How Debt Ruins Systems

Black Swan author Nassim Nicholas Taleb on fragility, centralization, and capitalism


Nassim Nicholas Taleb is a former trader and hedge fund manager, a bestselling author, and a groundbreaking theorist on risk and resilience.

A finance professor at New York University and a research scholar at Oxford, Taleb drew wide attention after the 2007 publication of The Black Swan: The Impact of the Highly Improbable, which warned that our institutions and risk models are not designed to account for rare and catastrophic events. Among other things, the book presciently cautioned that oversized and unaccountable banks using flawed investment models could trigger a financial crisis. He also warned that the government-sanctioned housing finance agencies, Fannie Mae and Freddie Mac, were sitting on a "barrel of dynamite." One year after The Black Swan was published, Taleb's predictions came to pass. 

Taleb doesn't identify as a libertarian, but he often sounds like one. He supported Ron Paul in the 2012 presidential election and has cited the libertarian economist Friedrich Hayek as an influence. He has called New York Times columnist Thomas Friedman "vile and harmful," and he coined the phrase "Stiglitz Syndrome" after Nobel Prize–winning economist Joseph Stiglitz, referring to the phenomenon of public intellectuals being held utterly unaccountable for their bad predictions. The economists Paul Krugman and Paul Samuelson are among Taleb's other Nobelist bêtes noire.

Taleb's new book, Antifragile: Things that Gain with Disorder, argues that in order to create robust institutions we must allow them to build resilience through adversity. The essence of capitalism, he argues, is encouraging failure, not rewarding success.

Reason TV Editor in Chief Nick Gillespie sat down with Taleb in January for a wide-ranging discussion about debt, technology, the banking system, capitalism, and why he'll never take writing advice from "some academic at Cambridge who sold 2,200 copies." Video of this interview can be seen at reason.com.

reason: What is antifragility and why is it so important?

Nassim Nicholas Taleb: Antifragility is something that likes volatility and likes variation, likes turmoil, likes stress—up to a point. The opposite would be robust. Robust is like a rock. It doesn't care. Diamond is perfectly robust. What is antifragile gains from disorder and may even need disorder for fuel. 

reason: You talk about it in terms of materials, but antifragility applies more to systems or living organisms, right?

Taleb: Exactly. What people fail to understand—and this is what libertarians tend to pick up rather quickly—is that even when you read Adam Smith, you have this illusion that the economy functions like a machine. But it's not like a washing machine. A washing machine needs maintenance. It's more like a cat than a washing machine. A human body needs some stressors. And everything organic and complex communicates with the environment via stressors.

reason: Is it kind of a fractal system?

Taleb: Exactly. It's fractal because you have layers. Like the restaurant business. It's composed of restaurants. And for the restaurant business to be robust—or perhaps antifragile—you need every single restaurant to be fragile. It's the opposite of Nietzsche's "What doesn't kill me makes me stronger." What kills me makes others stronger.

(Interview continues below video.)

reason: Because they learn?

Taleb: They learn from your mistakes. You have evolutionary forces where the individuals sacrifice for the collective. It works within your biological system. You're composed of cells. If you harm some cells, your overall health will improve. 

reason: Most people would say when you have a system and if there's a contagion in it, if there's a cancer in it, if there's some kind of stressor that starts taking over, it's going to spread to the whole system. This is what we hear about the banking system, the financial crisis. You're arguing that a robust or an antifragile system is capable of seeing this part of the system being cancered and learning from it.

Taleb: To cite the great Yogi Berra, a good antifragile system is a system in which all mistakes are good mistakes. And the bad system is one, again to paraphrase Yogi Berra, where you tend to make the wrong mistakes. Let's compare the banking system to, say, transportation. Every plane crash makes the next plane crash less likely and our transportation safer. Now, with the banking system, [a failure] leads to increased probability of failure of an entire system. That's a bad system.

reason: What's the best way to stop that so you're not allowing the problem to replicate throughout the system?

Taleb: What fragilizes an overall system? Three things: One, centralization. Decentralization spreads mistakes, makes smaller mistakes. Decentralization is where we converge with libertarians. A second one is low debt. The third is skin in the game. 

reason: Paul Krugman, one of your great friends or nemeses, just recently wrote that these trillion-dollar deficits don't matter. 

Taleb: All these economists, let's put it this way: Risk is not their thing. 

Debt leads to fragility. We've discovered since the Babylonians that debt has systemic consequences whereas equity doesn't. Let's say that you have two brothers. One of them borrowed and they both had predictions about the future—forecasts. One brother borrows. The other issues equity. The one who borrows will go bust if he makes a mistake. The one who issues equity will fluctuate but will be able to survive a forecast error. 

reason: But is it also true that the brother with equity can never really have that big payday?

Taleb: For him! But overall the system is well distributed. There's an accounting equality. Debt traditionally has blown up systems and has been very good for governments to wage war. I'm not against credit. I'm against leverage. 

reason: So you give me a loan and I say I'm going to pay you back and that gives me the ability to get something in the short run that will help me produce more in the long run. That's OK? 

Taleb: Banking started [like this]: You're going to Aleppo, Syria, and Florence and you're going to send me some silk. You trust me, and my correspondent in Aleppo would pay you the minute I get my silk—that kind of transaction. That's called letter of credit, where you have debt conditional on some commercial transaction being completed. And it also allows people to finance some inventory, provided the buyer is a committed buyer. That kind of facilitation of commerce is how it all started—the letter of credit—and it developed very well.

Before that we had debt in society and it led to blowups in Babylon, and then they had to have debt jubilees. Then of course the Hebrews also had debt jubilees. And of course, they say neither a borrower nor a lender be. The Romans didn't like debt. The Greeks didn't like debt, except for a few intellectuals. Intellectuals for some reason, like Mr. Krugman, like debt.

Later on debt came back to Europe with the Reformation and it was mostly to finance wars. The industrial revolution was not financed by debt. California was not financed by debt; it was financed by equity. So debt is not necessary. You can use it for emergencies. Catholic societies—Aquinas was against debt and his statements were stronger than the Islamic fatwa against debt.

We have learned through history that debt in the form of leverage can blow things up. Debt fragilizes. Now what we have had in this economy is a growth of debt mostly financed indirectly by governments. Because if you blow up, we're going to be behind you.

reason: So this is the problem of too big to fail, which went from being a worry to being inscribed in official policy?

Taleb: Exactly. When you're a banker and you have the upside but no downside, what are you going to do? Create the maximum number of loans that don't blow up often, and collect your bonuses. 

You're paying for his downside. This, to me, is not capitalism. It is a misunderstanding of basic rules. Skin in the game started with Hammurabi, led later on to eye-for-eye, and led to the Golden Rule.

reason: You talk about decentralization. One of the most fascinating things in the global economy in the last 50 years—you could argue over the past 1,000 years—is that in many ways it's becoming more and more decentralized. Certain types of knowledge are more decentralized than ever before. Economies compete in a way that they didn't before; countries can no longer force investors to keep their money in a particular currency, in a particular geographic location. Even as we're facing a global crisis, is globalization generally a good thing?

Taleb: It is if you know how to handle it—if you let firms fail.

There is something called the island effect. In nature, an island will have a higher number of species per square meter than a continent; it's actually proportional to the square of the area. We've lost the island effect. Now you have Google dominating the whole planet. It's not a problem. The thing is that if we stop letting these firms fail when they become ill, they can get large enough to dominate government. Now, computer firms I'm not worried about.

reason: Why aren't you worried about computer firms? 

Taleb: Because it's a competitive environment. Google is a product of a competitive environment.

reason: So we can see the end of Google on the horizon.

Taleb: We can see the end of Google, and it doesn't make a difference. It makes no difference for you and I. If Google fails tomorrow, there will be something else, don't worry. The government won't save them. And I don't think they'll fail, for that reason: They know the government won't save them. But you can have some centralization/concentration. That's not the problem. 

The problem we have had in almost all Western countries is that nominally they say they are decentralizing, but effectively they've [given] more and more power to the central government. You want decisions to be spread out. Government debt is a result of centralization, and typically the cause of more centralization. It's a very bad circle.

reason: I suspect one of the reasons you are as popular as you are is that in the United States it's rare for an intellectual, particularly one who is good at math, to also have any sense that history has something to teach us. You decided at an early age you were interested in becoming a philosopher. Talk about that and how that linked into the work you're doing.

Taleb: I wanted to be a philosopher from the beginning, but there was civil war in Lebanon. I left. I came back from France and I realized I had too many books to read. And I loved reading but I hated to be given books to read because if you're bored with it you lose the option. I like the optionality of switching to finding your own path rather than being in a straitjacket of university. 

Then I realized that I had better study something more technical. I continued two lives, one technical and one nontechnical. The technical led to options trading. And the option trading led to a doctorate related to probability theory applied to options, and in some obscure stuff. 

reason: What is your goal as a public figure?

Taleb: I don't want to be a public figure. After Black Swan, for the first six months, nine months, one year, I was thinking it was nice to go to Davos. And then I didn't like it, so I came back home and became a private figure.

reason: Why didn't you like it?

Taleb: Too many empty suits. And also, what's my profession? It's to write books. I only write articles to explain some of the ideas of the books. I do technical papers and books. And everything else I do is because a publisher wants me to write op-eds. 

reason: Let me put it differently: What are you hoping that your ideas add to the public understanding of how a good society would work better, and what kinds of mistake to avoid?

Taleb: It has already led to beautiful results. With [U.K. Prime Minister] David Cameron, when I was contacted by him and his administration, to go before, to help—I told him, "Listen, I'm not a public intellectual, but we can talk about my ideas through my books. I'm not going to write articles, and we're going to have a conversation." It led to being demonized by sections of the British public—who cares?—and as well as here. But it had an effect.

I say people can pick up these ideas very quickly. My point is to have a systematic approach to making decisions under incomplete information and under incomplete understanding of things, and build a society that doesn't blow up if someone makes a mistake, which is the same thing. Society seems to think I have unique attributes. I'm not the first person to think of these matters. It's just that I've devoted my life to furthering the cause intellectually. 

reason: When you think about the future are you optimistic? Are you pessimistic? Or is that the wrong way to approach it?

Taleb: It's the wrong way to view it. My view of the future is you don't have to be right, you have to have a dominant strategy to act as if you were pessimistic. I don't want the pilot of the plane to be optimistic. But I want the flight attendants to be extremely optimistic. So it's functional. I don't believe in beliefs. 

reason: You talk about how pilots who are too comfortable with their knowledge—they're bad pilots, the ones who make the errors. 

Taleb: Exactly. You have to have paranoid pilots, stressed all the time. So technology, it weakens; the [Federal Aviation Administration] figured out it makes flights less safe. 

But again I take a stance against knowledge. Knowledge isn't what runs society. Knowledge is largely a narrative that comes after we do facts. There is so much we narrate and so much that we do without the complete theory of things. This is my central idea. 

reason: Talk a bit more about capitalism. A lot of people think that what's great about capitalism is that it creates incentives that lead to success. Actually capitalism in your view is about decentralization, about creating disincentives and failing early. 

Taleb: Since Hammurabi we've had civilized society, people living together. We're only able to do that when people are accountable for their mistakes.

reason: Where are the signal incidents of decentralization that's leading to better outcomes, broadly speaking? Where do you see that either in the United States or in the West or in particular pockets and subcultures?

Taleb: Take Switzerland as a culture, where nobody can name the president easily but they can name the president of France. This is a good society because you have a lot of volatility—but at the local level, the lower level, micro level, translating to macro level stability. So Switzerland is a well-decentralized system.

The problem is size. As size gets larger you have some gains of economies of scale, whatever it is. But you have some losses in governance, in a lot of other things. 

reason: The more homogenous you become the easier it is to be wiped out. 

Taleb: To make big mistakes and to be wiped out; this is the island effect at work. What we have had in this country is the progressive rise of central government. Particularly, deficits are the work of central government. [Scottish philosopher David] Hume figured it out. He said: Small states and city-states, they love commerce. And large governments love war. And that's what justifies large government—war. There is no justification for large government other than war. And they're not good at it.

reason: You say that you're not a libertarian, but a lot of this overlaps with what's considered libertarianism. So why aren't you a libertarian? 

Taleb: I'm a risk-based person. My libertarianism would be not demotic libertarianism—the philosophical libertarianism that freedom comes as a first good—so much as I want errors to be multiplied. 

reason: So it's a kind of John Stuart Mill. You like the idea of experiments in living.

Taleb: Exactly. Errors need to be multiplied. That's it. I'm more of a left-wing conservative, if you want. 

reason: Ayn Rand called libertarians right-wing hippies.

Taleb: There you go. So left-wing conservatives—that would map exactly. In a way, I'm conservationist. I want to not break things that have been around for a long time, things that have their own logic. [Successes] come from tinkering, not from some radical transformation of things.

reason: It's curious that you are so popular in the business market, because business books will end each chapter with bullets points about what this chapter was about.

Taleb: The minute I'm bored writing I stop. Particularly with The Black Swan, [the idea was to] make sure that no content of any section can be discovered without surprising the reader somewhere. Textbooks bore you. Critics hate it because they want to skim books. People who read will not hate it. I'm an empiricist. If I sell 3 million copies of a book writing in some way, I'm not going to be lectured about style. Of course the critics come in and they tell you it's a mess. The Black Swan sold more probably in a day than they sold in a lifetime.

reason: But you're not going to say that the market is always right, and that 50 million Elvis fans can't be wrong?

Taleb: No. My point is that someone who just arrived in a limo does not take lectures on finance from someone who just took the subway. That's the idea. You can take ideas, maybe, but you don't take instructions about how to write a book. So if you want to write a book, either take instructions from the Harry Potter lady or take instructions from Seneca, who survived 2,000 years. But definitely not from some academic at Cambridge who sold 2,200 copies.

My idea of living is taking risks for causes. The more I do, the more I feel good about myself.