Contemplating the end of the world is in vogue, and for good reason. With climate change, a global pandemic, and now Russia flirting with nuclear war, there is a lot of motivation to think about the end of the human race.
Now, if you think the world of stocks, bonds, and capital markets will all look a bit silly in a post-apocalyptic nightmare, you’d be absolutely right. The end of civilization would by definition be the end of finance as we know it, because it is a core feature of a civilized world. Finance exists largely on two fundamental concepts: first is the time value of money and the second is the distribution of risk. But distributing risk and money itself only exist in a world where there is an authority to enforce rules, contracts, and agreements. Without that in a post-nuclear holocaust there is no possible room for money or risk distribution to exist—not until a new governmental order emerged from the ashes of the end of our current civilization.
While this might sound like the backdrop of a science fiction novel, it’s an issue that has gotten real analysis in some Wall Street notes in recent days. After the Russian invasion of Ukraine, analysts, economists, and bankers have all discussed what to do with stocks in preparation for the worst-case scenario: the war escalates, there is a nuclear exchange, and modern society is wiped off the face of the earth.
Obviously, if that were to happen, stocks and bonds would be worthless. Even real estate would be worthless, because your legal claim of real estate ownership would be unenforceable without a government, courts, and a police unit. If enough survivors could get together to create a new civilization, they could recreate these institutions—but until that happens, property ownership would be by fiat, essentially meaning one only owned what was in one’s physical possession for as long as it could be protected from others. Lawless societies are a nightmare of death and destruction, which is why the rule of law is so important, to financial markets and personal property as well as to human life.
On the level of this binary event—will the Ukraine war escalate into the end of humanity or not—the answer from a financial perspective is obvious: invest as if that end will not happen. Since the stocks will be worthless in an apocalypse, selling in advance of that apocalypse makes no sense—with the caveat of course that selling to buy survival gear and supplies in anticipation of a nuclear exchange could be advisable.
That is, if that nuclear event happened, and if you survived, and if you had the skills, luck, and training to survive the marauding anarchy that would follow (let alone nuclear radiation and a myriad of other problems). Those variables are all unpredictable and idiosyncratic, so even then the financial advice to sell stocks and become a prepper for the end days doesn’t really make sense either.
We have been here before. Saber rattling from North Korea has caused downturns in the markets as investors sell for fear of a nuclear war starting. But this isn’t a very rational move, and it is why the panic selling doesn’t last very long. And when it does, one could argue the majority of selling pressure isn’t from first-level investors getting cash to stock their bunkers with supplies or from first-level investors just selling because a nuclear war will be bad for stocks—it’s probably more from second-level investors who are selling because they anticipate other people will sell because a nuclear war will be bad for stocks, as irrational as that selling would be. Then there are third-level investors who are selling in anticipation of those second-level investors, and so on.
This is the key lesson of the Keynesian beauty contest, and it is a big motivator of capital markets’ short-term volatility. Many sell not because they think a possible external event is bad for the asset, but because they think other people think that possible external event is bad for the asset. Aggressive traders can take advantage of this momentum to make profits—but that advantage is gained by being able to predict the market’s animal spirits. That is no easy task.
For this reason, those Wall Street notes opining on a nuclear war are urging investors to keep investing as if the worst-case scenario does not happen—and to not hedge for the worst case either, since the worst case in this situation means all assets go to zero and never recover. Thus we’re in a rare situation where one must prepare not for the worst case scenario but for the middle-cases: the war is prolonged, resulting in more supply chain lockups, a decline in commodity production, and a new leg of inflation for everything from oil to wheat.
Right now, analysts are busily modeling for complex macro events as a result of this war but in a rare exception to the rule, they are not modeling for the worst possible case. Because the worst possible case is simple, this time: capital markets disappear for good.