Books: The Fat Tail

Ian Bremmer
Ian Bremmer (Oxford University Press)
Ian Bremmer
Author and President, Eurasia Group
Wednesday, March 25, 2009; 12:00 PM

Ian Bremmer, author of The Fat Tail: The Power of Political Knowledge for Strategic Investing and president of Eurasia Group, a global political risk consulting firm, will be online Wednesday, March 25, at Noon ET to discuss how politics is increasingly driving the world economy and having direct implications for investors and multinational corporations. The book serves as a road map to help identify and manage volatile political developments and seemingly improbable events known as "fat tails."

On Leadership: Leading in an Unstable World.

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Ian Bremmer: Hi, Ian Bremmer here to talk about my new book, "The Fat Tail: The Power of Political Knowledge for Strategic Investing." Very happy to chat about the intersection of global politics and the markets...in an increasingly volatile environment.

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New York, N.Y.: How will instability affect a nation's drive toward a democratic form of government? Thanks for the chat.

Ian Bremmer: It depends on how besieged the government in question is (or perceives itself to be). When a government thinks its very survival is at stake, it takes short-term measures, which typically involves a hard line response towards greater authoritarianism (think Venezuela). When that's the not the case, a major crisis can actually push a country towards greater reform and ultimately more openness and democracy (which we're now seeing in, of all places, Saudi Arabia).

It's a critical question, because there are some countries that could go either way in the next year. Russia is top of my list...

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Chicago, Ill.: Hey Ian, do you subscribe to Nassim Taleb's scathing indictment of the financial economics profession? Were portfolio theory and black-scholes worthy of a Nobel? (you are now an official arbiter of Nobel worthiness) Has it done more damage than good as Taleb argues?

Ian Bremmer: That's quite an honor. I actually discussed some of this with Nassim in Moscow back in January. I'm on board with the notion that financial markets consigned a series of important variables to the "error term" and accordingly missed the fat tail/black swan likelihood of them hitting (after all, Wall Street does indeed tend to be hit with one in one hundred year storms every fifteen minutes nowadays). But he moves from that point into the notion that fat tails can't actually be anticipated or effectively managed...where the point of my book, "The Fat Tail" is that these risks increasingly stem from political factors...which aren't historically assessed well by Wall Street, but can be.

Btw, greetings from Chicago--I'm actually there/here today.

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Herndon, Va.: Can you tell us what you mean by "Fat Tails"?

Ian Bremmer: Briefly, a fat tail is the "fatter" than expected tail end of a distribution of occurrences that are presumed to be random (and therefore thin). When major risk events happen with much greater frequency than expected (like, say the subprime crisis), you have a fat tail.

I believe that a combination of many factors--global energy coming increasingly from unstable parts of the world; emerging markets increasingly providing the engine for global economic growth; dangerous technologies becoming more diffuse and empowering rogue states and organizations; and the move away from a US-led unipolar global system without a related shift in global architecture increases the likelihood of politically-driven fat tails in the global economy today.

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Arlington, Va.: We are continuing to ask unrealistic things from some of the managers at large corporations. We ask them to work for one dollar a year with the promises of bonuses, and then we are willing to rip the bonuses away the second the mob gets upset. It could lead to the ruining of companies that the federal government is supposed to be saving. In fact according to this resignation letter, that may already be happening. If anyone needs to be more politically savvy, it's the politicians who are creating uncontrollable mobs.

Dear A.I.G., I Quit! (The New York Times, March 25)

Ian Bremmer: I'm as outraged as anyone that CEOs and senior executives (in part) responsible for the mess we're presently in are walking away with millions. But you can't disenfranchise all the people we presently want to actually rebuild the system in the private sector. It's fine to work to differentiate "good guys" from the "bad guys" but there's a nuance there that won't play effectively with Congress or the media, especially in the context of present popular discontent. Obama and Geithner are going to have to get closer than comfortable to Wall Street and Big Business to make the bailout work effectively, and that will undermine their popularity. Individual members of Congress have the luxury of not mattering as much to the process, and can therefore get away with playing with populism.

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Chicago, Ill.: Are you giving a speech in town somewhere?

Ian Bremmer: Already did--at the Chicago Council on Monday. I've a full calendar at www.fattailbook.com.

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San Jose, Calif.: I'm sure you've studied China closely. They appear poised to become the next economic superpower. Does the fact they own over $1 trillion in U.S. Treasuries give China economic leverage over the U.S., or does that lock both of us in "deadly embrace" over the fate of the U.S. dollar? Now that several Chinese government officials have recently suggested that China should look to diversify their investments, what sort of changes should everyday investors consider, or should we be concerned at all? Finally, and I apologize if I am using the term incorrectly, do you see any "fat tails" in China's political (and hence economic) future?

Ian Bremmer: Lots of questions coming up on China. We're married to China in the United States, no question...though we're not going to like it when they increasingly say that our children aren't so attractive.

Beijing knows they need the United States economy to grow, but they don't like it...in part because they can't control the outcome, and in part because they increasingly doubt the sustainability of the model. So they're moving to politically decouple themselves from the US (hence the talk about moving away from the dollar to a competitive currency--not realistic short term, but it's very important to think about the underlying motivations of the statement)...and they're hoping to eventually economically decouple, at least to a greater degree, by stimulating consumer demand and working their way up the export value chain.

Longer term, that can't be good for the US dollar, and will lead to significant inflation to finance spiraling debt. I expect regionalization of capital flows to grow accordingly. On the investment side, I'd say that's probably good news for Southeast Asia...

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New York, N.Y.: I know some financial firms have (had?) political experts on their investment staffs as some were able to chart market responses to political developments. How well do you believe markets respond to political developments and what advice would have you for those who analyze market responses to politic?

Ian Bremmer: Markets tend to respond to political events after they occur, which creates opportunities for those who assess key political variables as leading indicators.

So whenever China and Taiwan engage in saber-rattling, Taiwanese markets go down. Then they go up again when there's a realization that the crisis is a tempest in a teapot. Very predictable. For folks understanding that underlying dynamic, there's an opportunity.

We see much the same in emerging market elections around the world. I remember with King Fahd died, oil prices spiked on the news. Yet focusing on dynamics in the House of Saud, it was pretty clear that the path was finally cleared for (then) Crown Prince Abdullah to move on succession, paving the way for more reformers. The Saudi oil premium declined accordingly.

All sorts of examples of this kind in the book, we see them all the time.

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Oxford, Ohio: Hey Ian, Martin Wolf wrote this in the FT this morning, "I fear, however, that the alternative -- adequate public sector recapitalization -- is also going to prove impossible. Provision of public money to banks is unacceptable to an increasingly enraged public, while government ownership of recapitalized banks is unacceptable to the still influential bankers. This seems to be an impasse. The one way out, on which the success of Monday's plan might be judged, is if the greater transparency offered by the new funds allowed the big banks to raise enough capital from private markets. If that were achieved on the requisite scale - and we are talking many hundreds of billions of dollars, if not trillions - the new scheme would be a huge success. But I do not believe that pricing legacy assets and loans, even if achieved, is going to be enough to secure this aim. In the context of a global slump, will investors be willing to put up the vast sums required by huge and complex financial institutions, with a proven record of mismanagement? Trust, once destroyed, cannot so swiftly return.

The conclusion, alas, is depressing. Nobody can be confident that the US yet has a workable solution to its banking disaster. On the contrary, with the public enraged, Congress on the war-path, the president timid and a policy that depends on the government's ability to pour public money into undercapitalized institutions, the US is at an impasse."

Do you agree with that analysis?

Ian Bremmer: Great question. I think Martin's point is a bit of last week's analysis. Since then, Obama has pulled back from cheerleading public outrage, the Senate has asked for some time to think about it, and a bunch of recipients of AIG bonuses have "voluntarily" returned them (about time!!). So I'm somewhat more optimistic than I was last week...and certainly President Obama (and the market response) has bought Geithner a little time.

Having said that, Congress's ability to run with wrongheaded policies is a serious risk going forward. It's one thing when they spend a day grilling Roger Clemens on steroids use when the country's economy is going well. It's a sideshow, but it's a sideshow that nobody's watching. When the country faces the most serious economic crisis since the Great Depression, it's a much greater risk.

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Libertyville, Ill.: I have a hard time wrapping my head around the concept that people who were paid in the millions and billions to lead financial firms have no idea what debt is on their books -- or that their companies were leading the way into catastrophe.

It seems that for business leadership in many companies in America, their primary motivator has been greed -- not leading a business to profit and sustainability.

Do you agree? If not, why not?

I am particularly gloomy these days because it seems that American business leaders are unable to focus on sound business practices, obsessing instead over the size of their paycheck.

Not all leaders act in this way -- obviously -- but so many do that our country is on the brink of economic collapse.

Do we need to accept as a given that American business leaders are primarily motivated by greed? Or can we anticipate that business leaders will be able to stop themselves from following the terrible -- but profitable -- business practices that led us to the brink?

Ian Bremmer: I think we need to accept that a significant level of regulatory authority is critical to make free-market capitalism work in an equitable (and long-term functional) fashion. The absence of that authority over the past decade, the fetishized hypercapitalism, led to an excess of very short-term decision-making and got the country as a whole well over its skis. There's no reason AIG should have been allowed to take on businesses that they fundamentally didn't understand...it's the Enron example all over again.

As a country, though, we really need to recognize that it's not just the corporates who deserve blame here. Where were the regulators, where was the SEC in all of this? Where were the ratings agencies that are supposed to provide unvarnished assessments of the viability of these organizations? Where were the investment advisors telling us to go long? There's more than enough blame to go around here...we really damage the viability of the free-market model (which remains the worst economic system in the world...except for all the others) when we single-mindedly go after the execs. Oh I can see the hate mail coming already...

Btw, why is Illinois so well represented among the questioners? Maybe the collapse of New York is more serious than I feared...

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Alexandria, Va.: Oil. Everyone wants it, but not everyone has it. With supply and pricing down with reduced demand (at the moment), is this just a ticking time bomb once some instability occurs in the Middle East? And is this the time to load up (investment-wise) on energy?

Ian Bremmer: Um, yes. I can't see oil long-term sticking in a low price environment. Oil at $50 only serves to delay investment in important new fields (off-shore Brazil, Venezuela, and Canada oil sands) and, more importantly, in alternative energy. Which puts the developed economies at greater long term risk.

To give one example, when oil was at $147, everyone saw an "Iran premium" in the price of a barrel. At $50, nobody pays attention to Iran anymore. But actually, the likelihood of conflict between Israel and Iran is much greater in 2009/2010 than over the last two years. It's hardly a given (indeed, and thankfully, I wouldn't bet on it), but it's considerably more likely than the markets think. That's the case with risks today around the Middle East. Thanks for the question.

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Manassas, Va.: I'm absolutely conflicted about China. On the one hand it is a country whose government subjugates, tortures and kills its own. On the other hand, there seems to be a greater emphasis on free economy, emerging personal freedoms and business growth. What is your take? Are they a country slowly emerging from totalitarianism or are they merely presenting a false front to the world while they maintain business as usual?

Ian Bremmer: They're definitely emerging towards greater economic, and even social freedoms. Political freedom is another matter entirely. It's a huge quandary. Which is why China is ultimately the biggest fat tail of all. It works very well...until it doesn't.

I happen to think there's a great deal of resilience in the Chinese model--a significant capacity of the Chinese people to tolerate economic difficulties (much more than widely assessed), huge political capital built up by Beijing over the past three decades, and major surpluses to stimulate growth in the economy. But they're completely destroying their environment in the process. At some point, the math doesn't work. It's just not anytime soon...

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New York, N.Y.: Do you foresee possibilities where a nation holding great amounts of debt, such as China, could hold debt repayment issues over other countries such as the U.S. for political purposes, such as keeping criticism of their policies muted?

Ian Bremmer: Not really. In the same way that I don't expect the United States uses it's navy to keep China away from commodities in far flung regions like Africa and Latin America. The reality of the imbalances ensures both countries actually discuss these conflicts before they become directly confrontational. But there's a lot of backroom gnashing of teeth...and the relationship will become more tense, no question.

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Phladlephia, Pa.: Aren't "fat tails" self-fulfilling prophecies? Don't clusters of risky events only increase the possibilities for even greater numbers of risky events to result?

Ian Bremmer: When the global system is in a non-equilibrium state, yes. But eventually, a fat tail hits that's so large that it forces countries to create a more stable environment.

Think about nuclear proliferation. The international regime is completely broken. We have North Korea with nuclear weapons; Iran's program continues unchecked. That's going to continue until there's a sufficient shock that the world's major powers--the US, China, the UK, Germany, and others--force a serious change...force Israel to admit to its program, force Iran to tolerate intrusive inspections or else, force North Korea to have all its export cargo checked...etc. That could well happen with a significant shock (say, God forbid, a dirty bomb in Moscow, or Hezbollah with radiological capacity). The good news--that shock is still quite unlikely (albeit more likely than, say, a year ago). The bad news, the system isn't likely to address the problem adequately until such a shock is in place.

I could make analogous arguments about collective security (in Iraq and Afghanistan), climate change, and even global financial architecture. It's a very important question.

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Washington, D.C.: Hi Ian, Given the way the administration and Congress have reacted to public sentiment for the AIG bonuses, do you foresee Congress and the administration bowing to protectionism, and what about our trade partners... it seems to me like this is a gobal trade "prisoner's dilemma" in the making, fueled by the realities of democracies facing unemployment. Thanks for your thoughts.

Ian Bremmer: I actually think the risks of serious protectionism are overstated in the near term, at least as long as the economy doesn't fall towards the worst case scenarios.

Here's something I've written recently on the topic...should give you a sense of my thoughts on the issue:

There is one serious risk i think we can downplay -- a global trade war. the past months have brought all sorts of fears of growing us protectionism and the spiraling international reaction. and a wide array of localized protectionist measures have been taken around the world-indeed, the world bank has counted about 50 trade restrictive actions and only a dozen liberalizing ones since the g20 countries promised to forestall protectionism last November. to list just a few examples--multiple countries have given low cost or no cost cash to their automakers; the united states has restricted stimulus procurement to a subset of countries under a "buy American" provision; in response to us cancellation of a Mexican trucking program that country has put over $2 billion in tariffs in place on trade with the united states.

But thinking about the magnitude rather than the quantity of events uncovers that this is more conventional, rather narrow protectionism than the opening salvos of a trade war. certainly in the united states, the highest stakes for protectionism are around the automotive sector (after all, the millions of jobs potentially at stake would undo the Obama administration's job preservation goals in one swoop). but there has been no serious suggestion of raising tariffs on foreign autos, and congressional votes and nationwide polls have made clear that there is no public will to keep the industry alive through massive subsidy. if the auto sector-where unionized labor and management could easily point to foreign competition as a cause of its problems-is not enough to merit nuclear protectionism, what is?

Nothing, probably. the biggest silver lining to the economic and financial crisis in the united states is that it has very little to do with globalization. to date, there has been no blaming foreigners; rather, the recession has been a story of domestic greed and poor oversight. certainly, as Americans feel poorer, the risk of redistribution from the have-lots to the have-littles increases. but it's not a backlash against interconnectedness, trade, or global supply chains.

To be clear, the risk of a global trade war remains if the recession doesn't bottom out. and I certainly see more tit-for-tat protectionism internationally (especially out of Beijing, where economic nationalism is on the rise) as an unintended consequence of us policy. but absent a depression scenario, the near-term likelihood of an all-out trade war is small.

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Columbia, S.C.: It seems to me that increasing uncertainty and instability naturally require increasing flexibility in planning, which in turn tends to favor shorter lead times between the initiation of an activity and the resulting benefits of the activity. For example, I have a hard time understanding how an investment such as a nuclear power plant, with their ten-year construction time frame, can be as secure as simpler energy-saving investments such as weatherization and conservation that can be implemented in less than one year. How can long term investments possibly compete for investment capital without some external force (such as a government) guaranteeing the expected return?

Ian Bremmer: It's true. Both for the private sector and the public sector. The world is moving much faster, but it takes just as long for a Board of Directors to approve an investment. And while we're at it, just as long for an Administration to get political appointees at Treasury appointed and confirmed. Not a happy confluence of trends.

One thing corporates need to do is pay more attention to near-term (12-24 month) scenario planning, and stress test existing investments against a much broader range of potential outcomes, particularly in emerging markets. Companies that require longer-term capital outlay need to be centralized in their decision-making and risk assessment structures, so they can more effectively process this information and compare the changing exposures of various investments around the world.

Some of this can't be hedged by certain sectors, of course. Which implies an eventual discount to the asset pricing of companies in sectors with less flexibility...

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Washington, D.C.: What are the main differences between Enron and AIG, etc., aside from the obvious fraud? On one hand almost all of the Enron employees were deemed victims, but almost all the AIG employees are not receiving the same benefit of the doubt.

Ian Bremmer: The average American today is much less optimistic about their future, and the loss of wealth is much greater and more broadly spread. There's a lot more anger to go around...

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Burke, Va.: Hello. Of the top 10 Global Wind energy companies, the U.S. only has one member, GE at #2. How important do you think it is that the USA build up our Wind and Renewable Energy industrial base to establish a par trading position with European and Asian companies?

Ian Bremmer: On renewables, the US truly needs to take a more active position. The world is going to move beyond oil in the coming decades, and it's critical that the United States gets out ahead of the curve on all of the major alternatives, especially since it's still far from clear which technologies will be efficient, scalable, and suitably market-friendly.

There's good news here, though. As the world's largest economy with the most advanced institutions of higher education and effective intellectual property rights and rule of law, it's still a good bet that most of the new patents for the post-oil generation will be held in the United States. It's not as strong of a bet as it was five years ago (with more talented Chinese immigrants going back to China for opportunities, for example, the "sea turtle phenomenon"), but it's still one I would take.

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Centreville, Va.: Would you consider the global trend of Radical Islamic Fundamentalism a "Fat Tail"? How do you think this trend will play out and what short term/long term effects will it have on the global economy and global politics?

Ian Bremmer: I'd consider the diffusion of dangerous technologies a fat tail, which is slightly different. Most radical Islamic fundamentalism is oriented towards local governments and is intra-Islamic (Sunni v Shiia and vice versa). That's a growing problem for a host of countries around the world (and particularly in South Asia), but not a global fat tail.

However, the fact that Hezbollah can now hit Tel Aviv with a ballistic missile...when three years ago they could basically only hit settlements across the border...that's a global trend. So even if radical Islamic fundamentalism ends up on the back foot (as it clearly has, say, Iraq over the past two years), there's a growing fat tail because of the comparative disruptive capacities of small numbers of disenfranchised individuals.

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Ian Bremmer: Thanks so much for all the questions! I got to as many as I could reasonably type... I appreciate the interest, and hope you enjoy the book! Yours truly, Ian

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