Can You Short the Apocalypse?

by on August 12, 2017 at 7:25 am in Current Affairs, Economics | Permalink

If the probability of nuclear war just went up why isn’t the stock market down? The stock market also didn’t fall during the Cuban Missile Crisis, as Lars Christensen points out:

If indeed we were on the brink of a nuclear exchange, one would certainly have expected the stock market to drop like a stone. Nothing of the sort happened. Instead, the S&P500 was little changed during the 13-day standoff between the United States and the Soviet Union.

Lars argues that the market must have figured out that MAD was a brilliant policy and thus the nuclear risk wasn’t anywhere near as large as most people thought (and nuclear war didn’t happen so the markets were right, right?)

Historian Arthur M. Schlesinger Jr., who was in the White House at the time, thought the Cuban Missile Crisis was the “most dangerous moment in human history.” None of the participants thought it was a yawn. I am inclined to accept their judgment. So why didn’t the market drop like a stone? It’s not so obvious that the apocalypse is priced into the stock market.

Let’s remember why markets are good at forecasting events. If you think IBM’s dividends are going to fall then you sell IBM stock and the fall in price signals the future event. But what do you do with the proceeds from the sale of IBM stock? You buy some other asset. Since IBM is only a small share of the market there are lots of other assets to buy.

If you think a nuclear war is likely, and you sell your stocks, what do you buy? It’s pointless to buy other assets like bonds–the bond markets probably won’t exist. You could buy land but who will enforce your property right? Even cash might be useless following a nuclear war. Maybe some gold coins and canned goods would be useful but you may not be around to enjoy them.

If the apocalypse really is coming your best bet is to cash out and spend it all now. But really how much fun would that be? Sure, you could have a great week of hookers and coke but I suspect a lot of people might prefer the cheaper option of a walk in the forest.

If the apocalypse were coming, I would have a second helping of chocolate cake and maybe a third helping but utility diminishes. Since utility diminishes you get a lot less enjoyment by consuming all your wealth now than by spreading it over a lifetime.

Diminishing marginal utility means that the optimal strategy to meet the apocalypse is very costly. Suppose you expect IBM dividends to fall and so you sell your IBM stock and use the proceeds to buy something else. If IBM dividends don’t fall, you haven’t lost much. But if you expect a nuclear war, cash out and blow it all, then you’ve lost a lifetime of consumption in return for a momentary buzz.

The bottom line is that selling stock doesn’t really help you to deal with a nuclear war or even to improve your life much before the nuclear war happens. The problem isn’t markets. An information market could still be used to produce information about the probability of a nuclear war it’s just that I wouldn’t necessarily expect that probability to correlate with the broader markets. Since any actions you might take in the broader markets are fruitless or very high cost, knowing that the probability of a nuclear war has increased is mostly useless information. You might as well ignore useless information and proceed to buy and sell stock as if the information didn’t exist.

You can’t short the apocalypse. As a result, I am not much comforted by the fact that markets appear steady in the face of apocalyptic risk.

1 Stephen Carter August 12, 2017 at 7:36 am

Perhaps the risk of nuclear apocalypse was priced into the market before the Cuban Missile Crisis began.

2 prior_test3 August 12, 2017 at 9:29 am

Shhh – just because all American military dependents were pulled out of Berlin during this (so I was told by a mother with children in Berlin at the time) – https://en.wikipedia.org/wiki/Berlin_Crisis_of_1961 – there is no reason for a former Canadian to have learned about it in school. Most of my knowledge of the event comes from people involved in it, while in Berlin, plus some later reading. Before the Cuban Missile Crisis, it seems that this was considered the most dangerous confrontation of the Cold War.

But Kennedy was just getting starting, it appears. Or Khrushchev. Though I assume that Trump supporters would be fully on board with the idea that Kennedy was the loose cannon, while Russia’s natural interests should be treated in the best possible light, in the same fashion that Trump seems to view Russian actions in the present.

3 GoneWithTheWind August 12, 2017 at 10:13 am

There was a plan in place to take Castro out of power and allow the Cubans to take their country back. JFK abandoned it and in the process abandoned the Cubans who were captured by Castro and tortured and killed in his jails. This mistake precipitated the events that lead to the Cuban missile crisis. The biggest mistake by JFK early on in his presidency (later he made a bigger mistake in Vietnam but that’s another story). The MSM accommodated JFK and printed photos of him and his brother in the oval office seemingly deep in planning to “save” the country from the disaster he had placed us in. The also hid most of the reality going on in Southern U.S. dealing with the possibility that Castro might just be crazy enough to fire nukes at the U.S. All in an attempt to make JFK look presidential as he dealt with this problem between mistresses.

4 Thiago Ribeiro August 12, 2017 at 11:05 am

“oval office seemingly deep in planning to ‘save’ the country from the disaster he had placed us in. The also hid most of the reality going on in Southern U.S. dealing with the possibility that Castro might just be crazy enough to fire nukes at the U.S.”

What Castro may have been crazy enough to do didn’t matter. Castro wanted to launch and Khruschev overruled him.

“Cubans to take their country back.”
The Cubans and the American Mafia are too different things, the same way the Cubans and the Communist Party are two different things. How the Cubans could take back something they didn’t have even before Castro took over is left as an exercise in understanding paranoid thinking.

5 Doc at the Radar Station August 12, 2017 at 1:06 pm

+1

6 Thor August 12, 2017 at 9:14 pm

According to the Mitrokhin archives and other sources, when the Comintern leaders met, the Soviets and East Germans would have to talk Castro out of proposing crazy stuff. “First strike, c’mon, we can do this! Take out the gringos!” (I’m paraphrasing.)

7 Thiago Ribeiro August 13, 2017 at 7:58 am

Khruchev’s autobiography says the same. Famous Brazilian Communist leder Prestes said Khruschev told him Castro was too excitable.

8 The Lunatic August 12, 2017 at 11:47 pm

Fuck Trump, but Kennedy was a loose cannon. The missiles in Cuba didn’t substantially change the risks to the US as a whole.

But the panic in the White House is easily explicable, though not excusable, when you evaluate who was suddenly at greater risk of being killed in a nuclear war. Soviet bombers would take a relatively long time to reach the US. Soviet ICBMs would similarly have relatively long flight times and accuracy difficulties. Soviet SLBMs were few, presumably had small warheads, and were likely inaccurate. As a result, the risk to high-ranking government personnel and their families was relatively low. Evacuation of small numbers of “important” people to shelters where they’d be safe from even a full-scale Soviet nuclear strike was entirely possible.

Right up to the moment when Soviet missiles were mounted in Cuba, where they could far more quickly and accurately hit Washington, DC, severely reducing the safety margin for the “important” people. Who, incidentally, were the ones comprising the decision-makers and advisers in the Cuban Missile Crisis. Who, with their lives in sudden danger, panicked, went public, whipped up hysteria, and committed acts of war against Cuba and the Soviet Union (the “quarantine”). When they had ample opportunity to simply and quietly open negotiations first, and reach a reasonable deal (the same mutual withdrawals of missiles from Cuba and Turkey that ended the crisis) without any crisis, and without making Khrushchev lose face.

Really, it was fortunate for all Americans that Khrushchev was willing to take the hit of seeming to unilaterally back down in public rather than continue the crisis. And it’s likely a major factor in why Khrushchev was removed by the Politburo a few years later, so it’s not like it was costless for the man. He was the real hero of the Cuban Missile Crisis.

9 JWatts August 14, 2017 at 9:32 am

“Right up to the moment when Soviet missiles were mounted in Cuba, where they could far more quickly and accurately hit Washington, DC, severely reducing the safety margin for the “important” people.”

While I’m sure that was a factor, those same people were probably also worried that a quick launch from Cuba would make a first strike by the USSR a more viable option. And thus make a nuclear war in general more likely. There was a legitimate US (and world interest) in keeping nuclear missiles out of Cuba.

10 William Woody August 12, 2017 at 7:37 am

I overheard the following on CNBC, and I’m paraphrasing from memory:

“When the missiles fall, buy, don’t sell. If the trade was bad, we won’t be around for the trade to go through.”

11 celestus August 12, 2017 at 7:51 am

But “the apocalypse” isn’t coming. The worst case scenario of a nuclear war with North Korea is that a few cities, mostly on the West Coast, and a few military bases suffer Hiroshima-like attacks. The death toll might not make it to a million, and definitely wouldn’t make it to 10 million. This would be by far the greatest disaster in American history, but it’s not like stock and bond markets would cease to exist. They might not even go down by 50%.

12 clayton August 12, 2017 at 8:32 am

” But “the apocalypse” isn’t coming.”

Exactly — sober people & markets know that.

If the apocalypse was generally deemed imminent– no one would be concerned about the stock market or making their next mortgage payment

(but there must be a market for academics to feed the current media hype on nuclear war)

13 Jacob August 12, 2017 at 8:43 am

You have an odd conception of “worst case scenario.” Seems more like “best case scenario conditioned on nuclear strikes occurring.”

14 clayton August 12, 2017 at 9:10 am

….well, the specific discussion here is on current NorthKorea & 1962 Cuba scenarios

NorthKorea now has zero capability to nuke any state in U.S.
In 1962, the Soviet Union could only target a small number of nukes in U.S.
so the stated worst-case scenario above… is not odd at all

15 prior_test3 August 12, 2017 at 9:45 am

‘In 1962, the Soviet Union could only target a small number of nukes in U.S.’

Not specific to you, but this is starting to get a bit strange to read. The Soviet Union strategic bomber fleet was not precisely trivial – https://en.wikipedia.org/wiki/Tupolev_Tu-95

We can certainly argue about the effectiveness of North American air defenses, but the odds that at least 10% of the Russian strategic bomber fleet would survive to reach their targets means a minimum of 14 bombers. Obviously, their targeting/payload is an open question (one can assume that some military targets would be a priority – SAC HQ, for example), but potentially losing 8 or more of America’s major cities to 1-2 megaton range airbursts is not exactly trivial. The variables make it hard, but imagine that the Russians did wipe out DC (obvious reasons), SF/Oakland (naval facilities), Detroit (GM et al), Boston (fairly close transpolar target), Seattle (Boeing), then add three more major cities of your choice – St Louis and Buffalo and Chicago? Or maybe San Diego, Norfolk, and Pittsburgh?

16 celestus August 12, 2017 at 11:31 am

No, the best case scenario is that due to some combination of preventive strikes, North Korean technical problems and noncompliance with launch orders, imprecise aim over intercontinental distances, and hidden-ace-up-the-sleeve US military technology, the only nukes that detonate in US territory hit wilderness or less significant population centers and the death toll is under 100,000, making it higher than but comparable to some estimates for a major earthquake and tsunami in the Pacific Northwest. An outcome like that is probably more likely than over 1 million (US) casualties.

17 Jacob August 12, 2017 at 1:16 pm

Alright fine. But let’s not split hairs on this one. My point is that your original “worst case scenario” is far from the actual worst case scenario. It may be highly unlikely, but far worse scenarios are possible than what you speculated would be the worst.

18 BC August 12, 2017 at 9:22 am

The misuse of the “apocalypse” label is even worse than that. If hostilities break out now, it will be to *stop* North Korea’s nuclear program from progressing to the point where it can strike one or more US cities. A war with North Korea now would be much less apocalyptic than a war with a future North Korea that has a large arsenal of functional, nuclear-armed ICBMs. (Of course, both are more apocalyptic than a scenario where North Korea’s nuclear program is halted without war.) If the market believed that war with North Korea were imminent, we would expect it to decline not because of fear of the apocalypse but because of the potential damage to Japan and South Korea and the spillover effects onto the global economy. Bottom line: apocalypse risk goes up as North Korea’s nuclear program progresses but actually declines if hostilities prevent its progression.

Regarding the Cuban Missile Crisis, Alex is probably correct that there was significant apocalypse risk, not reflected in the market. I disagree with him in that, if apocalypse were certain, I think a lot of people would cash out for the hookers-and-coke option. However, with high but not certain probability of apocalypse, one still needs to plan for the no-apocalypse outcome, which steers one away from spending all one’s money immediately. If the apocalypse happened, the regret in not spending all of one’s money beforehand would probably be significantly less than the regret of spending all one’s money and the apocalypse having not happened (even if one would be happier in the second case than in the first).

19 prior_test3 August 12, 2017 at 9:50 am

‘Alex is probably correct that there was significant apocalypse risk’

Which existed for those famous 13 days in October (9 business days), back in age where it was typical for an investor/brokerages to actually possess paper shares which needed to be signed, and then sent by mail.

The world was a very different place in 1962, including the fact that stock ownership was still quite rare among most Americans.

20 clayton August 12, 2017 at 11:21 am

… so you take issue with the term “a small number of nukes” ?? Rather odd

In 1962 the entire Soviet strategic nuclear capability was objectively small and unreliable relative to the huge U.S. capability

USSR had only 36 ICBMs and 135 nuclear bombers that could nominally target the U.S.
Most of the bombers were propeller driven with very low probability of reaching their U.S. targets, especially the well-defended priority targets. Successfully reaching a target and successfully detonating a nuke (with 1960 Soviet technology) is much more difficult than you might assume

21 prior_test3 August 12, 2017 at 12:44 pm

Actually, I do – nuclear war in 1960 was based on a number of different concepts than even a decade later, after the replacement of the strategic bomber with MIRVed ICBMs and SSBNs. Including massive sized bomb yields compared to even a decade later, designed to eliminate as many people as possible within a target area that corresponded to a city.

‘In 1962 the entire Soviet strategic nuclear capability was objectively small and unreliable relative to the huge U.S. capability’

You are talking about something else, which was how the Soviet threat was politically presented in a context of American politics. This is no where the same as one 2 megaton airburst equals the total destruction of a city. And in the real world, Soviet/Russian military hardware is generally renowned for being reliable.

‘Successfully reaching a target and successfully detonating a nuke (with 1960 Soviet technology) is much more difficult than you might assume.’

Detonating? Please, Soviet hardware worked just fine in this area. And I did point out in my example that only 10% of the bombers may have reached a target. The Soviet ICBMs may or may not be relevant in this context, to be honest, but if only 10% also reached their targets effectively, think another 3 American cities obliterated – Soviet strategic doctrine seems to have been explicitly designed to achieve this result. Meaning that if the Soviet ICBMs were 50% effective, you are talking about 10 or more American cities wiped off the earth.

That the U.S. had a much larger and effective strategic nuclear force is not really relevant in this context.

22 Massimo August 12, 2017 at 1:16 pm

One year earlier the Soviets tested the 50 megatons (upgradable to 100) Tsar Bomb: https://en.m.wikipedia.org/wiki/Tsar_Bomba

Maybe that one was difficult to deliver, but they had plenty of others.

23 Ray Lopez August 12, 2017 at 1:27 pm

+1. Celestus is right, nuclear war is quite survivable. Not that I wish it upon anybody, but radiation fallout is overrated (unless you are young, but older people will likely die of old age before they die of cancer in many cases, when we’re talking fallout). And let’s face it: Kim is targeting Guam. If he targets LA the chances are the missile might not even hit within 50 miles. A bigger danger is Kim selling a bomb to a terrorist group which will smuggle it in a container ship to Seattle, NYC or LA, but even then it’s likely 500k dead, not 10M. Ray “Dr Strangelove” Lopez.

24 Hadur August 12, 2017 at 7:54 am

Distant relative of mine was misdiagnosed with a terminal illness. He decided to cash out and have fun for the last few months of his life.

He survived, in poverty, for over a decade.

25 Thiago Ribeiro August 12, 2017 at 7:59 am

Couldn’t he sue?

26 ChrisA August 12, 2017 at 9:10 am

People post 70 years old all have exactly this diagnosis – they know they will die soon, but don’t know when. The normal way to deal with that would be an annuity.

27 Art Deco August 12, 2017 at 10:25 am

Your life expectancy does not fall below a year until you reach the age of 113. It does not fall below 10 years until age 78. A 70-year old has a life expectancy of about 15 years.

28 tjamesjones August 12, 2017 at 1:46 pm

that’s very interesting.

29 MTC August 12, 2017 at 7:57 am

This analysis makes sense for a Russia-US all out nuclear war, but I’m not so sure it works for the current situation with Trump and North Korea. Even in the worst case scenario, with Seoul and perhaps Tokyo gone and a few nukes detonating somewhere over the US, it’s not the apocalypse — a pretty small fraction of the world’s population dies, and in the scheme of things the physical/enviromental damage is not so great. No doubt it sets off the worst economic depression the world has ever seen, and for some investors maybe that’s equivalent to the apocalypse, but it’s hardly the end of
life as we know it.

So maybe the markets do have the NK situation priced in. The other thing to note is that at least initially Trump’s tweets on NK were not much of a story in SK or Japan, suggesting the people most likely to be affected are not all that concerned.

30 Thiago Ribeiro August 12, 2017 at 8:01 am

“Even in the worst case scenario, with Seoul and perhaps Tokyo gone”
I call it Christmas. Or two birds with a crazy, nuclear stone.

31 Alistair August 12, 2017 at 11:49 am

Not sure the NK’s could get more than 1 nuke off, maybe 2, if one target was Seoul. It takes time to set up their missiles; their ICBMs are first generation delivery systems, even under optimum conditions it could take days to mate the device and ready the launch on a limited number of unhardened fixed sites. So the nuclear response could prevent more than 1 launch ever taking place.

32 Anon August 12, 2017 at 7:22 pm

It’s extremely likely that by now, the US has all sorts of secret nuclear countermeasures, like drones with lasers.

33 Massimo August 12, 2017 at 7:59 am

This recent piece in the WSJ makes your point. Check the quote of the guy (the usual Kim) toward the end: “If war breaks out with North Korea and they fire a nuclear weapon, what happens to the stock market is meaningless.”
https://www.wsj.com/articles/north-korea-risk-is-an-investment-opportunity-why-south-koreas-markets-are-booming-1502282093

However, I think I see a problem here. The theory could apply to the scenario of a gigantic world-war 3, like in the Cuban missile crisis. But in the current crisis the likely worst scenario is a completely nuked NK and a vaporized Seoul. Here the IBM comparison should apply. At least for people that does not live in Seoul, why not moving the money somewhere else?

34 Art Deco August 12, 2017 at 10:27 am

Not likely a vaporized Seoul. Greater Seoul has a population of about 12 million. The death toll at Hiroshima was about 80,000.

35 Alistair August 12, 2017 at 11:37 am

It’s a significantly larger city, yeah. Tighter density in the core though. Maybe 150k deaths if a 20 kt device is well-delivered?

36 dmcharette August 12, 2017 at 7:59 am

VIX is up a lot this week, so there are some seeing increased movement, at least.

Other than that, is there a spam (canned food, not unsolicited email) index?

37 prior_test3 August 12, 2017 at 9:57 am

Just as long as there is absolutely no current movement of the VX index, since this event – ‘On February 13, 2017, Kim Jong-nam, half-brother of North Korean leader Kim Jong-un, died after an assault in Kuala Lumpur International Airport in Malaysia. According to the authorities he was murdered by poisoning with VX which was found on his face. The authorities further reported that one of the women suspected of applying the nerve agent experienced some physical symptoms of VX-poisoning. The director of a non-proliferation research program of the Middlebury Institute of International Studies at Monterey stated that VX fumes would have killed the suspected attackers even if they had been wearing gloves, suggesting that the VX was applied as two non-lethal components that would mix to form VX only on the victim’s face.’ https://en.wikipedia.org/wiki/VX_%28nerve_agent%29

38 Alistair August 12, 2017 at 11:50 am

All the real world data on nerve agents suggests they are not _quite_ as lethal in real use than the LD 50 estimates from the lab.

39 prior_test3 August 12, 2017 at 12:47 pm

Sure – it was mainly playing with VIX and VX, while noting that the North Koreans do seem to potentially possess a fairly sophisticated capability in this area.

40 MattW August 12, 2017 at 8:11 am

“If you think a nuclear war is likely, and you sell your stocks, what do you buy?”

Tangible things you can trade with, real gold, silver, maybe gasoline, etc.

41 Mark Thorson August 12, 2017 at 10:19 am

No, you invest in gold and canned foods. I’ll invest entirely in guns and ammo. Whatcha gonna do, throw some cans of beans at me?

42 Alistair August 12, 2017 at 11:53 am

It’s an interesting question on what the optimum spend of apocalypse survival might be. I suspect “good location” is the best thing to buy over even guns and food. And after that, the mix will depend on the number of survivors.

43 Jason Bayz August 12, 2017 at 8:59 pm

“I’ll invest entirely in guns and ammo.”

But what about diminishing returns? You only have two hands.

44 Alistair August 12, 2017 at 10:44 pm

It’s an anti-co-ordination problem! You want some people to invest in guns and ammo, and others to invest in canned food and toilet paper! Solve for equilibrium!

45 Sandia August 12, 2017 at 8:25 am

In general, there are not liquid short markets in things unless there are two natural sides to the market (enough people are interested in hedging in enough numbers in either outcome to create a liquid market) or the short outcome can be hedged by market makers. Here I think both conditions apply, no significant numner of people benefit if the apocolypse occurs, and it is not easy/impossible to hedge the short outcome.

46 Sandia August 12, 2017 at 8:28 am

So where there are not hedging markets, there may be insurance markets. Here hedging against disasters works by holding assets against them in reserve. Hedging against the non-occurence of disasters is just called living, as Alex effectively concluded.

47 The Other Jim August 12, 2017 at 8:43 am

>As a result, I am not much comforted

Well, of course not. The entirety of your discomfort is because your tribe lost the historic 2016 election, causing you tremendous loss of status and self-worth.

Your coping mechanism consists solely of interpreting each day’s events as signalling that your tribe is somehow still the “right” one. But the North Korea stories don’t do that for you; in fact, they mostly just confirm that there are indeed foreign monsters in the world, a fact that your tribe works very hard to deny.

This is not going to end well for you. Get used to the discomfort, friend.

48 prior_test3 August 12, 2017 at 10:23 am

‘The entirety of your discomfort is because your tribe lost the historic 2016 election’

One can be fairly confident that Prof. Tabarrok’s ‘tribe’ did not lose the historic 2016 election, as Republicans now control the executive and legislature. Protestations about libertarianism aside, Prof. Tabarrok’s discomfort if the Democrats had won even a single government branch would have been much higher than the current situation.

ALEC (not Alex) will probably only be achieving 80% of its goals under Trump, after all. Do keep in mind that Prof. Tabarrok is much closer in perspective to the Freedom Caucus when it comes to actual laws than he ever will be anyone calling themselves a Democrat.

And let us be honest – the Freedom Caucus has Trump’s number, so don’t get all upset about it, OK? From three days ago – ‘Trump again blamed the House Freedom Caucus for the failure of the GOP’s healthcare bill.

The president then reassured the public that he’ll still achieve healthcare reform, repeating his prediction that the current law will collapse under its own weight, and then Democrats will want to make a deal with the White House.

Some observers branded his remarks irresponsible, saying they signal that the Trump administration will either neglect or actively undermine the Affordable Care Act, which could drive insurers out of the individual market. http://www.latimes.com/politics/la-pol-updates-everything-president-trump-takes-another-shot-at-freedom-1490670437-htmlstory.html

The Freedom Caucus doesn’t care about making Trump look like a political failure, even if Trump remains obsessed with blaming them.

49 Anonymous August 12, 2017 at 10:52 am

A tribe is not a political party but a cultural unit. OP, by saying tribe, isn’t referring to Republicans vs Democrats, he’s referring to working class vs globalist, SJW vs kekistani. You may be right that Prof. Tabarrok would have been even less happy with HRC, but that would be about showing that his cultural incompatibility is even higher with HRC than with Trump. Not about pointing out that he’s Republican and they won.

50 prior_test3 August 12, 2017 at 11:11 am

‘A tribe is not a political party but a cultural unit.’

Prof. Tabarrok’s ‘cultural unit’ (think the Independent Institute – http://blog.independent.org ) is completely fine with Republicans controlling the executive and legislative branches.

It is so bizarre to see any member of the GMU econ dept. be accused of being disconsolate because the Democrats continue to lose elections, both at the federal and state level, considering how many of them are doing their best to ensure that the Democrats continue to lose elections, both at the federal and state level.

51 Anonymous August 12, 2017 at 11:57 am

He can be happy that Republicans won while also being distressed that the party has been hijacked by nationalists, racists and dumb people.

52 prior_test3 August 12, 2017 at 12:50 pm

‘He can be happy that Republicans won while also being distressed that the party has been hijacked by nationalists, racists and dumb people.’

Hijacked? Really? Trump’s coattails seem to be remarkably short at this point, to be honest. Congress did not significantly change from being full of Republican non-nationalists, non-racists, and non-dumb people in a single election, after all.

53 Boonton August 12, 2017 at 9:17 am

The market lacks any good models for limited nuclear war. In terms of a massive nuclear war there’s a limit to how much you can provision yourself against that. You can build a shelter for yourself and stockpile it but that’s only optimal if you do it over time with intelligence and planning. Selling your stocks on Monday because you think the world will end Friday and you’re going to do ‘doomsday prepper’ on the fly isn’t going to cut it.

54 dearieme August 12, 2017 at 9:22 am

The destruction of NYC by medium range missiles from Cuba wouldn’t have been substantially different from its destruction by an ICBM coming over the pole. That being true, and bleedin’ obvious even to the US government, meant that there was no logical reason why the US should risk oblivion just because of a few missiles in Cuba. Nor was there any compelling reason for Moscow to risk oblivion to keep those missiles in Cuba. Therefore the only fears should have been about (i) the chance of a mistake, (ii) the danger of grandstanding by politicians, or (iii) acts of hysteria by politicians.

Different suppositions. The US government knew there was a huge “missile gap” in favour of the US and therefore feared that the Soviet missiles in Cuba might reduce that imbalance, giving the US an incentive to take risks to avoid that reduction. But Kennedy’s untruthful propaganda had persuaded the US population that the Soviets had the advantage of a large “missile gap”. In which case the rational American citizen might conclude that a few Soviet missiles in Cuba would make scarcely any difference to the USSR’s advantage, therefore there wasn’t really anything to worry about.

Last guess: enough people with money realised that when the US govt tries to whip up public hysteria it means that the underlying fear is bogus.

55 prior_test3 August 12, 2017 at 10:10 am

‘that when the US govt tries to whip up public hysteria it means that the underlying fear is bogus’

Which has this historical corollary – a Pearl Harbor scenario of a surprise attack that cripples a nation’s ability to respond to an attack is an even more attractive in a nuclear era, especially since all American adults alive in 1962 would also be fully informed about that day of infamy.

I really think it is extremely hard for a non-American to grasp just how completely American attitudes to the advent of nuclear weapons was influenced by what demonstrably occurred at Pearl Harbor, and the reality that a surprise first strike was about the only conceivable method to actually win a nuclear war, by thoroughly crippling the other nation’s ability to respond in kind.

To quote Dr. Strangelove again, but with a core of undeniable truth, from exactly the time frame under discussion –

‘General “Buck” Turgidson: Mr. President, we are rapidly approaching a moment of truth both for ourselves as human beings and for the life of our nation. Now, truth is not always a pleasant thing. But it is necessary now to make a choice, to choose between two admittedly regrettable, but nevertheless *distinguishable*, postwar environments: one where you got twenty million people killed, and the other where you got a hundred and fifty million people killed.

President Merkin Muffley: You’re talking about mass murder, General, not war!

General “Buck” Turgidson: Mr. President, I’m not saying we wouldn’t get our hair mussed. But I do say no more than ten to twenty million killed, tops. Uh, depending on the breaks.’

The advantage of a first strike diminished considerably after the launching of a sufficient number of SSBNs, however – https://en.wikipedia.org/wiki/Ballistic_missile_submarine

56 dearieme August 12, 2017 at 4:18 pm

“a Pearl Harbor scenario of a surprise attack that cripples a nation’s ability to respond to an attack is an even more attractive in a nuclear era”: certainly, but the USSR didn’t have that capability; the US would have been left with enough missiles and bombs to obliterate the USSR. The federal government knew this but seems to have hidden that truth from the population.

“The advantage of a first strike diminished considerably after the launching of a sufficient number of SSBNs”: which happened, of course, well before the Cuban crisis.

57 Jeff August 12, 2017 at 9:27 am

As others have pointed out, North Korea probably doesn’t have the capability to cause the entire US economy to collapse. Even if a small nuke detonated in the city center of Los Angeles, only a small portion of the city would be destroyed. It would be hellaciously expensive and thousands would die but this still isn’t the end of the world unless you happen to be one of those killed.

That said, one can in fact “short” for a real apocalypse. Sell lots of stuff short and use the proceeds to build and equip your underground bunker. Unwinding the transaction might be more difficult though.

58 chuck martel August 12, 2017 at 9:52 am

The best approach to an impending nuclear holocaust is getting elected to the US Congress. They will be protected as effectively as possible, now at nearby Fort McNair rather than the more remote Greenbrier that once served as their nuclear refuge: http://www.washingtontimes.com/news/2013/apr/23/congress-has-new-shelter-case-attack/

59 Alistair August 12, 2017 at 12:00 pm

Excellent. Stage 1: Concentrate the survivors at a single site. Stage 2. Tell the enemy where that site located. Stage 3. Profit!

Surely the best plan for the survival of congress would be simply to disperse them for an arbitrary 3 months? The executive branch will be busy fighting the war anyway and can call them back once the rubble has stopped bouncing.

60 Jens Nordmark August 13, 2017 at 1:35 pm

Destroying some city centers might even be good for growth. When it’s time to rebuild, those who stand to gain from nimbyism have been vaporized.

61 Stephen Landry August 12, 2017 at 9:37 am

A former colleague of mine who now lives in Flagstaff, AZ, once told me that if the end of the world was imminent he’d take a long hike down into the Grand Canyon, knowing he wouldn’t have to hike back up!

62 ChrisA August 12, 2017 at 9:40 am

In this NK particular case, the odds of something really bad happening that will make US companies worth nothing must be pretty low, perhaps below 1%. Multiple levels of failure must occur, like the NK’s actually having the capability to do more than threaten, the chance that their missiles are not shot down on launch, the whole diplomacy thing not working out, the NK’s not backing down etc. On an expected value basis then the discount should be less than 1% for the US stock which is well within the daily fluctuation, so would not be noticed.

But let’s discuss the more fundamental question of whether you can short a serious civilisation threatening event. I think the key insight is that any specific threat is never 100% sure of occurring, so you should invest for the case where it doesn’t happen after all. For example say you have special information about a major asteroid likely to hit the earth of the magnitude of the dinosaur one, how would you profit from it? The odds are one in two say, whereas most people think they are much lower. Your arbitrage could be to borrow as much money as possible while interest rates are still low, then use this to buy cheap assets sold in the panic when the threat becomes known and interest rates spike as people cash out for the coke and hooker option. If the asteroid strikes, then your assets and debts are probably worthless, but if it misses, you would presumably become extremely wealthy as prices return to normal. Of course this is actually a fairly safe strategy, if for some reason prices don’t crash because of a panic, just repay the loan.

Turning to the Cuban missile crisis and as to why the stock market didn’t crash then – I would guess that a nuclear war was already priced in given the fact that there were constant tensions between the USSR and the USA already.

63 chuck martel August 12, 2017 at 10:02 am

” If you think IBM’s dividends are going to fall then you sell IBM stock and the fall in price signals the future event. But what do you do with the proceeds from the sale of IBM stock?”

Stocks are bought and sold everyday regardless of the international situation. The proceeds, just like the much-feared rise in wages that supposedly creates inflation, aren’t necessarily re-invested in stocks or other financial instruments. They buy houses, cars, Beaujolais Nouveau, tickets to Broadway shows and access to Democrat politicians. After all, investing in stocks is done for the purpose of making money, not for the joy of owning a tiny portion of a corporation or no one would do it.

64 McMike August 12, 2017 at 10:17 am

There will be no nuclear exchange because north korea is not suicidal. NK is not going to trade its certain anhiliation for an experimental lob at Guam. The markets (whatever that means) presumably share that assesment.

The real wild card is how China will play this. And recent indications seem to be they are distancing from NK. China probably wants this resolved as much as we do.

The biggest obstacle to dealing with NK has been concerns about triggering China.

As an aside, this whole exercise is premised on the notion that the markets get truly spooked by anything external anymore. The only thing that spooks these markets are risks that internal faults will collapse it on itself.

65 Brian August 12, 2017 at 10:23 am

A limited nuclear war with North Korea isn’t at all the same as a nuclear war with the U.S.S.R. The former is survivable at a great economic cost, the later is not.

So if the probability of a nuclear exchange destroying one or two U.S. cities went up, stocks should absolutely decline. The fact that they haven’t strongly suggests an irrationality in the equity market that simply ignores tail risk events.

66 Tyler Cowen August 12, 2017 at 10:24 am

It is hard to short a certain apocalypse, but if it comes in steps, and eventually may not come at all, standard theory still applies.

67 Tyler Cowen August 12, 2017 at 10:25 am

…this of course does require that a thwarted apocalypse is worse than no risky path at all.

68 prior_test3 August 12, 2017 at 11:14 am

Well, at least one columnist would argue that planning for the apocalypse is a net plus when it involves government spending, leading to the sorts of advances in technology that are useful.

69 rayward August 12, 2017 at 10:35 am

Well, market participants are motivated by belief (psychology) not economic fundamentals; hence, if market participants don’t believe there will be a nuclear war, then they won’t sell short. Of course, beliefs, if shared, have a tendency to be self-fulfilling. And that includes both markets and nuclear war. As to the latter, the assumption is that we and NK have a shared belief: that the costs of nuclear war are so great that it has to be avoided. That was certainly the case with the U.S. and the Soviet Union: the absence of nuclear war providing the evidence. As for NK, the belief here is that Kim shares that belief. If Kim is rational that is true, since he has far m,ore to lost than gain in the event of a nuclear war. But Kim is but one side of the equation: Donald Trump is the other side. Does Trump share the belief that the costs of a nuclear with NK are so great that it must be avoided? If Trump is rational, probably not. Nuclear war with NK has many potential benefits to Trump, including ending the Mueller investigation, focusing attention on the war and recovery from it rather than the many inadequacies, mistakes, and misdeeds of Trump, giving him vast powers that only he determines the limits, and postponing the 2018 and possibly 2020 elections. The real risk here is likely Trump not Kim. If market participants come to that belief, then market participants will sell short.

70 rayward August 12, 2017 at 10:47 am

I should point out that Trump’s intellectual supporters were drawn to Trump based on his penchant for disorder and chaos not in spite of it, believing that’s what America needed to jump start the economy. Now, some of them have come to realize that order and stability, once lost, are difficult to recover, and that disorder and chaos can spell disaster. I understand the Cowen’s friend Peter Thiel is in that category.

71 dearieme August 12, 2017 at 4:20 pm

“Trump’s intellectual supporters were drawn to Trump based on his penchant for disorder and chaos”: hm. In my case I was attracted to Trump by virtue of his not being Hellary Clinton.

72 Alistair August 12, 2017 at 12:04 pm

Frame it differently. War now or a more destructive war in 10 years? Or even a peace which becomes increasingly “expensive” over time?

Put it another way; do we regret NOT bombing in 1995? Would we play things differently with perfect information?

73 austrartsua August 12, 2017 at 10:40 am

The flaw in this analysis is the assumption that the ‘apocalypse’ is so devastating that no amount of money would give you a fighting chance of survival… Given knowledge that an apocalypse is on the way, don’t you think billionaires and millionaires would make preparations for survival: buying islands, armies, space stations etc… Faced with the prospect of anihlation, wouldn’t a rich man spend everything he owns to improve the odds? All of this needs capital which can be funded by your sold stock… Thus the stock market will drop.

74 Jack August 12, 2017 at 10:52 am

I think the more likely interpretation of the market’s reaction is that the market thinks these events are unlikely. Odd to see the Cuban missile crisis held up as an example of the market failing to spot risks since notwithstanding Schlesinger’s point of view, nothing in fact did happen.

75 Saint-Frusquin August 12, 2017 at 11:02 am

The Matrix (Yep, the movie) gave you the answer about the Apocalypse : it dumbs down to how little you may need to survive, with winners take all at the end.

And since my ancestors were dumb enough to giv govs the required capital to make the Apocalypse true, I don’t can’t do anything against that

76 Ann Ominous August 12, 2017 at 11:50 am

Short America, long Argentina, be out of town when the war happens.

77 Alistair August 12, 2017 at 12:12 pm

It doesn’t seem hugely expensive to buy cheap land and hut in the boondocks. Stock with food and water and gas and gun. The land will hold value even if the apocalypse doesn’t happen and you are out of pocket only for the consumables. Maybe $30k?

Hey, maybe there is a market in selling time-limited slots in shelters/refuges? Build a large shelter complex in the boondocks (quite cheap really for just huts and consumables). And then you can sell apocalypse insurance, raising the price as slots get sold in times of stress….I know there are communities like this, but the innovation seems to be you don’t sell a slots forever but only for a limited period, so people’s downside is limited.

78 David H August 12, 2017 at 7:48 pm

It’s less simple than you think. On most US land (basically all land east of the Rockies), it will be fallout that kills you, not the blasts and fireballs. Second, you have no other idea about how to survive on your own on radioactive land. If your ass is saved, it’s because you’re a part of a network of cooperating people, not some loner crank with a gun and a can opener. Third, even if the first two points were wrong, you would actually have to be on the land when the shit goes down. Remedying all of these issues will require a pretty significant investment.

79 Alistair August 12, 2017 at 10:42 pm

Indeed. I have some experience with nuclear war modelling. Firstly, an effective 2 to 4 week fall out shelter would raise capital costs, but not excessively. Many commercial shelters are over-kill, if you’ll pardon the expression, and conceived of as long-term dwellings or bomb shelters rather than shot-term respites. Away from primary blast areas, a simple cut-and-cover earth shelter, properly lined, with filtration, waste disposal and power needn’t cost too much. There are large returns to scale. $200-300k might cover it comfortably. There are non-nuclear apocalypses to consider, too, so not all utility is bundled up in fall-out sheltering.

Secondly, the model is designed as a short-term respite to ride out the worst 3 to 6 months in total, not a longer term survival model. After the apocalypse, land will be cheap, so why buy in advance?

Thirdly, yes, client self-evacuation in good order is their problem. Note many scenarios allow for longer warning and evacuation times. But from a business perspective, this may not inhibit sales as what people are buying is a sense of “somewhere to run”; and casually over-estimate their ability to evacuate in good order.

80 Ricardo August 12, 2017 at 12:41 pm

I believe Niall Ferguson has documented how little financial markets reacted to the threat of world war right up until August 1914.

81 JKY August 12, 2017 at 12:47 pm

Can nuclear war be framed on a spectrum, perhaps with three regions of net positive, net negative but not catastrophic, and apocalyptic?

Net Positive:

Causes: inneffective NK nuclear strike, effective US preemtive strike

Results: averted future apocalypse, favorable shift in balance of power, NK disarmament

Ex: NK fires a missile at Guam but either the missile misses the target or the bomb fails to detonate. NK loses its credible nuclear deterrent, and the US lead coalition neutralizes NK military without significant (?) global casualties.

Net Negative:

Causes: Effective nuclear strike on the SK, Japan, or US populace; successful NK artillery barrage on SK, successful NK asymmetric attack,

Results: NK military neutralized, NK regime weakened to a Chinese vassal state, conflict contained at the regional level

Ex: NK strikes Guam with a nuclear bomb and strikes Seoul with an artillery barrage. The US lead coalition strikes backs and neutralizes the NK military. There are significant casualties in the region yet the global economy proves resilient.

Apocalyptic:

Causes: intervention by a major power (China), nuclear escalation beyond the Korean peninsula and western Pacific Islands

Results: significant global casualties, global economy grinds to a halt

Ex: China mistakes US lead strikes as a hostile act and retaliates with a nuclear strike.

82 lisabenn August 12, 2017 at 12:53 pm

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83 Boris_Badenoff August 12, 2017 at 6:52 pm

The saving grace here is that Kim’s behavior is consistent with many years of Nork practice: they hope to extract concessions with threats of reigniting the Korean War, developing nukes, testing nukes, developing missiles, testing missiles, etc. At times it has worked. Without the full cooperation of China & Russia (sources of nearly all trade & support for the regime), new sanctions are unlikely to have any noticeable effect at all. The people are already starving & impoverished (#213 in the world in per capita GDP @ $1500 annually vs ROK’s #46 @ $37,900), no evidence Kim cares at all. Top priority for the regime is self-preservation, the status quo.

For all their bluster & provocative acts, Norks have stopped short of actual acts of war, at least of the significance that would demand a response. A hot war brings uncertainty; to those desperate to maintain the status quo (their privileged position), it is a risk of last resort. But they do view any intrusions of outside culture as dangerous as bombs: in any just world, all those in the regime leadership would swing from a rope in short order.

Experience today indicates the Norks understand the old chess maxim, “The threat is more deadly than its execution.” They see great potential upside (& little real risk) from continued armament & threatening war, while an actual shooting conflict holds much uncertainty & huge potential downsides. In this sense & in their way, they are rational actors. They aren’t looking to become martyrs, just to keep their cozy arrangements in their police state as long as possible.

IOW, chillax.

84 Li Zhi August 12, 2017 at 7:06 pm

I get pretty disgusted with bloggers misusing the language. Tabarrok’s ridiculous misuse of “Apocalypse” is a case in point. A few questions occur to me. 1. How sure can we be NOW that a near-future launch from NK isn’t sanctioned by China? (What would the CPC/PRC have to lose?)(A corollary is how sure can we be that the launch is purely NK technology and not “augmented” by Chinese equipment?) 2. Coke and Hookers. There has to be a market. The worst case seems to me to be the total collapse of, say, electronic trade. 3. I’m no historian, but wouldn’t we expect that a extremely limited exchange (best case nuclear exchange) would, after the inevitable knee-jerk reaction, be GREAT for business?

85 David H August 12, 2017 at 7:34 pm

I’ve seen declassified fallout maps, based on known wind pattern and Soviet targeting information. Turns out he safest places in the contiguous US are on the coast of California, because unless they are struck directly, they will basically remain entirely free of radiation. All that Pacific air pushes away the radioactive dust basically within hours. Given that, one would predict that prior to a nuclear apocalypse, property prices in coastal California would become rather inflated.

86 H_WASSHOI August 12, 2017 at 8:02 pm

Just put in moral hazardous (leveraged) traders in your model

87 Marius Solem Johansen August 13, 2017 at 3:09 am

Wouldnt the optimal strategy be to sell a certain percentage of your assets, so as to increase consumption while you still can consume/there still exists things to consume?

88 Boonton August 13, 2017 at 7:16 pm

Had lunch with someone who grew up in South Korea on Friday. Asked him what he made of this thing, his opinion was that he was not very worried nor were most of the people he knew back home. North Korea is all talk and the blustering threats crop up once a year or so and in the end nothing will happen. His only regret was that he didn’t have a lot of cash on hand so he could buy assets in S. Korea due to their stock market being slightly down.

I understand people in Guam feel more or less the same.

This hints to me the market is wise in pricing a nuclear war as a very slim, very ‘black swan’ possibility that isn’t zero but has not yet moved that far from zero.

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90 Robin Hanson August 14, 2017 at 8:15 am

You can’t short the apocalypse now, but if we made the right markets you might:
http://www.overcomingbias.com/2010/12/compare-refuges-resorts.html

91 B.B. August 14, 2017 at 10:32 am

Several things.

War with North Korea could easily be just conventional, including a possible conventional war invasion of South Korea by North. Should the stock market price that? Odds are this war would not go nuclear. The US stock market sank after Pearl Harbor and rose after the Battle of Midway.

Second, North Korea cannot blow up the whole world. How should stock markets in Europe and South American price a US-North Korea war, even if there are limited nuclear attacks?

Third, consider that North Korea might be developing electromagnetic pulse weapons (EMP). Just one nuke exploded high in the atmosphere over the US could destroy the electrical grid and much of the electronics of the US. The US GDP would fall by more than half (if anybody is measuring) and famine would result. The US stock market might not be functioning, but others countries would function. They would price the Great Depression.

Finally, the US stock market did sell off during the Cuban Missile Crisis, and rallied massively after it was over.

92 ben August 14, 2017 at 10:45 am

That is why you should be 100% invested in stocks (and bitcoin) till you are 60. If all your money in the stock market goes away, you have probably been vaporized along with it.

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