Resultuncertainty,wrongtheoriesandpretenseofknowledge

Yesterday we had cautioned against using any kind of certitudes while dealing with election results. The situation has not changed much even now, only that the uncertainty of the whole charade has moved from poll counting centres to legal corridors where the contents of the ballot boxes will be challenged. But the markets especially of equity variety are happy with whatever they are witnessing. Dow Jones, German DAX, Hang Seng are up. Dollar Index has retreated. US treasury yields especially the 10 year is trading around 0.74% level having touched 0.94% on Wednesday.

Now let’s try to decode the market reaction even amidst the deadlock situation. The most plausible explanation is that the market is now discounting a Democrat win in the White House but without a majority in Senate. This will result in higher stimulus figures which are not accompanied by higher taxes. Democrat policies on taxing the rich will now possibly meet a republican check on the senate gate. But wait a minute, didn’t we write earlier that a gridlock kind of situation where the race is close and probably contested legally will be bad for markets fanning a risk off. So, the earlier theory on a gridlock has proved wrong. But was it incomplete, incorrect or pure baloney? There comes the need to make a distinction between the theories formulated in the field of physical sciences and social sciences.

In 1974, economist Friedrich von Hayek during his speech while accepting the Nobel prize in economics spoke at length about the above point. The speech was called The Pretence of Knowledge and is even now considered a seminal intellectual piece. Hayek starts by defining what is a scientific approach to  problem solving. He says that in physical sciences any important factor which determines the observed events will be directly observable and measurable. Take the example of Newton’s first law of motion, in an inertial frame of reference any object at rest or in motion will remain at rest or in motion with constant velocity unless acted upon by an external force. Here the properties like velocity of an object and an external force are both observable and measurable.

In contrast in the fields like economics or markets (or psephology) which deal with the essentially complex phenomenon, the aspects of the events to be accounted for about which we can get quantitative data are necessarily limited and may not include the important ones. In markets which depend on actions of many individuals, all circumstances impacting the outcome will hardly ever be fully known or measurable. Hence the theories will lack the certitudes both in time and space. Readers would appreciate that he is not even referring to a black swan problem.

Domestically the Rupee has been a beneficiary of rally in EM currencies. It now trades at 74.33. The 10-year benchmark bond trades at 5.87.