists of two things: the establishing of equality in wealth and equality in dignity among citizens” (Condillac). Oh, writers! Remember that this clay, which you so arbitrarily dispose of, are men! They are your equals! They are intelligent and free like yourselves! They, too, have received from God the faculty to observe, to plan, to think, and to judge for themselves!”


  9. Pingback: The Real 2013 Cliff « azizonomics

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s