COVID-19 and Taboo Tradeoffs

COVID-19

Scott Alexander has written a great “where are we now” primer on COVID-19: When all you have is a hammer, everything starts looking like a dance.

Apart from his updates on how we’re doing in our battle against the virus, there were two pieces I wanted to call out. One interesting, and one insightful.


Why are some countries containing COVID-19 better than others?

Scott evaluates the different theories for why some countries are doing better than others.

  • Stay at home orders: Don’t seem to have mattered at all.
  • General government policy: Also seem to matter much less than we’d imagine. We thought Korea and Taiwan are doing well because of their brilliant governments. Japan, on the other hand, denied the problem for a long time so they could still stage the Olympics. Yet, they’re not doing too shabbily.
  • Testing policy: Yes, this matters, as I’ve mentioned before in Sunday Reads #85: Black Swans, Honesty, and Dishonest Statistics. But most (developed) countries are now testing properly, so this doesn’t explain the differences either.

Clearly, there’s still a lot to discover about this virus.


Lockdowns and taboo tradeoffs.

Second, and I found this far more insightful: He also talks about the importance of framing.

Coronavirus has killed about 100,000 Americans so far. How bad is that compared to other things?

Well, on the one hand, it’s about 15% as many Americans as die from heart attacks each year. If 15% more people died from heart attacks in the US next year, that would suck, but most people wouldn’t care that much. If some scientist has a plan to make heart attacks 15% less deadly, then sure, fund the scientist, but you probably wouldn’t want to shut down the entire US economy to fund them. It would just be a marginally good thing.

On the other hand, it’s also about the same number of Americans who died in the Vietnam War plus the Korean War plus 9/11 plus every school shooting ever. How much effort would you exert to prevent the Vietnam War plus the Korean War plus 9/11 plus every school shooting ever? Probably quite a lot!

Sure, you say, “This is a good example. But I already know the importance of framing, and anchoring.”

Great. Then let’s try another one for size.

Suppose you reopened the economy tomorrow. You tried as hard as you could to put profits above people, squeezed every extra dollar out of the world regardless of human cost. And then you put a 1% tax on all that economic activity, and donated it to effective charity. Would that save more people than a strict lockdown?

If a lockdown costs $5 trillion, then the 1% tax would make $50 billion. That’s about how much the Gates Foundation has spent, and they’ve saved about ten million lives.

Ten million is higher than anyone expects US coronavirus deaths to be, so as far as I can tell this is a good deal.

This reminds me of the discussion on Taboo Tradeoffs in the Rationality fan-fic, Harry Potter and the Methods of Rationality. Won’t share any spoilers, but the gist (I paraphrase from Chapters 78-85):

When you compare the value of sacred vs. secular objects (e.g., paying $5M for a liver replacement so a person can live, vs. for improving medical equipment), you make a taboo tradeoff.

Whenever you refuse to pay a certain amount (“I will not donate $2M for upgrading medical equipment”), you set an upper bound on a life.

Whenever you agree to pay a certain amount (“I will pay $5M to get this poor person a liver”), you set a lower bound on a life.

And if these two bounds are inconsistent, it’s an opportunity to move money to achieve a greater good.

What the hell is going on with the stock markets?

The world is tipping into the mother of all recessions. And yet the stock markets are on a tear like nothing’s happened.

As I mentioned in COVID-19 is a Black Swan, but not for the reason you think, this is the state of the real economy in the US:

And here’s the S&P 500, halfway back to its previous highs.

Why is the stock market going up?

The stock market back home in India is not as exuberant. But it has also risen, after a dip in March. Although the situation has only gotten worse.

What the hell is going on with the stock markets?

Over the last weeks, I’ve come across three hypotheses for this strange behavior. I don’t know which is right – I’m not a stock market expert. Truth be told, I’d guess it’s a combination of all three.

Hypothesis #1: What kills you makes me stronger.

Maybe the stock market is still efficient. We actually expect large companies to do well. And we expect a real divergence between equities and the broader economy.

As Bryne Hobart says in V-Shaped Recovery for Me, L-Shaped Recovery for Thee:

Large companies are unusually well-equipped to survive, and they’re better able to benefit from monetary interventions—which have been far faster and more effective than fiscal ones.

Meanwhile, small companies, individuals, and municipalities just don’t have the cash reserves or flexibility to react.

There are two ways in which this could play out:

The pessimistic scenario is front-end corporatization: small businesses just evaporate, their real estate is taken over by big companies.

Amazon and Walmart (and Jiomart in India) are the villains of this story.

The optimistic view is back-end corporatization: that software companies and lenders launch an all-out sprint to modernize and recapitalize small businesses, applying the scale advantage of big companies to solving the problems of local ones.

In that happier outcome, small companies hang on for dear life, and come back leaner and ready to fight. Unlike big companies, they won’t necessarily respond to efficiency growth with layoffs.

Shopify, Square, and fintech lenders are the heroes of this story. As are the SMEs that struggle through and survive.

Hypothesis #2: Everyone’s buying ETFs.

The Relentless Bid, Explained posits a different model. It’s an article from 2014, but it’s rung true throughout the crazy bull run of the last decade.

The [stock market] dips have become shallower and the buyers have rushed in more quickly each time. Sell-offs took months to play out during 2011 – think of the April-October peak-to-trough 21% decline for the S&P. In 2012, these bouts of selling ran their course in just a few weeks, in 2013 a few days and, thus far in 2014, just a few hours.

Why is that?

75% of the wealth business in this country [US] is largely driven toward fee-based strategies and accounts.

The vast majority of this snowballing asset base being reported by both wirehouse firms and RIAs is being put to work in a calm and methodical fashion: long-term mutual funds, tax-sensitive separately managed accounts (SMAs) and, of course, index ETFs.

What does this mean for the character of the stock market?

It means that, almost no matter what happens, each week advisors of every stripe have money to put to work and they’re increasingly agnostic about the news of the day. They’re well aware that their clients are living longer than ever – hence, a gently increased proportion of their managed accounts are being allocated toward equities. And so they invariably buy and then buy more.

In short, it means a relentless bid as the torrent of assets comes flowing in every day, week and month of the year.

The lighter volume on the NYSE in recent years also suggests this. Trades are only taking place at the margin and about half of it is ETF creation-redemption related.

Hypothesis #3: Zero Interest Rate Policy (ZIRP for the hip crowd).

Money is always swimming towards yield. All of Capitalism rests on this constant flow – of investments in search of return.

As Ranjan Roy says in ZIRP explains the world, strange things happen when the risk-free rate nears zero.

At an individual level, most of us have become accustomed to bank savings accounts effectively returning zero. That wasn’t enough for us though. Our money felt antsy, so it found index funds and other passive funds, to once again, find a bit of yield.

That same, tiny behavioral shift takes place at every level of the risk curve, from your savings account to the trillions of dollars managed by large pension funds.

So all these dollar-organisms all start swimming towards riskier waters. Treasury investors shift to corporate debt. Public equity hedge funds shift to late-stage private equity. Late-stage private equity shifts to mid-stage, mid-stage to early stage. Seed rounds become bigger. Angel investors become a thing. Unicorns, unicorns, and more unicorns. Ashton Kutcher.

Blackrock gets jealous of KKR who gets jealous of a16z who gets jealous of YC. There is just so much money looking to do so many new, riskier things.

Where does this take us? It takes us to bike graveyards.

[Source: All Tech Asia]

As Howard Marks explains in The Most Important Thing: when people are less risk averse, risk premiums reduce.

When interest rates are near zero, even a slight increase in yield feels like an immense reward for taking risk.

And that’s what has been happening since 2009, as KKR says in their 2018 paper, Rethinking Asset Allocation:

This is the historical risk-reward ratio.

And this is what is happening now.

Investors are ready to take on higher amounts of risk (x-axis), for much lower return (y-axis).

The yield curve is flattening. (Unfortunately, it’s not the curve we’re trying to flatten).

This is why, even now while the economy seems headed for a never-before seen recession, investors are piling into the stock market. Desperate for a little yield. Hungry for a little return.


Which of these hypotheses ring true to you? I’m leaning towards Hypothesis #3: ZIRP.

Yes, COVID-19 is a Black Swan. But not for the reason you think.

COVID-19 is a Black Swan.

Many pundits call COVID-19 a Black Swan event. And I have done the same. In countless conversations with clients, suppliers and others, ruminating wisely, “yes, it’s a black swan event. All bets are off.”

But is it really?

Black swans are supposed to take us by complete and utter surprise. Unpredictable before the fact, inevitable after.

But, a lot of people have predicted this pandemic. Not only predicted it, but also highlighted how unprepared we are. Among the famous examples, here’s Bill Gates, warning of a pandemic that could kill 33 million. And the resemblance of the current situation to the 2011 movie Contagion is eerie.

So, no – the epidemic was foretold.

Black swans are supposed to take us by complete and utter surprise. Unpredictable before the fact, inevitable after. But this pandemic was predicted.

What wasn’t foretold though, was the immediate and devastating economic armageddon. That was the Black Swan.

image

That spike at the far right of the graph – from 300K jobless claims to 3.3 millionThat was the Black Swan.

The video in the tweet below illustrates this vividly.

COVID-19 was foretold. But the economic impact wasn’t.

Experts (and movies) predicted, sometimes in frightening detail, how medical capacity would run out. How we’d wait, interminably, for a vaccine.

But they didn’t think – what will happen if everyone has to sit at home for two months? What will happen if every business closes, all at once?

Like all Black Swans, seems blindingly obvious after the fact. Hindsight, especially in the case of Black Swans, is 20:20.

Alex Danco talks about this in his article on Black Swan Events.

Why did our governments react so slowly to the pandemic?

Separately, the chart above also explains why so many democratic heads of state reacted slowly at the start.

In The Dictator’s Handbook (an excellent book on Politics and Game Theory), Bruce Bueno de Mesquita says,

Politics is about getting and keeping political power, not about general welfare. Leaders do what they can do to come to power, and stay in power.

That’s what happened.

In the early days of the pandemic, COVID-19 was an unknown quantity. Many hoped prayed fervently that it was “just another flu”. On the other hand, every head of state knew what a lockdown meant. Unemployment.

And in any democracy, unemployment means one thing for sure – the leader in power crashes out in the next election.

Like Upton Sinclair said:

“It is difficult to get a man to understand something when his salary depends upon him not understanding it.”

Amen.

[Note: This article appeared in my newsletter Sunday Reads #85: Black Swans, Honesty, and Dishonest Statistics]