To start off our black swan event discussion, let’s start with Lebanese-American writer and statistician, Nassim Nicholas Taleb, who wrote something interesting about improbability in one of his essays:
“Think of the terrorist attack of September 11, 2001: had the risk been reasonably conceivable on September 10, it would not have happened. If such a possibility were deemed worthy of attention, fighter planes would have circled the sky above the twin towers, airplanes would have had locked bulletproof doors, and the attack would not have taken place, period. Something else might have taken place. What? I don’t know. Isn’t it strange to see an event happening precisely because it was not supposed to happen?”
What he was mainly referring to was something that we now recognize as ‘Black Swan logic’. At its core, it is about making the unknown far more relevant than it ever would be. One can apply this to an array of fields (finance, societal issues, etc), so it doesn’t necessarily have restrictions.
Over time, the term managed to gain traction due largely in part to its relatability. Nowadays, it is a significant type of ‘event’ in the fields of business and many others. This article will go more into detail about what Taleb was discussing in his essay.
What does it mean?
Taleb’s use of 9/11 is only one way to approach the definition of what a ‘black swan’ is. Indeed, it is a recognizable situation that makes understanding the concept that much easier. Be that as it may, there is more ground to cover.
It would be easy to define a black swan as being an unpredictable event. While that is true, there are additional elements to it that make it more than an unforeseeable event. In reality, it is one that is beyond what is normally expected of a situation. What’s more, there is a good chance that it will have severe consequences.
The main indicators of black swan events are their extreme rarity and severe impact. Moreover, there is also the practice of explaining widespread failure to forecast them as simple nonsense in hindsight.
Black swan events are capable of causing catastrophic damage to an economy. The fact that one cannot easily predict them is especially alarming. As such, all we can really do is prepare for them by way of constructing strong systems. However, reliance on standard forecasting tools can often backfire. It can fail to predict, as well as potentially increase vulnerability to black swans by propagating risk. Not only that, but it can also offer false security.
Origins of the term
Taleb was the trailblazer of this concept, having written about it in a 2007 book. It is worth mentioning that this book is the source of the 9/11 quote. This is compelling in that the release of this book was before the events of the 2008 financial crisis.
Taleb makes an argument regarding the rarity and catastrophic consequences of a black swan event. Because they are impossible to predict, it’s crucial for people to always assume the possibility of a black swan event. This is regardless of whatever it may be. In doing so, they must also be sure to plan accordingly.
Later on, Taleb would use the 2008 financial crisis to his advantage. He applies the idea of black swan events as a means to make another argument. That being if a crippling system is able to fail, then it actually strengthens it. To elaborate, it will ultimately strengthen the system against the debacle of any future black swan events. He also argues that, contrarily, a system propped up and secluded from risk will become more susceptible to catastrophic loss. This is especially true upon encountering events that are rare and unpredictable.
There are three ways to describe a black swan as an event, and that is it…
- …goes beyond normal expectations that are so rare that even the possibility that it could actually occur is a mystery
- …has a catastrophic impact whenever it does happen
- …is explained in hindsight as if it were actually predictable
For the more rare events, Taleb claims that the conventional tools of probability and prediction do not apply. Such tools include the likes of normal distribution. They don’t apply because they depend heavily on a large population and past sample sizes. These factors are rarely – if ever – available for infrequent events by definition. Extrapolating by using statistics drawing from observations of previous events is not beneficial in predicting black swans. If anything, it might make us even more vulnerable to them.
Our inherent inability to forecast black swans matters a great deal. This is largely due to the fact that they can have such severe consequences. Insignificant events – no matter their unpredictability – are evidently a lot less interesting.
The final key aspect is that, as a historically important event, observers are keen to explain it after the fact. Moreover, they are eager to make speculations on how the prediction of its occurrence could have happened. Though, this kind of retrospective speculation does not actually help to forecast black swans. If the black swan already occurred, and they are very rarely similar, then what’s the point?
One of the most infamous black swan events is the financial crash of the U.S. housing market during the 2008 crisis. On top of its notoriety, it is also the most recent black swan event. The effects of the crash were catastrophic on a global scale. In fact, only a handful of outliers were fortunate enough to be able to see it coming.
This crash, however, was not the only black swan event in 2008. Zimbabwe would have inarguably the worst case of hyperinflation to ever occur in the 21st century. Its peak inflation rate would have a percentage of more than 79.6 billion. An inflation level of that amount is practically impossible to predict and is capable of financially ruining a country.
In 2001, there was a black swan event with several similarities to the 2008 financial crisis. This event was the ‘dot-com bubble’. At the time, America was enjoying rapid economic growth, as well as private wealth increases. All of a sudden, the economy came to a catastrophic collapse. Keep in mind that the Internet was still in its infancy in terms of commercial use. Because of this, an array of investment funds were investing in technology companies. Specifically, companies with inflated valuations and no market traction. Upon the folding of these companies, the funds were hit especially hard. Furthermore, the downside risk would pass on to the investors. Since the digital frontier was new, it was nearly impossible to predict the disastrous collapse.
In 1998, the once successful hedge fund, Long-Term Capital Management (LTCM), would be driven into the ground. The cause of this was a ripple effect stemming from the Russian government’s debt default. This was something that the company’s computer models could not anticipate.
Could there be another occurrence?
To say that another black swan event is on the horizon would be jumping the gun, so to speak. They are difficult to predict, so it isn’t easy – or even appropriate – to say “One shall occur in two week’s time.” For that matter, it is impossible to pick up on a pattern because they occur at such random times. There is no coherency, ergo there is nothing to draw from.
With that in mind, a tweet from investor and writer, Charlie Bilello, displays interesting statistics. These include S&P, Dow, Nasdaq, and High Wilshire 5000 being at all-time highs. Additionally, job growth is at its longest streak in history and economic expansion is at its longest, too. One commenter on this post says that “Black swans gathering for an imminent appearance,” while also mentioning that GDP growth is at 1%. “Credit and leverage overflowing everywhere,” they add.
So, should we expect a black swan? It’s possible, but it is difficult to tell, just as it’s always been.
How about black swan events in cryptocurrency?
In terms of cryptocurrency, the unpredictability of a black swan event remains the same. Be that as it may, a black swan event can take on several forms within this particular industry. Vice president of research and development at Bitwise, Mathew Hougan, cites a notable incident of this. This example is a commendation of regulatory risk because of a majority of cryptocurrency trading occurring on exchanges within specific countries. A crackdown on cryptocurrency trading, alternatively on particular exchanges by governments in such countries, could crash the prices.
Engaging in cryptocurrency trading, ICOs, and various other crypto activities are risky undertakings in and of themselves. It would not be a stretch to assume that black swan events are a regular occurrence in the crypto field. To reiterate, these events take many forms when it comes to cryptocurrency, ergo the difficulty in predicting them is the same as it always is.
In keeping with the topic of unforeseeable events, Taleb has this to say about ‘black swan blindness’:
“Who gets rewarded, the central banker who avoids a recession or the one who comes to ‘correct’ his predecessors’ faults and happens to be there during some economic recovery? Who is more valuable, the politician who avoids a war or the one who starts a new one (and is lucky enough to win)? … everybody knows that you need more prevention than treatment, but few reward acts of prevention. We glorify those who left their names in history books at the expense of those contributors about whom our books are silent.”
This ties into mistreatment and misinformation that stems from such events that equate to catastrophic results. History will remember certain aspects (ex. people) more than others. In a way, one can relate this to the habit of speculative thinking following the occurrence of a black swan event. Of course, we can scrutinize specifics of what led to the event, but we ultimately miss the big picture. That being no matter how hard we try, we cannot predict these events.