TRUE UNCERTAINTY RISING: SCARIER THAN RISK
“About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.” -John Maynard Keynes
The markets seem to have wide and contradictory forecasts for a limited number of risks:
1) Stock market valuations
2) Central bank policy
Differences of opinion are normal, but current disagreements may point towards something more ominous than risk: true uncertainty. While common usage makes risk and uncertainty synonymous, many think otherwise. Risk is usually a well-defined problem that can be quantified by the probability of events. True uncertainty, on the other hand, encompasses problems so complex that probabilities cannot be calculated because we largely do not fully understand the process or the likelihood of events. Keynes wrote the above quote in “The General Theory of Employment” (1937). In 1921, Frank Knight wrote about true uncertainty so convincingly that we often refer to “Knightian Uncertainty.” I, myself, wrote about true uncertainty in my 1999 book, “Patterns in the Dark.” While an old idea, true uncertainty is so frightening that references hardly occur in day-to-day analysis.
But now the wide variety of passionately held expert opinions on a narrow set of topics may point towards a rise in true uncertainty. Everyone agrees that stock market valuations are high, but well-known pundits can either say that is not a problem because there is no alternative to stocks (TINA), or that low returns are inevitable for the next 10 years. Likewise, many respected analysts and former central bankers are either saying that the Fed is making one of the biggest blunders in history or the Fed’s patience will be rewarded. Some see inflation as temporary, while others see embedded inflation that’s rapidly getting worse. Many say cryptocurrencies are the future, while others think they’re a modern day tulip bulb craze. The wide dispersion of expert opinion suggests we are in a state of true uncertainty.
What makes true uncertainty frightening? We use probabilities to make “rational decisions” under conditions of uncertainty. Such behavior gives us a feeling of control because we believe that we understand the process even if the outcomes are probabilistic. But making probabilistic decisions under conditions of true uncertainty gives us an illusion of understanding and control that is actually irrational, since likelihoods are unknown. If we are, indeed, in such an environment, what happens next is anyone’s guess. And that’s scary.
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