0:00:00.818,0:00:02.328
Once upon a time

0:00:02.328,0:00:08.979
we lived in an economy of financial growth and prosperity.

0:00:08.979,0:00:12.674
This was called the Great Moderation,

0:00:12.674,0:00:16.080
the misguided belief by most economists,

0:00:16.080,0:00:19.383
policymakers and central banks

0:00:19.383,0:00:22.714
that we have transformed into a new world

0:00:22.714,0:00:26.571
of never-ending growth and prosperity.

0:00:26.571,0:00:31.314
This was seen by robust and steady GDP growth,

0:00:31.314,0:00:34.314
by low and controlled inflation,

0:00:34.314,0:00:36.553
by low unemployment,

0:00:36.553,0:00:40.459
and controlled and low financial volatility.

0:00:40.459,0:00:47.091
But the Great Recession in 2007 and 2008,

0:00:47.091,0:00:50.570
the great crash, broke this illusion.

0:00:50.570,0:00:55.594
A few hundred billion dollars of losses in the financial sector

0:00:55.594,0:00:59.674
cascaded into five trillion dollars

0:00:59.674,0:01:01.558
of losses in world GDP

0:01:01.558,0:01:05.361
and almost $30 trillion losses

0:01:05.361,0:01:09.306
in the global stock market.

0:01:09.306,0:01:14.501
So the understanding of this Great Recession

0:01:14.501,0:01:19.862
was that this was completely surprising,

0:01:19.862,0:01:21.208
this came out of the blue,

0:01:21.208,0:01:24.125
this was like the wrath of the gods.

0:01:24.125,0:01:25.916
There was no responsibility.

0:01:25.916,0:01:27.839
So, as a reflection of this,

0:01:27.839,0:01:31.448
we started the Financial Crisis Observatory.

0:01:31.448,0:01:35.386
We had the goal to diagnose in real time

0:01:35.386,0:01:37.757
financial bubbles

0:01:37.757,0:01:43.614
and identify in advance their critical time.

0:01:43.614,0:01:46.972
What is the underpinning, scientifically, of this financial observatory?

0:01:46.972,0:01:51.598
We developed a theory called "dragon-kings."

0:01:51.598,0:01:54.804
Dragon-kings represent extreme events

0:01:54.804,0:01:58.076
which are of a class of their own.

0:01:58.076,0:02:00.919
They are special. They are outliers.

0:02:00.919,0:02:04.359
They are generated by specific mechanisms

0:02:04.359,0:02:07.245
that may make them predictable,

0:02:07.245,0:02:10.143
perhaps controllable.

0:02:10.143,0:02:13.970
Consider the financial price time series,

0:02:13.970,0:02:16.143
a given stock, your perfect stock,

0:02:16.143,0:02:18.495
or a global index.

0:02:18.495,0:02:20.549
You have these up-and-downs.

0:02:20.549,0:02:24.111
A very good measure of the risk of this financial market

0:02:24.111,0:02:26.533
is the peaks-to-valleys that represent

0:02:26.533,0:02:28.829
a worst case scenario

0:02:28.829,0:02:32.502
when you bought at the top and sold at the bottom.

0:02:32.502,0:02:36.251
You can look at the statistics, the frequency of the occurrence

0:02:36.251,0:02:38.606
of peak-to-valleys of different sizes,

0:02:38.606,0:02:41.157
which is represented in this graph.

0:02:41.157,0:02:44.189
Now, interestingly, 99 percent

0:02:44.189,0:02:47.982
of the peak-to-valleys of different amplitudes

0:02:47.982,0:02:51.442
can be represented by a universal power law

0:02:51.442,0:02:54.893
represented by this red line here.

0:02:54.893,0:02:59.039
More interestingly, there are outliers, there are exceptions

0:02:59.039,0:03:00.942
which are above this red line,

0:03:00.942,0:03:04.701
occur 100 times more frequently, at least,

0:03:04.701,0:03:08.854
than the extrapolation would predict them to occur

0:03:08.854,0:03:12.791
based on the calibration of the 99 percent remaining

0:03:12.791,0:03:15.040
peak-to-valleys.

0:03:15.040,0:03:19.640
They are due to trenchant dependancies

0:03:19.640,0:03:23.152
such that a loss is followed by a loss

0:03:23.152,0:03:26.115
which is followed by a loss which is followed by a loss.

0:03:26.115,0:03:29.226
These kinds of dependencies

0:03:29.226,0:03:34.838
are largely missed by standard risk management tools,

0:03:34.838,0:03:37.767
which ignore them and see lizards

0:03:37.767,0:03:41.586
when they should see dragon-kings.

0:03:41.586,0:03:45.503
The root mechanism of a dragon-king

0:03:45.503,0:03:48.639
is a slow maturation towards instability,

0:03:48.639,0:03:50.261
which is the bubble,

0:03:50.261,0:03:52.891
and the climax of the bubble is often the crash.

0:03:52.891,0:03:56.516
This is similar to the slow heating of water

0:03:56.516,0:03:59.419
in this test tube reaching the boiling point,

0:03:59.419,0:04:01.909
where the instability of the water occurs

0:04:01.909,0:04:05.246
and you have the phase transition to vapor.

0:04:05.246,0:04:08.923
And this process, which is absolutely non-linear --

0:04:08.923,0:04:11.203
cannot be predicted by standard techniques --

0:04:11.203,0:04:15.379
is the reflection of a collective emergent behavior

0:04:15.379,0:04:17.758
which is fundamentally endogenous.

0:04:17.758,0:04:20.971
So the cause of the crash, the cause of the crisis

0:04:20.971,0:04:24.155
has to be found in an inner instability of the system,

0:04:24.155,0:04:30.191
and any tiny perturbation will make this instability occur.

0:04:30.191,0:04:33.891
Now, some of you may have come to the mind

0:04:33.891,0:04:36.516
that is this not related to the black swan concept

0:04:36.516,0:04:39.451
you have heard about frequently?

0:04:39.451,0:04:41.868
Remember, black swan is this rare bird

0:04:41.868,0:04:45.277
that you see once and suddenly shattered your belief

0:04:45.277,0:04:47.751
that all swans should be white,

0:04:47.751,0:04:51.295
so it has captured the idea of unpredictability,

0:04:51.295,0:04:52.804
unknowability, that the extreme events

0:04:52.804,0:04:55.635
are fundamentally unknowable.

0:04:55.635,0:04:57.360
Nothing can be further

0:04:57.360,0:04:59.998
from the dragon-king concept I propose,

0:04:59.998,0:05:03.716
which is exactly the opposite, that most extreme events

0:05:03.716,0:05:06.939
are actually knowable and predictable.

0:05:06.939,0:05:10.444
So we can be empowered and take responsibility

0:05:10.444,0:05:12.663
and make predictions about them.

0:05:12.663,0:05:15.863
So let's have my dragon-king burn this black swan concept.

0:05:15.863,0:05:17.489
(Laughter)

0:05:17.489,0:05:20.429
There are many early warning signals

0:05:20.429,0:05:22.308
that are predicted by this theory.

0:05:22.308,0:05:24.675
Let me just focus on one of them:

0:05:24.675,0:05:27.827
the super-exponential growth with positive feedback.

0:05:27.827,0:05:28.987
What does it mean?

0:05:28.987,0:05:31.160
Imagine you have an investment

0:05:31.160,0:05:34.314
that returns the first year five percent,

0:05:34.314,0:05:37.469
the second year 10 percent, the third year 20 percent,

0:05:37.469,0:05:40.011
the next year 40 percent. Is that not marvelous?

0:05:40.011,0:05:43.409
This is a super-exponential growth.

0:05:43.409,0:05:45.346
A standard exponential growth corresponds

0:05:45.346,0:05:49.090
to a constant growth rate, let's say, of 10 percent

0:05:49.090,0:05:52.571
The point is that, many times during bubbles,

0:05:52.571,0:05:56.168
there are positive feedbacks which can be of many times,

0:05:56.168,0:05:59.867
such that previous growths enhance,

0:05:59.867,0:06:03.355
push forward, increase the next growth

0:06:03.355,0:06:05.857
through this kind of super-exponential growth,

0:06:05.857,0:06:08.971
which is very trenchant, not sustainable.

0:06:08.971,0:06:12.028
And the key idea is that the mathematical solution

0:06:12.028,0:06:15.666
of this class of models exhibit finite-time singularities,

0:06:15.666,0:06:19.019
which means that there is a critical time

0:06:19.019,0:06:22.223
where the system will break, will change regime.

0:06:22.223,0:06:25.499
It may be a crash. It may be just a plateau, something else.

0:06:25.499,0:06:27.766
And the key idea is that the critical time,

0:06:27.766,0:06:30.295
the information about the critical time is contained

0:06:30.295,0:06:35.779
in the early development of this super-exponential growth.

0:06:35.779,0:06:40.139
We have applied this theory early on, that was our first success,

0:06:40.139,0:06:43.698
to the diagnostic of the rupture of key elements

0:06:43.698,0:06:46.227
on the iron rocket.

0:06:46.227,0:06:49.049
Using acoustic emission, you know, this little noise

0:06:49.049,0:06:51.346
that you hear a structure emit, sing to you

0:06:51.346,0:06:55.037
when they are stressed, and reveal the damage going on,

0:06:55.037,0:06:57.477
there's a collective phenomenon of positive feedback,

0:06:57.477,0:06:59.174
the more damage gives the more damage,

0:06:59.174,0:07:01.649
so you can actually predict,

0:07:01.649,0:07:03.789
within, of course, a probability band,

0:07:03.789,0:07:05.702
when the rupture will occur.

0:07:05.702,0:07:08.137
So this is now so successful that it is used

0:07:08.137,0:07:12.502
in the initial phase of [unclear] the flight.

0:07:12.502,0:07:15.309
Perhaps more surprisingly, the same type of theory

0:07:15.309,0:07:18.037
applies to biology and medicine,

0:07:18.037,0:07:21.733
parturition, the act of giving birth, epileptic seizures.

0:07:21.733,0:07:25.357
From seven months of pregnancy, a mother

0:07:25.357,0:07:31.021
starts to feel episodic precursory contractions of the uterus

0:07:31.021,0:07:35.125
that are the sign of these maturations

0:07:35.125,0:07:38.549
toward the instability, giving birth to the baby,

0:07:38.549,0:07:40.920
the dragon-king.

0:07:40.920,0:07:43.526
So if you measure the precursor signal,

0:07:43.526,0:07:49.751
you can actually identify pre- and post-maturity problems

0:07:49.751,0:07:51.222
in advance.

0:07:51.222,0:07:54.982
Epileptic seizures also come in a large variety of size,

0:07:54.982,0:07:58.262
and when the brain goes to a super-critical state,

0:07:58.262,0:08:01.835
you have dragon-kings which have a degree of predictability

0:08:01.835,0:08:07.342
and this can help the patient to deal with this illness.

0:08:07.342,0:08:09.527
We have applied this theory to many systems,

0:08:09.527,0:08:12.382
landslides, glacier collapse,

0:08:12.382,0:08:15.949
even to the dynamics of prediction of success:

0:08:15.949,0:08:20.335
blockbusters, YouTube videos, movies, and so on.

0:08:20.335,0:08:23.471
But perhaps the most important application

0:08:23.471,0:08:25.837
is for finance, and this theory

0:08:25.837,0:08:29.276
illuminates, I believe, the deep reason

0:08:29.276,0:08:31.972
for the financial crisis that we have gone through.

0:08:31.972,0:08:36.020
This is rooted in 30 years of history of bubbles,

0:08:36.020,0:08:39.732
starting in 1980, with the global bubble

0:08:39.732,0:08:41.819
crashing in 1987,

0:08:41.819,0:08:44.188
followed by many other bubbles.

0:08:44.188,0:08:46.900
The biggest one was the "new economy" Internet bubble

0:08:46.900,0:08:48.825
in 2000, crashing in 2000,

0:08:48.825,0:08:50.873
the real estate bubbles in many countries,

0:08:50.873,0:08:53.653
financial derivative bubbles everywhere,

0:08:53.653,0:08:55.942
stock market bubbles also everywhere,

0:08:55.942,0:08:59.893
commodity and all bubbles, debt and credit bubbles --

0:08:59.893,0:09:02.606
bubbles, bubbles, bubbles.

0:09:02.606,0:09:05.245
We had a global bubble.

0:09:05.245,0:09:09.486
This is a measure of global overvaluation

0:09:09.486,0:09:13.492
of all markets, expressing what I call

0:09:13.508,0:09:16.677
an illusion of a perpetual money machine

0:09:16.677,0:09:20.629
that suddenly broke in 2007.

0:09:20.629,0:09:24.863
The problem is that we see the same process,

0:09:24.863,0:09:27.594
in particular through quantitative easing,

0:09:27.594,0:09:30.778
of a thinking of a perpetual money machine nowadays

0:09:30.778,0:09:35.181
to tackle the crisis since 2008 in the U.S., in Europe,

0:09:35.181,0:09:37.469
in Japan.

0:09:37.469,0:09:39.859
This has very important implications

0:09:39.859,0:09:43.937
to understand the failure of quantitative easing

0:09:43.937,0:09:45.813
as well as austerity measures

0:09:45.813,0:09:48.622
as long as we don't attack the core,

0:09:48.622,0:09:53.813
the structural cause of this perpetual money machine thinking.

0:09:53.813,0:09:56.429
Now, these are big claims.

0:09:56.429,0:09:59.311
Why would you believe me?

0:09:59.311,0:10:02.191
Well, perhaps because, in the last 15 years

0:10:02.191,0:10:05.383
we have come out of our ivory tower,

0:10:05.383,0:10:08.119
and started to publish ex ante --

0:10:08.119,0:10:11.447
and I stress the term ex ante, it means "in advance" —

0:10:11.447,0:10:13.585
before the crash confirmed

0:10:13.585,0:10:16.271
the existence of the bubble or the financial excesses.

0:10:16.271,0:10:19.993
These are a few of the major bubbles

0:10:19.993,0:10:24.471
that we have lived through in recent history.

0:10:24.471,0:10:27.311
Again, many interesting stories for each of them.

0:10:27.311,0:10:30.025
Let me tell you just one or two stories

0:10:30.025,0:10:32.071
that deal with massive bubbles.

0:10:32.071,0:10:34.407
We all know the Chinese miracle.

0:10:34.407,0:10:37.477
This is the expression of the stock market

0:10:37.477,0:10:40.357
of a massive bubble, a factor of three,

0:10:40.357,0:10:42.527
300 percent in just a few years.

0:10:42.527,0:10:45.729
In September 2007,

0:10:45.729,0:10:49.376
I was invited as a keynote speaker of a macro hedge fund

0:10:49.376,0:10:51.825
management conference,

0:10:51.825,0:10:55.880
and I showed to the conference a prediction

0:10:55.880,0:11:00.073
that by the end of 2007, this bubble

0:11:00.073,0:11:02.042
would change regime.

0:11:02.042,0:11:05.127
There might be a crash. Certainly not sustainable.

0:11:05.127,0:11:10.369
Now, how do you believe the very smart,

0:11:10.369,0:11:15.799
very motivated, very informed macro hedge fund managers

0:11:15.799,0:11:17.755
reacted to this prediction?

0:11:17.755,0:11:19.711
You know, they had made billions

0:11:19.711,0:11:22.546
just surfing this bubble until now.

0:11:22.546,0:11:24.130
They told me, "Didier,

0:11:24.130,0:11:27.167
yeah, the market might be overvalued,

0:11:27.167,0:11:29.063
but you forget something.

0:11:29.063,0:11:31.415
There is the Beijing Olympic Games coming

0:11:31.415,0:11:33.679
in August 2008, and it's very clear that

0:11:33.679,0:11:36.871
the Chinese government is controlling the economy

0:11:36.871,0:11:38.224
and doing what it takes

0:11:38.224,0:11:42.671
to also avoid any wave and control the stock market."

0:11:42.671,0:11:45.142
Three weeks after my presentation,

0:11:45.142,0:11:47.268
the markets lost 20 percent

0:11:47.268,0:11:49.529
and went through a phase of volatility,

0:11:49.529,0:11:52.255
upheaval, and a total market loss of

0:11:52.255,0:11:54.523
70 percent until the end of the year.

0:11:54.523,0:11:57.399
So how can we be so collectively wrong

0:11:57.399,0:12:01.541
by misreading or ignoring the science

0:12:01.541,0:12:04.372
of the fact that when an instability has developed,

0:12:04.372,0:12:06.823
and the system is ripe, any perturbation

0:12:06.823,0:12:10.504
makes it essentially impossible to control?

0:12:10.504,0:12:15.209
The Chinese market collapsed, but it rebounded.

0:12:15.209,0:12:19.965
In 2009, we also identified that this new bubble,

0:12:19.965,0:12:22.551
a smaller one, was unsustainable,

0:12:22.551,0:12:26.183
so we published again a prediction, in advance,

0:12:26.183,0:12:30.510
stating that by August 2009, the market will correct,

0:12:30.510,0:12:33.191
will not continue on this track.

0:12:33.191,0:12:36.343
Our critics, reading the prediction,

0:12:36.343,0:12:40.256
said, "No, it's not possible.

0:12:40.256,0:12:41.750
The Chinese government is there.

0:12:41.750,0:12:44.432
They have learned their lesson. They will control.

0:12:44.432,0:12:46.239
They want to benefit from the growth."

0:12:46.239,0:12:49.895
Perhaps these critics have not learned their lesson previously.

0:12:49.895,0:12:53.727
So the crisis did occur. The market corrected.

0:12:53.727,0:12:56.063
The same critics then said, "Ah, yes,

0:12:56.063,0:12:57.912
but you published your prediction.

0:12:57.912,0:12:59.568
You influenced the market.

0:12:59.568,0:13:02.701
It was not a prediction."

0:13:02.701,0:13:06.058
Maybe I am very powerful then.

0:13:06.058,0:13:08.102
Now, this is interesting.

0:13:08.102,0:13:11.039
It shows that it's essentially impossible until now

0:13:11.039,0:13:13.167
to develop a science of economics

0:13:13.167,0:13:16.310
because we are sentient beings who anticipate

0:13:16.310,0:13:20.373
and there is a problem of self-fulfilling prophesies.

0:13:20.373,0:13:24.106
So we invented a new way of doing science.

0:13:24.106,0:13:26.818
We created the Financial Bubble Experiment.

0:13:26.818,0:13:29.490
The idea is the following. We monitor the markets.

0:13:29.490,0:13:33.658
We identify excesses, bubbles.

0:13:33.658,0:13:36.962
We do our work. We write a report

0:13:36.962,0:13:41.234
in which we put our prediction of the critical time.

0:13:41.234,0:13:43.809
We don't release the report. It's kept secret.

0:13:43.809,0:13:46.674
But with modern encrypting techniques,

0:13:46.674,0:13:50.696
we have a hash, we publish a public key,

0:13:50.696,0:13:54.651
and six months later, we release the report,

0:13:54.651,0:13:57.050
and there is authentication.

0:13:57.050,0:14:01.818
And all this is done on an international archive

0:14:01.818,0:14:06.018
so that we cannot be accused of just releasing the successes.

0:14:06.018,0:14:09.410
Let me tease you with a very recent analysis.

0:14:09.410,0:14:12.668
17th of May, 2013, just two weeks ago,

0:14:12.668,0:14:14.346
we identified that the U.S. stock market

0:14:14.346,0:14:16.738
was on an unsustainable path

0:14:16.738,0:14:20.540
and we released this on our website on the 21st of May

0:14:20.540,0:14:22.585
that there will be a change of regime.

0:14:22.585,0:14:27.369
The next day, the market started to change regime, course.

0:14:27.369,0:14:28.860
This is not a crash.

0:14:28.860,0:14:31.459
This is just the third or fourth act

0:14:31.459,0:14:34.322
of a massive bubble in the making.

0:14:34.322,0:14:37.418
Scaling up the discussion at the size of the planet,

0:14:37.418,0:14:38.443
we see the same thing.

0:14:38.443,0:14:41.364
Wherever we look, it's observable:

0:14:41.364,0:14:44.594
in the biosphere, in the atmosphere, in the ocean,

0:14:44.594,0:14:48.498
showing these super-exponential trajectories

0:14:48.498,0:14:51.129
characterizing an unsustainable path

0:14:51.129,0:14:53.746
and announcing a phase transition.

0:14:53.746,0:14:55.450
This diagram on the right

0:14:55.450,0:14:58.450
shows a very beautiful compilation of studies

0:14:58.450,0:15:02.160
suggesting indeed that there is a nonlinear -- possibility

0:15:02.160,0:15:06.309
for a nonlinear transition just in the next few decades.

0:15:06.309,0:15:09.931
So there are bubbles everywhere.

0:15:09.931,0:15:11.895
From one side, this is exciting

0:15:11.895,0:15:14.655
for me, as a professor who chases bubbles

0:15:14.655,0:15:19.413
and slays dragons, as the media has sometimes called me.

0:15:19.413,0:15:22.464
But can we really slay the dragons?

0:15:22.464,0:15:24.608
Very recently, with collaborators,

0:15:24.608,0:15:27.311
we studied a dynamical system

0:15:27.311,0:15:30.215
where you see the dragon-king as these big loops

0:15:30.215,0:15:34.136
and we were able to apply tiny perturbations at the right times

0:15:34.136,0:15:39.071
that removed, when control is on, these dragons.

0:15:39.071,0:15:42.005
"Gouverner, c'est prévoir."

0:15:42.005,0:15:47.799
Governing is the art of planning and predicting.

0:15:47.799,0:15:50.552
But is it not the case that this is probably

0:15:50.552,0:15:54.452
one of the biggest gaps of mankind,

0:15:54.452,0:15:57.712
which has the responsibility to steer

0:15:57.712,0:16:00.415
our societies and our planet toward sustainability

0:16:00.428,0:16:05.272
in the face of growing challenges and crises?

0:16:05.272,0:16:09.767
But the dragon-king theory gives hope.

0:16:09.767,0:16:13.335
We learn that most systems have pockets of predictability.

0:16:13.335,0:16:18.235
It is possible to develop advance diagnostics of crises

0:16:18.235,0:16:21.794
so that we can be prepared, we can take measures,

0:16:21.794,0:16:24.549
we can take responsibility,

0:16:24.549,0:16:27.296
and so that never again will

0:16:27.296,0:16:31.150
extremes and crises like the Great Recession

0:16:31.150,0:16:35.560
or the European crisis take us by surprise.

0:16:35.560,0:16:37.035
Thank you.

0:16:37.035,0:16:43.328
(Applause)