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Saturday, February 29, 2020

Uncertainty

The coronavirus news flow is getting worse, and generating corresponding news flow. I just want to make a couple comments that stick close to my limited expertise. From a markets standpoint, the market that matters is the credit market, and not equities. I am not plugged into the credit market news flow, but I do not see anything that indicates that anything is irreversibly broken. Otherwise, the situation underlines the big difference between randomness and uncertainty. This is a geeky distinction, but is one of the things that distinguishes post-Keynesian thinking from neoclassical.

Credit: Too Early to Panic?

The equity market is more transparent (and more interesting), and so falling equity prices garner headlines. However, nobody uses the equity market to raise capital -- in fact, it is where capital goes to die (via stock repurchase strategies that are invariably implement the "buy high, sell low" equity trading strategy).

I have not even bothered checking, but it seems safe to guess that no new credit deals are being priced. This would be very bad if sustained. However, the credit market periodically shuts down for new issues (for example, Europeans go on vacation for most of August), and so issuers know that they need to work around temporary market closures.

Until there is evidence that re-opening will not happen, any panic selling is purely speculative. It might be entirely correct to panic, but I lack the information to offer any useful guidance.

Uncertainty

The problem with the virus is that we are faced with radical uncertainty.
  • We do not know what will happen to the economy under various scenarios about the disease.
  • We do not know the probabilities of the scenarios.
The geeky post-Keynesian line is that this uncertainty is very different from the randomness that infests (neo-)classical economics, which assumes that all states of the world are known, and a probability distribution of those states is also known.

This is different than the situation of even a few weeks ago, for those of us who did not pay too close attention to the situation in Wuhan. There was uncertainty -- what are the odds of a recession? -- but most of us probably thought that they could map out recession scenarios, and have rough probability of each scenario occurring. 

The situation in markets is extremely difficult because we are now groping through the news, trying to be able to convert this uncertainty into at least probabilistic scenarios. 

Central Banks to the Rescue?

There is a chorus of economists on my Twitter feed calling for emergency actions (of varying magnitude) to end the "doom loop" in markets. The Fed has so far resisted offering anything other than generalities. Given that we will be in a highly uncertain state for at least a couple weeks, I think waiting for a more effective moment is reasonable.

(c) Brian Romanchuk 2020

1 comment:

  1. Here is my thinking:

    Bank borrowing creates increased wealth at the rate of 1:1 (i.e., one bond per dollar loaned).

    CB borrowing/lend event creates increased wealth at the rate of 2:1 (i.e., one bond AND one dollar created per event).

    So, so long as government continues spending based on borrowing, the money supply/wealth continues to increase. The coronavirus has no role in this evolution.

    On the other hand, the virus-caused-pattern-disruption seriously unsettles steady-state valuation normal's. In general, supply and demand will both diminish in scale. This should result in less return/profit to ownership.

    In summation, equities should earn less at the same time that there is an increasing supply of money/wealth awaiting apportionment. Far and away from being a steady-state situation!

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