Peter Thiel on the Role of Technology and Globalization in Our Economy

Peter Thiel tends to be best known as an investor and entrepreneur. He is a co-founder of PayPal and the first investor in Facebook, both of which have made him wealthy and well-known.

I tend to be more interested in Peter Thiel for his regular and careful analysis of economic and technology trends. Though Thiel is a self-described conservative libertarian and Ron Paul supporter, his analysis tends to be more nuanced and thoughtful than a lot of people give it credit for.

Two weeks ago he gave a fascinating talk at the DLD 2013 Conference entitled “Developing the Developed World”. Thiel’s analysis mostly centers on the prospects for economic growth in the foreseeable future. His analysis takes into account both the instability related to our recent economic crisis, as well as the prospect that much of the growth that previously drove our economy may have been an historical anomaly.

Growth from Globalization or Technology Innovation?

Thiel’s primary thesis categorizes the two driving factors of the future of our economy as globalization and technological innovation. In Thiel’s view, globalization is the economic growth from copying existing technologies and models from the developed world to the developing world. Technological innovation, on the other hand, is growth derived from the creation of new things. Thiel’s conclusion is that sustainable growth requires strategies to pursue both.

As TechCrunch reported:

In Thiel’s view, four things are likely to happen to the current group of developed countries. Growth and innovation can continue at a decelerating rate, they can enter a cyclical pattern of growth and collapse, completely collapse, or continue to accelerate. In the end, of course, the only acceptable option in his view is accelerated growth.

Exponential Technology Growth: The Singularity

Since Thiel’s prescription emphasizes the need for innovation growth to accelerate, rather than stagnate, Thiel focuses on the potential for continued exponential growth in computing power and software. Thiel is a well-known supporter of singularity studies, the prediction that exponential technological progress will lead to a point in the near future where artificial intelligence outpaces collective human intelligence and leads to a new era of rapid progress. In the DLD speech, Thiel notes the continued importance of Moore’s Law and accelerating innovation growth as a potential driver of economic recovery. He cites examples such as the future of self-driving cars, and bioinformatics as possible technologies to lead this growth.

This is fun stuff to think about.

I’m excited see if some of these themes are given more depth in Peter Thiel’s up-coming book “The Blueprint: Reviving Innovation, Rediscovering Risk, and Rescuing the Free Market”

You can watch Peter Thiel’s entire 50-minute talk at the DLD Conference is here:

10 Steps to Risk-Proofing our Economy


Nassim Taleb’s Financial Times op-ed recommends 10 fixes to our economy

Last week in the Financial Times, Nassim Taleb published an op-ed entitled, “Ten principles for a Black Swan-proof world.” In it, Taleb lays out a number of major economic reforms we could make to limit the likelihood of catastrophic risk in the future (expanded upon in the full FT article):

  • 1. What is fragile should break early while it is still small.
  • 2. No socialisation of losses and privatisation of gains.
  • 3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
  • 4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks.
  • 5. Counter-balance complexity with simplicity.
  • 6. Do not give children sticks of dynamite, even if they come with a warning.
  • 7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence.”
  • 8. Do not give an addict more drugs if he has withdrawal pains.
  • 9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.
  • 10. Make an omelette with the broken eggs.

I have mentioned Taleb’s recommendations on rethinking on the economy before. He’s not always right, but he’s certainly worth understanding. In this case, his 10 principles are unlikely to be implemented, but maybe policy makers should give them some consideration.

Taleb is the author of the tremendously interesting (though somewhat disjointed) books “Fooled by Randomness” and “The Black Swan” and is also the subject of a great essay by Malcolm Gladwell. Check him out.

How Close Are We to an Economic Depression?

economic depression

Are we on the verge of a Second Great Depression?

There has been a lot of whispering lately that our current economic crisis may be leading to another Great Depression.

On Tuesday, the ultra-liberal Nation magazine proposed that we might already be in the midst of the Second Great Depression.

Though there is no universally-agreed-upon definition of the term “depression”, an op-ed in Wednesday’s Wall Street Journal proposed one common definition: a 10% decline in per capita GDP.

If we take the definition of “10% decline in per capita GDP” as our working definition, how close are we to this kind of economic depression?

For the sake of this analysis, we’ll equate real GDP with per capita GDP, since month-to-month national population changes are trivial. For the curious, the US Census does publish that data.

On Monday, the Associated Press reported:

“A Depression doesn’t have to be Great — bread lines, rampant unemployment, a wipeout in the stock market. The economy can sink into a milder depression, the kind spelled with a lowercase ‘d.’

“And it may be happening now.

“The trouble is, unlike recessions, which are easy to define, there are no firm rules for what makes a depression. Everyone at least seems to agree there hasn’t been one since the epic hardship of the 1930s.

“But with each new hard-times headline, most recently an alarming economic contraction of 6.2 percent in the fourth quarter, it seems more likely that the next depression is on its way.”

Government (and press) are inflating data to hype the economic crisis

Here’s the problem: the 6.2% decline that the AP cites doesn’t really exist. That piece of data comes from a Bureau of Economic Analysis report from last Friday that announced a 1.6% quarterly GDP decline estimate — with an annualized rate of 6.2%.

For those with quick brains: 1.6 x 4 = 6.4, not 6.2, the discrepancy is likely due to the rounding of both numbers for simplicity.

As the New York Times graph (above) demonstrates, the only actual decline in GDP, so far, has been the 1.6% of last quarter. Any annualized extrapolation beyond the current quarter’s data, is pure conjecture. This curve could turn up or down, we don’t yet know.

This is all to say that the government announcement, and the AP report on it, are hyping the data to indicate GDP declines four times worse than they actually are.

I’m perfectly willing to concede that the data for 2009 could be as bad as (or worse than) a 6.2% decline in the American economy, but let’s wait for the data. Hype and fear aren’t going to help anything.

Don’t Believe (All) the Hype About the Stimulus Plan

US Capitol

Nancy Pelosi Wants You to Think This Is the Current State of American Unemployment

Last Friday, Speaker Nancy Pelosi released a graph showing the number of unemployed Americans from each of the last three recessions:

“This chart compares the job loss so far in this recession to job losses in the 1990-1991 recession and the 2001 recession – showing how dramatic and unprecedented the job loss over the last 13 months has been. Over the last 13 months, our economy has lost a total of 3.6 million jobs – and continuing job losses in the next few months are predicted.

“By comparison, we lost a total of 1.6 million jobs in the 1990-1991 recession, before the economy began turning around and jobs began increasing; and we lost a total of 2.7 million jobs in the 2001 recession, before the economy began turning around and jobs began increasing. [Emphasis mine].”

The explicit purpose of this graph is to support the Speaker’s view that a stimulus package of some kind — any kind — needs to be passed immediately to do something about this “unprecedented” precipitous fall in employment numbers. From the data presented, this seems quite persuasive. But it’s not the whole story.

A Better Way to Think About American Unemployment — In Context

Jim Manzi at “The American Scene” created this graph in response to the Speaker’s graph, adding two pieces of context:

“Of course there are a couple of odd things about this. First, it shows absolute job numbers, rather than unemployment rate (that is, job losses per capita). This matters, because the U.S. labor force is a lot bigger now than in prior recessions. Second, it ignores the recession of 1981 – 1982, which was by far the most serious of recent recessions.”

He also apologizes in the blog post for using such an ugly Excel spreadsheet to present his new data.

Some Observations on the Stimulus Plan — From the Addition of Context

The American Scene” draws two observations from its additional data:

1. What seems to matter in getting to really bad job losses is the duration of the recession. So, speed in passing a stimulus bill is probably a lot less important than getting our countermeasures right. This is, of course, diametrically opposed to the natural conclusion one would reach in looking at the first chart.

2. The structural work on the economy is at least as important as how we deal with the recession. The stagflation of the 1970s meant that we started the ’81-82 recession at about the unemployment level that we have taken more than a year of recession to reach today. Doing something, anything, to stop the pain of the current recession, no matter what its structural effects on the economy, might seem practical, but it is not.

I think the two graphs also beg a question (which I don’t have the data to answer):

What does this picture look like when given lots of extra data — say all worldwide recessions of the past 100 years? Or even easier: If this job loss is really “unprecedented”, then how does it stack up against even just the 7 U.S. recessions from 1900-1980? If the picture continued to be consistent, or showed some other trending with LOTS of data, then I might feel comfortable drawing conclusions from it about policy solutions.

As it stands, the Speaker does her position a major disservice by withholding the context needed to interpret her data.

5 Ways to Rethink America’s Current Economic Crisis

economic insurance

Nassim Taleb and Daniel Kahneman Explain the Real Roots of the Economic Crisis

Check out this hour-long video of a panel discussion between Nassim Taleb and Daniel Kahneman reflecting on the current economic crisis:

Unfortunately the beginning of the discussion is a little disorganized, but it gets better at around 12 minutes.

Nassim Taleb is a financial trader and scholar and the author of the books “Fooled by Randomness” and “The Black Swan.”

Daniel Kahneman is a psychology professor at Princeton, Nobel Prize winner in economics, and the author of the seminal book on cognitive biases “Judgment Under Uncertainty.”

Five Ways to Think Differently About America’s Financial Crisis

Listening to this discussion, I draw five major points regarding the causes of Wall Street’s economic crisis and the problems with Washington’s response:

1. Banks and Politicians Misunderstand the Risks of Rare Events

Nassim Taleb and Daniel Kahneman argue that the true cause of our current economic crisis was not just the nation’s “housing bubble” or the derivative investments based on it, but Wall Street bankers’ and Washington politicians’ fundamental long-term misunderstanding of the concept of risk.

In Taleb’s book “The Black Swan” he develops the metaphor of the life of a turkey to describe the problem of trying to make future predictions based on the data of past events when faced with rare, but catastrophic, risk:

Taleb’s Turkey Metaphor: “A Turkey is fed for a 1000 days—every day confirms to its statistical department that the human race cares about its welfare ‘with increased statistical significance.’ On the 1001st day, the turkey has a surprise.”

The Fate of Today’s Banks: “The graph above shows the fate of close to 1000 financial institutions…The banking system (betting AGAINST rare events) just lost…trillion[s of] dollars…on a single error, more than was ever earned in the history of banking. Yet bankers kept their previous bonuses and it looks like citizens have to foot the bills. And one Professor Ben Bernanke pronounced right before the blowup that we live in an era of stability and ‘great moderation’ (he is now piloting a plane and we all are passengers on it).”

The problem with this misunderstanding of risk is that the fundamental economic principles underlying America’s banking industry were to make steady profits day after day by placing large, highly-leveraged bets against the possibility that rare, catastrophic events would ever occur.  Our banking and investing infrastructure (including public policies and regulations) supported the idea of consistently making money in the short term, because the risk of long-term collapse was unlikely.

The primary problems with this line of thinking are (1) no one can know when the collapse will come; (2) given enough time, rare events do eventually occur; and (3) big bets against rare events DO WORK day after day after day, until one day they blow up.

Experimental psychology has shown that humans prefer small gains over time to one big payday and conversely prefer one big loss to a series of losses over time.  This psychological inconsistency reinforces people’s beliefs in the theories underlying our current financial system.  Taleb calls this the phenomenon of “bleeds versus blowups.”  Society prefers people who are successful most of the time, even if they occasionally lose big, to people who are consistently losers, but occasionally win big — even if the net gains and losses for each are the same.

The cause of our economic crisis was not the housing bubble or even the complicated derivative instruments, but the fact that their risks were misunderstood by the banks and regulators that created them.

2. Wall Street and Washington Created a Dangerous Financial Monoculture

A second problem is that Wall Street and Washington have created a financial “monoculture” — an entire economic infrastructure built almost entirely on the same sources of risk: more and more money held by fewer, larger banks, all highly-leveraged on the exact same set of derivative investments.  When an entire system is built around a single idea (or single source of risk) — and that idea turns out to be exactly wrong — the system collapses.

The concept of monoculture comes from the idea that a farm planted with all the same variety of crop is at risk of complete collapse if a disease catches that crop.  This same problem of monoculture effects things like software viruses (when a single Windows virus can put almost all computers at risk) and manufacturing (as seen in the current peanut butter recall where products all over the country are sourced from a single facility).

Here the problem was that every major investment bank had taken the exact same risk against a specific rare event.

They did this primarily for two reasons: (1) almost all economic “experts” and investment bankers were schooled in the same theories and models; and (2) the incentive structures consistently in place throughout the market encouraged investment managers to seek high short-term gains, with little incentive toward long-term stability. (For an example of these two issues at play, see Taleb’s favorite case study: Long-Term Capital Management).

Washington regulators — especially Federal Reserve Chairmen Alan Greenspan and Ben Bernanke — helped to make this system more fragile by encouraging major bank consolidations — thus creating this monoculture.

We saw a major turning-point in the last few months when Alan Greenspan confessed that his theory of the world was wrong: “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.”  The problem is that financial institutions are simply collections of individual agents all operating with short-term incentives.

3. Financial Systems Need Redundancies

This financial monoculture has created another industry-wide problem.  Because large, publicly-trade banks had to compete with each other for analyst recommendations, every bank had short-term profitability as its primary motivation.  This narrowly-focused incentive structure discouraged investment managers from hedging their long-term risks through the use of insurance or redundancy.

Banks could have used a small percentage of their short-term profits to purchase options or other hedges on the rare possibility of extreme loss, but such a move would have made them comparatively less profitable than competitors.

In this case, the extreme competition among a small number of nearly-identical entities created a “race to the bottom” whereby any insurance or redundancy would have driven away investors – all of whom wanted short-term profit maximization.  This race to the bottom, did create extremely efficient short-term investment vehicles, but at the cost of extreme fragility and risk.

4. Bankers Keep Their Profits, We Pay Their Losses

The existing financial system has created a  “moral hazard” problem.  Moral hazard is the idea that a person tends to behave less carefully if they are insulated from the risks of their decisions than they do if they know they will have to bear the consequences of their actions.

In the current system, bankers were (and are) rewarded with huge bonuses for meeting or exceeding their short-term annual profit goals, but when it turned out that those short-term profits were derived from placing big, risky bets, and the system collapsed, the banks (and bankers) were bailed out by the Federal Government (on behalf of regular taxpayers).

These financial institutions didn’t have to bear the marginal cost of insuring against extreme risk because of this moral hazard — they could act recklessly, knowing full-well that catastrophe would be insured by the general public.

As Taleb describes it, this created a system of “capitalism for gains, socialism for losses” — when bankers MAKE money, they get paid (big), but when they LOSE money, we pay (big).  This incentive system creates perverse incentives related to short-term reward derived from long-term risk.

It is worth noting that — Obama’s temporary limits on executive pay aside — this short-term incentives payment structure continues to exist in America’s financial services industry.  For instance, we have not yet learned the ramifications of the broken hedge fund 2+20  incentives structure.

The main problem with the moral hazard of bank bailouts is that since bankers and investment managers don’t bear personal consequences from placing money at extreme risk, they are actually acting RATIONALLY as individuals when they do so.

For example, check out Taleb’s Facebook Group: “Make Bankers Accountable” accusing Citibank executive (and former Clinton Treasury Secretary) Robert Rubin of making over $100 million by putting the world’s largest bank in extreme risk — and then being bailed out by taxpayers.  It’s hard to say that a guy making $100 million should feel like he did anything wrong — he did what the system encouraged him to do.

5. When a System Breaks, Change It

Taleb concludes his discussion with two pleas: (1) financial services executives and regulators should all be fired — to actually face consequences for their actions, and (2) business schools should reassess their curricula, most of which teach a set of economic theories that created our financial monoculture.

When the people running our financial system have failed and their theories have been proven wrong, the people and their theories must be replaced.

Taleb argues that the American banking system should be nationalized, so that regular people’s savings and retirement accounts aren’t leveraged against risky investments.  He argues that simple savings-and-loan banking should be run by the Federal government, with no profit or competition incentives. He suggests that risky, leveraged investing should be done through private hedge funds — but then NEVER bailed out.  The idea is to separate most people’s desires for long-term stability from the minority of investors seeking riskier short-term gains.

Regardless of a bank nationalization plan, all the regulators and executives (Geithner, Bernanke, Summers, etc.) involved in the recent crisis need to be fired.  We have had a system run by people with a certain set of economic theories.  Their theories have been proven wrong.  Yet they continue to run our economic system.  Worst of all: because their economic theories do indeed result in day after day of short term profits, we are easily lulled into letting them remain in charge.  Their theories WILL look stable for a long time, until one day it again BLOWS UP.

Similarly, Taleb argues that business schools should pause their teaching and reassess their theories before graduating another class of students steeped in the economic theories that created this mess.  Taleb has called for a boycott of any business school that teaches modern portfolio theory. His argument is that no business school is better than a destructive business school – theories only have value if they outperform no theory.

Where Does Our Economy Go From Here?

I am glad to see that some of these ideas are beginning to gain acceptance in mainstream thinking about the American financial crisis.  If ever there was a time to reassess our ways of doing things, now is that time.  When Kahneman and Taleb find themselves at the elite Davos World Economic Forum, arguing their viewpoint before world leaders, it makes me optimistic that maybe we can find our way.

Here’s my recommendation.  As you hear about upcoming bailouts and stimulus packages, assess whether these issues are addressed:

1. Does the plan acknowledge the existence of FUTURE catastrophic risk? Or does it create a system where this same problem could arise again?

2. Does the plan provide for DIVERSITY in (1) recovery methods, (2) financial institution types, and (3) economic theories? Or does it perpetuate a few small institutions driving our economy with a single philosophy and a narrow set of investments?

3. Does the plan call for INSURANCE and redundancy – requiring that future investments are hedged against extreme risk? Or does it put all of our proverbial eggs in a single basket?

4. Does the plan create an appropriate system of rewards and consequences, making decision-makers ACCOUNTABLE for the risks that they take? Or does it create a situation where firms could be bailed-out again if (when) they fail?

5. Does the plan CHANGE the people and theories that have been running the economy? Or does it allow those who crashed our economy to keep driving our economy?