In the eye of the coronavirus storm

The phase of Knightian Uncertainty ends soon

I am going to keep it brief today because the sense I have had for the last few days is that we have finally reached a news plateau on this pandemic. The news flow is horrific, with alarming reports of escalating infection and death counts. But the news flow now also has a certain repetitive feel to it. I don’t feel like there is anything ‘new’ on the epidemiology front, on the economic side, regarding stimulus or regarding financial markets. I feel like we have mostly absorbed the first wave of this hurricane.

We are now in the eye of the storm, so to speak. And so, we are waiting for the backside of the storm to hit. And with that backside hit, we will gain a lot more clarity too. Right now, there are still a lot of unknowns – what people in economics call Knightian uncertainty. But, in the span of the next few weeks, we will understand the full measure of the health and economic crisis that awaits.

We will learn how deadly the virus truly is, how much of a hit to the economy it causes, how high unemployment goes, how many firms default on their debt or go out of business, and what impact all of this will have on asset prices, commodity prices, oil prices and inflation. None of that is known right now because there are too many ‘unknown unknowns’ to use a Rumsfeldian turn of phrase. In the next month those ‘unknown unknowns’ will become ‘known unknowns’ and a true risk assessment will begin.

Social distancing and prevention

The genesis of this post was a realisation on my part, as I awoke today and scanned the news flow, that nothing I read revealed any deeper understanding of where things go from here. I have been saying that we have been caught unprepared for this health crisis. And all indications are that it will lead to a mushrooming of infections and deaths. And the corollary of this is that we are in for a deep recession, even a depression, and that asset prices do not fully reflect this coming reality. I have a great deal of conviction about this economic outcome, but there is always room for doubt – at a minimum because I am not a virologist. I could easily be wrong.

Here are some of the specific pieces I read that led to this chain of thoughts.

For the last three weeks, 57-year-old Ann O’Connor has avoided leaving her home in Paradise Valley, Arizona, due to the Covid-19 pandemic. As a cancer survivor with asthma, she is considered high risk for severe illness, and she wants to do her part to stop the virus’ rapid spread.

But others here are not taking the same precautions. O’Connor’s house looks on to a private golf course, and she spends her days watching foursomes tee off, buy refreshments and pile into golf carts. She sees neighbors greet each other with hugs.

“It’s really disconcerting because you just see these people and there’s no social distancing,” O’Connor said in a phone interview from her home. “It is like a huge, sick experiment,” she added about the lack of consistent action across the country.

O’Connor has children living in Washington, California and Colorado, where governors have issued state-wide shelter-in-place orders and shut down all but essential businesses. She had expected it would just be a matter of time before the rest of the country followed suit.

But while more than 25 states and dozens of counties have ordered residents to stay home, 10 states, including Arizona, Arkansas, North Dakota, South Dakota and Wyoming, have no such orders at the state, county or city level.

“Many of you have asked if or when the state will move towards a stay-at-home policy,” Arizona’s governor, Doug Ducey, a Republican, said at a 23 March press conference. “The answer is, not at this time.”

‘It’s like a sick experiment’: Arizona lags behind as states urge residents to stay home – The UK Guardian

Thought bubble: Will this end in tears for Arizona with a mushrooming of infections and deaths as I now believe and epidemiologists like Gregg Gonsalves predict?

“There’s no virtue in waiting,” Gonsalves said. “Social distancing and business closures are meant to be a preventative. They’re not to be seen as something you do when it gets really bad – it’s to keep it from getting really bad.”

Or is Doug Ducey right in preventing an economic collapse?

We don’t know yet.

Economic fallout and stimulus

That leads to thought bubble 2: Is the trade-off of ‘lives for the economy’ ‘worth it’?

We don’t know yet.

For example, see Gavyn Davies:

The fiscal and monetary stimulus announced by the world’s major economies over the past month is a global policy event without precedent in peacetime.

The increase in fiscal spending and loans in the US this year alone will reach more than 10 per cent of gross domestic product, larger than the rise in the federal deficit through 2008 and 2009. Although this is probably not as big as the financial stimulus implemented by China after the financial crash 12 years ago, most big economies could see government debt to GDP ratios rising by 10-20 percentage points.

The impact of central bank injections will be equally enormous. For example, the US Federal Reserve may finance part of the country’s fiscal stimulus by buying Treasuries. On top of that, its balance sheet will grow from purchases of mortgage bonds and packages of private loan assets. It would not be surprising if the Fed’s balance sheet increased by $2tn-$3tn this year, up from $4.2tn at the end of 2019.

That is similar to the cumulative increase over the entire decade that followed the financial crash. Those who claimed that central banks would be irrelevant in handling this crisis could not be more wrong.

Can the world afford fiscal and monetary stimulus on this scale? – FT

Thought bubble 3: Have policy makers done enough stimulus to make the shutdown and quarantine approach ‘worth it’? Putting aside the fact that Davies’ calculations don’t take into account pre-existing social safety nets, the question still remains: is this enough stimulus to prevent an economic depression?

We don’t know yet.

And to highlight thought bubble 2 once more, here is the second most recommended comment on the Davies article:

Precisely. The government is spending millions of pounds per life saved to (in the majority of cases) extend the lives of sick people by a few months. Flu season last year killed 40,000.

At the expense of the deepest recession we will ever see: huge public debt, millions of jobs being lost (mostly the working class that aren’t office-based and capable of WFH), people will lose their homes, millions of kids not able to go to school or take exams. I could go on.

Our wartime leaders need to urgently appraise which human cost is worse

My view

My contention here is that, while we have a much greater understanding of the scale of this crisis, there are still a lot of unknowns right now. We have absorbed a lot so far, but there is still great uncertainty on the best course of action and on what the future will look like.

All of these unknowns will become knowns in due course. And I believe the next several weeks will be huge in that evolution. That’s when we’ll find out whether Arizona is playing Russian roulette with it’s citizens lives. We’ll also find out how well the economy and financial markets respond too.

As always, let’s hope for best and prepare for the worst.