110312 Rethinking Predictions

by | Mar 14, 2011 | Business, Economics

In light of the recent devastation in Japan, perhaps its time (again) to acknowledge the limits of our knowledge and pay heed to those constraints when making predictions about nature specifically and complex systems in general (such as economics, world trade, and the environment).

While watching yet another dumbfounded scientist babble about how their assumptions failed to account for actual events that transpired (the earthquake lasted 20 times longer than any of their assumptions) I was reminded of the Vernon Cooper quote “Knowledge is of the past, wisdom is of the future.”  Knowledge masquerading as wisdom is dangerous and  implies a level of precision that doesn’t exist.   History is rife with examples of overconfidence ending in tragedy with examples from the Titanic (the unsinkable ship) to the Space Shuttle Challenger (the “O” ring probability of failure being calculated at 1 in 100,000 or a flight a day for 300 years) to the government bank bailouts ( “Among the largest banks, the capital ratios remain good and I don’t expect any serious problems”-Ben Bernanke February 2, 2008) naming just a few.

At some point we simply have to acknowledge that we can not, and will not, be able to predict with any real measure of accuracy the consequences of actions in a complex system.  Some things are simply unknowable and rather than wasting time and effort knowing precisely what has occurred, to consider the wisdom of preparedness and plain old common sense along with the acknowledgement that accidents do happen, however unfortunate.  I’m not advocating ignorance of the past, simply that we must not continue to seek artificial comfort in incomplete datasets.  In the book “Slow Money” by Woody Tasch he describes Kurt Gödel’s Incompleteness Theorem this way: “Every formula is either complete and inconsistent, or consistent and incomplete.”  Many economists (and mathematicians, journalists, and politicians)  fail (sometimes tragically) to acknowledge the incompleteness of the formulas used as the basis of prediction.

I believe a far better methodology (wisdom) for dealing with systemic complexity comes from a talk I recently posted by Guy Kawasaki during which he suggests businesses perform a premortem on what circumstances might cause them to fail and address the problems before failing rather than waiting to conduct a postmortem assessment.  This slight but significant change in mindset removes the false sense of security resulting from flawed calculations performed with incomplete data (it’s impossible to know or control every variable).  In its place an iterative approach can be adopted to overcoming challenges as they are discovered with each cycle of assessment uncovering (hopefully) new errors and flaws to be remedied.

I’ll close with a few quotes:

“Where is the wisdom we have lost in knowledge?  Where is the knowledge we have lost in information?” -T.S. Eliot

“To know that we know what we know, and that we do not know what we do not know, that is true knowledge.” -Thoreau

“It is the tragedy of the world that no one knows what he doesn’t know – and the less a man knows, the more sure he is he knows everything..” -Joyce Cary

Historical Deja Vu

by | May 25, 2010 | Economics

Financial pundits love citing history and the myriad of anecdotal quotes that extol one strategy or another; comparing valuations and prices to bygone times, confident (or perhaps just hopeful) of a reversion to the mean.  But what if the history we are repeating is part of a larger cycle than the last 10, 20, or even 50 years?  What if the historical cycle we are allegedly repeating is more significant than just another economic recession?  Conversely, what if we are actually in uncharted territory?  What if globalization and the information age have plotted a new course, one for which we have no map?

As a country we face significant challenges; ones not simply resolved with collective optimism.  Like spoiled children we’ve ignored wisdom and squandered our inheritance; an inheritance not of a monetary endowment but a socio/political/ economic system that allowed hard work, ingenuity, and intelligence to be justly compensated.  My chief question is whether we’ll continue down this destructive path blissfully ignorant or wise up, make the necessary adjustments, and hopefully return to the ideals that previously allowed us to prosper.

From an investment perspective multiple possible outcomes is just information; it’s possible to profit in any environment if one is willing to question assumptions, face the facts, and act accordingly.  Success depends on preparation for a variety of outcomes, an ability to adapt to changing conditions, and a recognition of the unknown.  I plan to be prepared for whatever may come, protect what we have, and take advantage of opportunities as they are uncovered.

Have fun,

Joseph Graves

“In times of change, learners inherit the Earth, while the learned find themselves beautifully equipped to deal with a world that no longer exists.”

-Eric Hoffer