This evening I would like to add a new category to my printed thoughts, entitled “Rational Decision-making”. It is (among many other uses) an essential part of the stock-picking process.
I strongly believe that careful decisions come from careful thinking, and careful thinking requires careful use of words. Words are the algebraic substitutions of human language– a single word can have a rich, specific, enlightening (or obfuscating) meaning. Using the right word can make your valid argument clear to others, or lay bare the faults in invalid arguments. Sloppy use of words can lead an argument astray– to confusion, inappropriate connotations, or unsupported conclusions.
One way that word use gets sloppy is through fads and over-use. If a word or phrase becomes popular, it gets used by a widening circle of speakers, not all of whom know precisely what the word originally meant. Those sloppy uses reduce the impact of a good word or phrase by making it degeneratively less specific and more ambiguous.
One such phrase is “Black Swan”. This was coined by investment philosopher Nassim Nicholas Taleb in his best-selling 2007 book The Black Swan: The Impact of the Highly Improbable. Taleb described how Europeans assumed, absolutely, that all swans were white– because all the swans they had seen, ever, anywhere in the world, were white.
Until they visited Australia. There are black swans there. A certainty became a fallacy.
When Taleb used the phrase, he meant facts or events which were beyond improbable– they were assumed to be impossible. A discovery overturning a false Black Swan impression is not just extreme luck– it is epoch-making, paradigm-shattering.
The phrase has been diluted in these subsequent years of extreme economic events. It is widely used now, even by very smart and educated people, to mean an event which is very unlikely, but conceivable in advance. “Extremely unlikely” is the correct description.
My semantic-quibble button was pushed this evening by a Washington Post op-ed by PIMCO’s Bill Gross. Make no mistake, Bill Gross is a very smart guy, smarter than me and much better educated. None the less, he followed others into error.
In his “The euro may fall — and take the U.S. recovery with it”, he wrote “[The Euro's demise] is a diminished probability based on this week’s policy announcements, but it remains, in market parlance, a fat-tail, black-swan event — a factor to consider.”
A fat-tail event (from Statistics, meaning extreme but more likely than one might think), yes. A Black Swan, no. We’re discussing the likelihood; we are fully aware of the possibility.
The Black Swan is a very important concept.
Experts believed that a nationwide housing price collapse in America was impossible, not just unlikely. It had never ever happened. Experts (encouragingly not quite all) believed that financial derivatives had taken the catastrophic risk out of investing– risks could be encapsulated and passed to investors able to bear the losses. Derivatives (in their basic form) and exchanges for trading them have worked for centuries without catastrophe. Then overconfidence pushed everything too far, to unimaginable catastrophe.
I wish to defend The Black Swan from trivialization. Some events are unknowable, completely unpredictable, assumed to be impossible, and yet they happen. We need to have a word for that concept.
I hope I can encourage other writers and analysts to use that symbol carefully.
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