Black swans

Reader question:

Please explain why “‘Black Swan’ event” in this passage (Thinking the Unthinkable: What if China Devalues the Renminbi? Global Research, February 19, 2010):

Reducing investment and exports could create a severe recession in China. China has gone too far this time. They appear to be in a box that they and others don’t recognize. The “Black Swan” event this year, as far as China true believers are concerned, could well be a devaluation of the RMB. Were that to happen, the political consequences could be as significant as the economic.

My comments:

Here, Black Swans have obviously nothing to do with the birds, but a business jargon referring to extreme, unpredictable events, such as the subprime crisis in 2008 and the 2001 terrorist attacks on the World Trade Center in New York.

Nassim Taleb, a Lebanon-born writer, scientist and businessman, is credited with coining this term in his book The Black Swan: The Impact of the Highly Improbable.

A summary of the book explains how “black swans” came to represent unpredictable events (SqueezedBooks.com):

The idea of the black swan refers to the fact that, prior to the discovery of Australia, it was assumed that all swans were white, because no one (well, no European at least) had ever seen a black swan. However, they do exist.

However, in the book, a “black swan” refers to any event that is rare, has an extreme impact, and is explainable and predictable - but only in hindsight.

In short, if you want to use this term, make sure you used it to describe major – force majeure as a matter of fact – events that prove devastating but unpredictable.

Here are media examples:

1. For now, the hubris of spurious precision has given way to humility. It turns out that in financial markets “black swans”, or extreme events, occur much more often than the usual probability models suggest. Worse, finance is becoming more fragile: these days blow-ups are twice as frequent as they were before the first world war, according to Barry Eichengreen of the University of California at Berkeley and Michael Bordo of Rutgers University. Benoit Mandelbrot, the father of fractal theory and a pioneer in the study of market swings, argues that finance is prone to a “wild” randomness not usually seen in nature. In markets, “rare big changes can be more significant than the sum of many small changes,” he says. If financial markets followed the normal bell-shaped distribution curve, in which meltdowns are very rare, the stock market crash of 1987, the interest-rate turmoil of 1992 and the 2008 crash would each be expected only once in the lifetime of the universe.

This is changing the way many financial firms think about risk, says Greg Case, chief executive of Aon, an insurance broker. Before the crisis they were looking at things like pandemics, cyber-security and terrorism as possible causes of black swans. Now they are turning to risks from within the system, and how they can become amplified in combination.

- The gods strike back, Economist, February 11, 2010.

2. Greenspan sends a warning sign to all investors. He said that every crisis that the Fed faced in his 18 years as Fed chairman was “unpredictable.” The October 1987 crash, the 1997 Asian currency crisis, the 2001 terrorist attacks - they all were like “black swans,” to use Nassim Taleb’s term for unforeseeable events. Greenspan’s conclusion:“Because we cannot forecast these events, we must be prepared to deal with them when they occur.”

What does the Fed do to get prepared? Ben Bernanke, the current Fed chairman, has set up a “crisis center” to anticipate potential global problems, including a currency crisis, a housing collapse, another terrorist attack, or a sharp rise in inflation. The Crisis Center has been busy during the summer of 2007, dealing with the mortgage meltdown and credit crunch.

What should YOU do to get prepared? I say use protective stops to get you out in times of a stock market collapse; buy gold and silver coins for survival protection; and keep a large position in cash...If Alan Greenspan and his successor Ben Bernanke are preparing for future “black swans,” maybe you should too.

- One Word of Warning: Beware of Black Swans! WorldlyPhilosophers.com, September 30, 2007.