How Mr. Taleb Got Utterly Fooled by Randomness

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Nassim N. Taleb
wrote Fooled
by Randomness
in 2004. It became an instant success. And
no wonder. It’s lively to read. It’s funny. It fires verbal torpedoes
into the sides of floating tubs of Establishment lard. It is merciless
on CNBC’s investment gurus. It shows readers how and why investment
hot-shots have lost enormous amounts of money — other people’s money,
but also their own. This is the stuff of best-sellers.

Yet when we
look more carefully at Mr. Taleb’s operating presuppositions, we
find that he has made a supreme error. In his quest to uncover the
undoubted mysteries of the financial universe, he has come to a
conclusion so utterly incorrect that if it were widely believed,
it would undermine the moral and intellectual foundations of civilization.

He admits that
he is often fooled by randomness. He has no self-awareness of just
how fooled he is.

His book has
reinforced a popular philosophy of life that runs counter to Western
civilization. Yet he does not seem to comprehend the implications
of what he is saying. Or, if he does comprehend it, he is the Darth
Vader of pop investing. He is a press agent for the Dark Side of
the Force.

EINSTEIN
AND KEYNES

We get an inkling
of what this book is all about on page 48 of the second edition:
"The two greatest minds to me, Einstein and Keynes. . . ."

I don’t want
to get into an argument about how great Einstein’s mind was. I freely
admit that I don’t know what the photo-electric effect is, let alone
why Einstein’s 1905 essay on it won him a Nobel Prize. I do know
that he was smart enough to "creatively
appropriate
" Olinto de Pretto’s 1903 formula, e=mc2, in
his 1905 essay on special relativity, without getting caught during
his lifetime.

As for Keynes,
that’s another matter. Here, I am smart enough to assess the man’s
abilities. John Maynard Keynes was a bright enough fellow in his
academic field, probability mathematics. But hardly anyone, other
than Mr. Taleb, pays attention to his Treatise
on Probability
. That is because Keynes’ father, an academic
economist at Cambridge, put up the money to get his son hired as
an economist at Cambridge, a subject which his son had not formally
studied. He never returned to probability theory.

Keynes made
a name for himself by spending his entire career arguing for policy
positions that he would abandon within five years — sometimes less.
Taleb does not mention this aspect of Keynes’ career, but he would
surely approve of it. He writes: "Loyalty to ideas is not a
good thing for traders, scientists — or anyone" (p. 92). In
a universe where randomness governs, fixity is potentially suicidal
and often unprofitable.

Keynes’ final
book, The
General Theory of Employment, Interest and Money
(1936),
is one of the most garbled, incoherent, and poorly argued books
that has ever reached the level of universally acclaimed masterpiece.
It remains as unread today as it was in 1936. It justified the growth
of state power over the economy — just what the politicians wanted
to hear in the Great Depression.

The best evidence
that the book is a political tract is its incoherence. Keynes wrote
compelling prose throughout his life — just not when he wrote to
promote British economic policy. The very incoherence of The
General Theory is the tip-off that the author was self-deluded
in arguing for nonsense, namely, denying that sellers will lower
their prices when they find that nobody will buy at a higher price.
Keynes’ arguments rest on this bedrock presupposition: "Sellers
really do believe that no income is preferable to some income."
He believed in permanent gluts.

Why is Taleb
so impressed with Einstein and Keynes? Because they were advocates
of a theory of the universe to which Taleb is deeply committed:
"The universe is at bottom random." Einstein supplied
evidence for this belief in his third paper (out of five) in 1905:
his essay on Brownian motion. He dismissed this essay years later
as unimportant, but it is his paper most quoted today. Why? Because,
as physicist Mark
Haw writes
, it laid a foundation for the modern view of the
universe: "random fluctuations are fundamentally important
in many, if not most, of the phenomena around us."

Keynes did
the same in his Treatise on Probability.

Einstein refused
to accept this idea when applied to quantum physics. "God does
not play dice," he famously quipped. But Taleb, who does not
argue for God’s existence, does argue for the existence of cosmic
dice.

COSMIC
DICE

Taleb presents
his view of the universe early in his book, on page 26.

Reality is
far more vicious than Russian roulette. First, it delivers the
fatal blow rather infrequently, like a revolver that would have
hundreds, even thousands, of chambers instead of six. After a
few dozen tries, one forgets about the existence of a bullet,
under a numbing false sense of security. . . .

Second, unlike
a well-defined, precise game like Russian roulette, where the
risks are visible to anyone capable of multiplying and dividing
by six, one does not observe the barrel of reality.

Throughout
the book, he speaks of the random event as personal. He does not
believe that God controls the universe. He self-consciously has
returned to the view of the world which was held by late classical
Romans, wherein all of life is understood as a war between impersonal
luck and impersonal fate. He is a skeptic, and says so repeatedly.
He declares his respect for Rome.

Until the
Mediterranean world was dominated with monotheism, which led to
the belief in some form of uniqueness of the truth (to be superseded
later by episodes of communism), skepticism had gained currency
among many major thinkers — and certainly permeated the world
(p. 237).

This is true,
although what communism has to do with anything here mystifies me.
If Taleb has read Charles Cochrane’s Christianity
and Classical Culture
(1944), it is not apparent in his
bibliography. He should read it. The book shows that classical culture
broke down, above all, because the leading thinkers of the era adopted
a non-mathematical view of causation that was very similar to Taleb’s.
Taleb is also correct when he observes that it was monotheism (in
the form of Christianity) that replaced the morally collapsing civilization
of classical skepticism.

Taleb knows
this, and it angers him. His book appears to be a lighthearted romp
through the vagaries of investing, but when he gets to his religion
— the religion of skepticism — he drops his cloak of lightheartedness.
"I despise moralizers beyond anything on this planet,"
he announces in his Prologue.

He believes
that all men are condemned — as if an impersonal universe can condemn
— to be fooled by randomness. We cannot change morally; we can only
adopt what he calls "tricks" to deal with nature’s randomness
on the one hand and our own biologically programmed — i.e., biologically
determined — inability to recognize randomness on the other.

Perhaps ridding
ourselves of our humanity is not in the works; we need wily tricks,
not some grandiose moralizing help. I despise the moralizers beyond
anything on this planet: I still wonder why they blindly believe
in ineffectual methods. Delivering advice assumes that our cognitive
apparatus rather than our emotional machinery exerts some meaningful
control over our actions (p. xlv).

On the same
page, he asserts with the confidence of an Old Testament prophet:
"We are faulty and there is no one to bother trying to correct
our flaws."

He uses the
metaphor of a machine to describe man, who is the victim of an impersonal
system of causation. Man is metaphorically a two-brained machine:
cognitive apparatus vs. emotional machinery.

Metaphors are
significant. The metaphors of mechanics are metaphors of cosmic
impersonalism. Yet machines are designed. In his chapter on "Randomness
and Our Mind," he presents this long metaphor, which is supposed
to persuade us of the weakness of reason. Here is a fine example
of the metaphor of mechanism run amok.

For a long
time we had the wrong product specification when we thought of
ourselves. We humans have been under the belief that we were endowed
with a beautiful machine for thinking and understanding things.
However, among the factory specifications for us is the lack of
awareness of the true factory specifications (why complicate things?)
The problem with thinking is that it causes you to develop illusions.
And thinking may be such a waste of energy! Who needs it! (p.
185).

He presents
this metaphor of a machine that misunderstands itself. This machine
was deliberately designed (by whom?) to misunderstand itself. When
it attempts to understand itself, it misunderstands itself because
it has the wrong product specifications.

This is rhetoric.
What is he trying to prove? This: "Our minds are not quite
designed to understand how the world works, but, rather, to get
out of trouble rapidly and have progeny" (p. 56).

Spoken like
the true believing Darwinist that he is! Who designs our minds?
Uncaring, random yet law-bound, impersonal, autonomous nature.

Here is a man
obsessed with a desire to affirm a totally impersonal universe.
Yet, as he says, this impersonal universe is simultaneously vicious
— more vicious than Russian roulette. Or maybe he doesn’t mean vicious.
Maybe he means dangerous. Then why not say "dangerous"?

His message
is a counsel of despair. "We need tricks to get us there but
before that we need to accept the fact that we are animals in need
of lower forms of tricks, not lectures" (pp. 232—33). Again,
he rejects calls to personal repentance, to lifetime self-improvement.
"I am tired of moralizing slow-thinkers who pound me with platitudes
like I should floss daily, eat my regular apple, and visit the gym
outside of the New Year’s resolution."

I do not suggest
that he floss regularly. I suggest that he cease trying to undermine
Western Civilization.

POPPER’S
ARDENT DISCIPLE

Where did he
get all this? From Karl Popper, mainly. That is what he says, anyway.
Popper made him a philosophical skeptic.

Popper was
a brilliant philosopher whose career was helped by F. A. Hayek in
the mid-1940s. Popper was a skeptic. He proposed a rule for scientific
inquiries. Nothing can be verified empirically, he said. Science
must not rest on any concept of verification. Instead, it must rest
on a process of falsification. There are only two kinds of theories:
(1) theories known to be wrong; (2) theories that have not yet been
proven wrong — not yet falsified (p. 126). "Putting the matter
in context, Popper was rebelling against the growth of science"
(p. 127). Indeed, he was. "To him, verification is not possible.
Verificationism
is more dangerous than anything else" (p. 128).

To Popper,
the sophomore’s retort is appropriate, despite its sophomoric standing.
"In what way is Popper’s hypothesis subject to falsification?"
He should have written a lot of pages presenting criteria for how
his theory of falsification could be falsified. I guess I missed
that article. It surely is not in any of his books that I have read.

I read the
main one, The
Open Society and Its Enemies
, in 1963. In that book, which
Hayek helped to get published, is an assumption: The truly free
society is a society without permanent truths (other than the truth
of falsification, of course). Taleb summarizes the book’s thesis:
"An open society is one in which no permanent truth is held
to exist; this would allow counter-ideas to emerge." Again,
it’s time for the sophomore’s retort: "How about ideas that
deny Popper’s theory?"

I can see why
Hayek loved the book. Not because it took Plato to task, Hegel to
task, and Marx to task. That was why I loved the book. Hayek loved
it because it reinforced his own personal revolt against Ludwig
von Mises’ defense of economic theory.

Mises defended
the free market economy because it is the outcome of the deductive
logic of human action, coupled with informed free choices by rational,
self-interested people. Hayek, Mises’ early convert to capitalism,
defended the free market on an inductivist basis. I summarize: "Nobody
knows what is true, because nothing can be said to be permanently
true, so may the best ideas win in this phase of social evolution!"
He built the case for freedom on the survival of the fittest — ideas,
institutions, and moral rules. (So does Taleb.) I wrote about this
aspect of Hayek’s thought in 1982: "The Evolutionists’ Defense
of the Market," Appendix B of my book, The
Dominion Covenant
. You can download
it free
(if you have the DjVu reader installed).

Why should
we believe in anything for longer than a year or two? Things change.
So must ideas if they are to remain relevant. Hayek argued this
way. So does Taleb. He praises George Soros because Soros keeps
changing his mind (pp. 122—24). As Taleb says, "Self-contradiction
is made culturally to be shameful, a matter that can prove disastrous
in science" (p. 238). Then he goes on to say that the person
"most visibly endowed" with this trait is Soros (p. 239).

Taleb correctly
identifies David Hume as the modern world’s supreme philosophical
skeptic. Hume was obsessive, Taleb says. He "never believed
that a link between two items could truly be established as being
causal" (p. 127). This is exactly what Hume believed. The question
is: What is to prevent Taleb or Popper or Hayek from becoming equally
obsessive? Personal aesthetics, I guess. Or in Taleb’s case, his
current position in the options market.

WHAT
ARE THE OPTIONS?

Taleb makes
his claim to fame that he successfully makes money — enough money
to live in New York City — by trading options. We must take his
word on faith — a highly unskeptical attitude on our part, by the
way. He does not tell us how to make money trading options. He says
only that he makes money by losing small amounts of money on lots
of trades in order to make lots and lots of money when the market
moves radically against the conventional wisdom.

The book summarizes
contemporary scholarship on randomness and major market moves that,
statistically speaking, cannot possibly happen. He mentions the
mathematician Benoit Mandelbrot one time, as an aside, yet Mandelbrot
is the master of this field, who makes the case for randomness in
markets far more cogently and believably that Taleb does. He puts
Mandelbrot’s book, Fractals
and Scaling in Finance
, in the bibliography. I strongly
recommend his recent book, The
Misbehavior of Markets
.

Taleb makes
lots of intriguing observations on how to lose money. He says that
random moves of markets are inescapable. But how can anyone predictably
make money? Because there really are patterns that repeat. There
really is coherence in the apparent chaos. This is Mandelbrot’s
claim. Ultimately, there is no true randomness, Taleb says (p. 169).
So, there has to be order. But why isn’t order the rule and randomness
the exception? He affirms the law of large numbers. Fine. But he
argues that the law of large numbers rests on impersonal statistical
probability — nothing more. Moral cause and effect has nothing
to do with social order. We machines live in a vicious universe
in which “the black swan” — randomness with a vendetta —
will probably get even with us in the end (p. 251). He ends his
Epilogue with this message. He is not just being clever. He believes
it.

He gives us
insight into fear and greed. He says that the pain of loss is greater
than the joy of success. He cites recent psychology to this effect.
Is he correct? I don’t know. I have heard this before.

He says that
hard work doesn’t pay off predictably. He dismisses the work ethics
(plural). "Mild success can be explainable by skills and labor.
Wild success is attributable to variance" (12).

Like all the
other proponents of statistically random profitability, he cannot
explain Warren Buffett. He doesn’t even try. Instead, he launches
into a tirade against Buffett. On what basis? Buffett’s lifestyle.
Buffett still lives in the same modest house he bought when he was
young.

. . . I certainly
do not see the point of becoming one [a billionaire] if I were
to adopt Spartan (even miserly) habits and live in my starter
house. Something about the praise lavished upon him for living
austerely while being so rich escapes me; if austerity is the
end, he should become a monk or a social worker. . . ( p. 144).

My comment:
A monk or a social worker is not able to write the Bill and Melinda
Gates Foundation an annual check for $1.5 billion, up to $30 billion,
plus $12 billion more for other foundations. A monk or a social
worker has no ability to serve as a steward of a hundred billion
dollars in capital, directing it to its most productive uses, as
determined by consumers through their market decisions and actions.

CONCLUSION

Taleb describes
himself as a fool. This is the most accurate assessment in his book.
He is a fool for the reason that he repeatedly says he is a fool.
He is fooled by randomness.

He is fooled
by a few statistically unpredictable oddities found in nature, including
the human mind, into believing that there is no ethical cause and
effect in the universe. He is exactly what he claims to be: a consistent
Darwinist. "One must be either blind or foolish to reject the
theories of Darwinian self-selection" (p. 94). As such, he
hates moralists above all, as he says. Why? Because he hates the
idea that morality, not evolution through impersonal natural selection,
governs the universe.

The fact that
his book is a best-seller indicates just how far gone morally the
intelligent public is. Yes, the book is clever. True, it has a useful
bibliography. No question about it, it has some great one-liners.
But at bottom, it is the work of a suicide bomber. His targets are
people who still believe that there is a predictable relationship
between honesty and success, between hard work and success, between
thrift and riches. In short, it is a hand grenade against people
who think that Warren Buffett got rich through decades of entrepreneurial
service to consumers, not by statistically improbable luck.

Throughout
the book, he describes the person who works hard, makes a decent
living, and never gets rich except through impersonal luck. That
person is a dentist.

The fact is,
the dentist is perhaps the most representative figure in the history
of progress. I quote P. J. O’Rourke: "When you are told about
the good old days, think u2018dentistry.’"

What
Taleb identifies as luck, I identify as the providence of God. He
is a would-be Roman skeptic of the Stoic variety. I am a Christian.
My spiritual forefathers inherited the remains of the broken civilization
left behind by his spiritual forefathers. Or, as the Preacher put
it 3,000 years ago:

A good man
leaveth an inheritance to his children’s children: and the wealth
of the sinner is laid up for the just (Prov. 13:22).

March
10, 2007

Gary
North [send him mail] is the
author of Mises
on Money
. Visit http://www.garynorth.com.
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible
.

Gary
North Archives

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