Limits of Knowledge

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A online physics course reminded me of the ways we get ourselves in trouble. I tried to explain this to a buddy and he replied, “there’s simply too much to worry about.”

I’ll give the explanation another shot.

Better thinking is not building the capacity to worry constantly, about more things. Better thinking is about training ourselves to focus on making a limited number of excellent choices, given imperfect information.

  • When to worry?
  • Where to focus?

Limits to Knowledge

Snowflakes: even if a human mind could know everything there is to know about water molecules, it would not be possible to predict a snowflake’s structure.

Mobs: understanding individuals, in isolation, tells us very little about the actions of mobs, or markets, or cities, or nations.

Lots of other examples: DNA to elephants; Neurons to consciousness; the patterns of a sandbar; the shape of a cloud, politics, wars, life sciences.

Clouds are a current favorite of mine – a reminder to stay humble with any bet that requires me to be correct about outcome.

I’m currently debt-free. As a result, I’m able to make more mistakes, be less correct and less impacted by outside factors. The value of this position doesn’t show up in conventional analysis.

Properties that emerge, at scale, make prediction impossible. Joe Norman’s presentation at RWRI helped open my eyes to this aspect of our reality.

I don’t need to become a complexity expert to apply this knowledge. What is essential is understanding the nature of the system in which we find ourselves.

  • Are we in a complex system?
  • Are we in a system subject to extreme events?

To answer my friend’s question, “when to worry?”

Complex systems, subject to extreme events… exposures here are worth the time to carefully consider.

You don’t need to be the CEO of AIG to get bitten on the butt by complexity. If you’ll get fired for the mistakes of one of your direct reports then, given enough time, you’re fired.

Sudden unemployment is one way the nature of universe can come home to roost. Happened to me in 90-days at the end of the last boom.

Here’s another… if you woke up and discovered an undisclosed $20 billion dollar loss in an important counterparty then what would that mean to your life?

What about your family, your employer and your portfolio?

Concentration is a risk we can mitigate. It’s why I have unrelated jobs and several cash flow sources. Here again, conventional analysis fails to capture the value of this position.

In 2021, in a very benign financial environment, we’ve seen multi-billion dollar losses pop up in a week, or less. Rapidly emerging, massive losses are a feature of our system.

Things, that have been stable for a very long time, can disappear quickly.

Prediction: our minds love to predict, to assign causation and to tell stories about the world around us.

Grasping for a “why” is a waste of time.

When operating in complex environments, most importantly when surprises can bite me in the butt, I need to constantly remind myself NOT to make predictions.

For myself, I actually need to go further, I need to implement a policy of NEVER making predictions and NOTING surprises. There is useful information contained in every surprise.

Even further, I shun input from individuals (especially smooth talkers) who make predictions. A reason why I try to never watch videos — too persuasive.

I’ve found that even a little prediction, it leads me down a path of wasting thought.

  • What’s likely to happen – what happens to me if the opposite happens?
  • What’s the worst that can happen – can I mitigate?
  • Does the situation appear reasonable – given the above
  • There are games, investments, relationships and opinions… I don’t need to play, make, engage or have

There are a lot of business where “the burden of the worst” falls outside of the beneficiary class (government, general partners, VC, private equity, OPM, CEO-class, banking).

We can waste a lot of energy railing against the system, I’ve found it much more useful to make sure I understand…

My family cannot afford to take the same risks as my employers, my shareholders and my government.

This is a lesson I learned through, rather expensive, experience when I left Private Equity.

Families…

No Prediction => focus on getting rid of ruin => subject to not becoming a casualty myself… education of youth “buys” more than portfolio returns, or my personal savings rate.

Conventional analysis fails to capture the present value of teaching how to avoid future mistakes.

Risks => practices that make sense for large entities, given time, will wipe out my family

So my point was…

There is more to reality than we are capable of comprehending.

Stable situations can become fragile at scale.

There are certain domains where acting “irrationally conservative” can make rational sense.

We are going to be surprised over, and over, and over, again.

Philosophically, one could say reality is pointing towards a deeper form of intelligence.

From a more linear point of view… the next time you are on an airplane, write a list of your concentrations and counterparty risks. Blow them up, one-by-one, and carefully consider if you need to mitigate.