Black swan refers to a largely unexpected event that’s difficult to predict and leads to catastrophic consequences — such as the housing meltdown that triggered the 2008 crisis.
Years after the metaphor became commonplace among financial market watchers, Taleb thinks there are still misconceptions that people have about such events.
“I took the notion that there are some events that are unpredictable, but we know where they can come from, what domains tend to produce these events,” Taleb said in an interview with Yahoo Finance at the SALT Conference in Las Vegas.
“And you should just build yourself some kind of protection against these, or walk away from them, or be in a position to not be harmed by them. So my whole idea was defensive,” the ex-derivatives trader and scholar said.
According to Taleb, one can’t fully understand what will cause a black swan, or how they will ultimately play out.
Even as economists devote whole schools of thought to trying to dissect such events, Taleb — who accurately predicted the 2008 crisis — suggested they shouldn’t waste time doing so.
“People thought that they should be in the business of predicting these black swans, when in fact, it's the complete opposite,” he said. “It's too deep uncertainty. You should just not try to predict them at all.”
The idea is that something fragile is eventually going to collapse, he explained. The more uncertainty about something, the more one should know what to do.
“[If] you're uncertain about the water in Las Vegas, drink bottled water, right? So you know what to do — you just walk away from it. And the other point is that we know if a bridge is fragile, but we don't know when it's going to collapse,” Taleb told Yahoo Finance.
“We know if something is defective or prone to having defects, but we don't know exactly how it's affected,” he said.
In his 2007 book “The Black Swan,” Taleb illustrated what would happen to the economy by highlighting the fragilities in the banking system.
“And I gave an example Fannie Mae that it was very fragile sitting on dynamite, without knowing when. So the idea is not so much to predict these as to walk away from them or to know where they can occur,” he said.
Even today, he sees fragilities in the system "caused by the reaction to the last spate of events” — especially with major economies loaded up with debt.
After the crisis, “the debt shifted largely from private to public, which is very bad, because private debt, people have skin in the game, so they may be liable,” he said.
“Government debt, civil servants walking away and retiring without any, any, any, any cost to their decision. So this is why I worry greatly about public debt," Taleb added, describing the current debt situation as “very precarious.”
The United States — the world’s largest economy — is growing with a strong job market, but a surging fiscal deficit that will top $1 trillion in the current year.
“We have very low unemployment — record low unemployment, they say. But what— the deficit is swelling? Something doesn't work,” Taleb said.
Taleb is also the “Distinguished Scientific Advisor” to Universa Investments, a hedge fund founded by Mark Spitznagel in January 2007 that specializes in convex tail hedging and investing. The purpose of tail-risk hedging is to limit losses from an outsized market event.
Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.