March 24, 2020 / 2:04 PM / 13 days ago

Breakingviews - Chancellor: Coronavirus crash is inverted bubble

LONDON (Reuters Breakingviews) - The language commonly used to describe speculative manias is borrowed from epidemiology. A new technology sparks “contagion”. Investors are “infected” with greed. Speculative “fever” breaks out. During the panic phase, contagion becomes more “virulent”. After the South Sea Bubble collapsed 300 years ago, contemporary observers likened the market situation to a plague. In fact, by late 1720 the bubonic plague was spreading across Europe. Today, the world is faced with another epidemic. The response to coronavirus resembles the inverse of a speculative mania, with fear replacing greed, and errors of pessimism those of optimism.

A man wearing protective face mask, following an outbreak of the coronavirus disease (COVID-19), walks in front of a stock quotation board outside a brokerage in Tokyo, Japan, March 10, 2020.

In his engaging and eerily well-timed new book, “The Rules of Contagion”, Adam Kucharski observes that bubbles and diseases go through similar growth phases. Both experience periods of exponential growth. Eventually the spread peaks, the bubble bursts and the number of infections declines sharply. A typical outbreak chart resembles an inverted “V”. Bubbles follow a similar trajectory. As the ecologist Robert May observed in 2013, “the recent rise in financial assets and the subsequent crash have rather precisely the same shape as the typical rise and fall of cases in an outbreak of measles or other infections.”

Financial bubbles and epidemics are both prone to cross borders. In 1720, the genie of speculation jumped from Paris to London, and later spread as far as Portugal and Russia. In the early months of 2020, Covid-19 was carried from Wuhan, China to much of the rest of the world. Bubbles produce unreal times: rumours abound and bizarre promotions are launched. Speculators snapped up shares 300 years ago in a company “for the immediate, expeditious and cleanly manner of emptying necessary houses [toilets] throughout England.” Their descendants have lately taken to stockpiling toilet rolls, a product that England still produces in ample quantity. In an atmosphere of dread, gossip and tall tales spread more virulently than the virus itself.

Bubbles are a form of social contagion. When the markets are soaring, “fear of missing out” drives investors. They lose the capacity to make reasoned judgments. Herd-like behaviour and groupthink prevail. Bullish narratives proliferate. It’s not just that speculators want to hear such stories: Wall Street is incentivised to circulate them. Optimistic visions are maintained in the face of contradictory evidence. During the late 1990s dotcom boom, for instance, Wall Street claimed that internet traffic was doubling every ten weeks. In fact, as researcher Andrew Odlyzko, now at the University of Minnesota, revealed at the time, traffic was growing one-tenth that fast. This inconvenient finding was ignored, and the investment splurge continued, leading to billions of dollars in misallocated capital and the bankruptcy of numerous telecoms firms, including Worldcom.

The coronavirus panic has a familiar ring. Charts of reported Italian deaths rising vertically recall bitcoin’s trajectory a couple of years ago. Friends and contacts have taken to forwarding articles by an alarmist coronavirus commentator (not a professional epidemiologist) who boasts millions of readers and claims that his article is the only thing you’ll ever need to read, and will save lives. It’s impossible to say whether this advice is sound or not. But it certainly feels like the pandemic mirror image to the Wall Street pied pipers, such as Henry Blodget, who loudly played their tunes during the internet bubble.

Trust the experts, we are told: Follow the data and science. If only things were that simple. During the internet and real estate bubbles, financial experts were wrong. A top hedge fund manager once complained to me that “every bubble has an academic shill.” Epidemiology, like finance, is as much art as science. A colleague and I once gathered data on every bubble we could find. Each one turned out to be different. Epidemiologists face the same problem – as they like to joke, “if you’ve seen one pandemic, you’ve seen… one pandemic.” 

Both investors and epidemiologists face chronic uncertainty. During an epidemic, the data is always changing. Differences in climate and social behavior affect the spread of disease across geographies. This poses enormous challenges when trying to model a pandemic. Like investment strategists, epidemiologists are prone to egregious forecasting errors. In September 2014, the Centers for Disease Control and Prevention forecast 1.4 million cases of Ebola in West Africa by the following January. In the end, this epidemic produced fewer than a reported 30,000 cases. An earlier CDC model anticipated a potential smallpox outbreak would result in 77 trillion deaths – as Kucharski says, both models included an unlimited number of susceptible people.

Covid-19’s true infection rate is unknown, as outside of South Korea testing has been inadequate and no antibody test is yet available. China cannot be trusted to provide accurate data. As for the fatality rate, Italians may be recording deaths due to coronavirus when other illnesses may also be prevalent. Last week Imperial College predicted more than 2 million people would die in the United States and half a million in the United Kingdom if Covid-19 was not suppressed. Imperial’s dire warning persuaded the U.S. and UK governments into draconian action, shuttering large swathes of the economy. On Monday, Boris Johnson locked down Great Britain.

Yet the assumptions in Imperial’s model – the reproduction rate, fatality rate, etc. – are at best educated guesses. The model’s predictions must be hugely sensitive to slight changes in a variety of inputs. Even Imperial admits that what it calls “conservative” assumptions are pessimistic. Such pessimism, or call it excessive caution, appears to be the institutional bias of epidemiologists, just as finance types are prone to hyper-optimism.

Dissenting forces can be heard through the noise. Stanford University epidemiologist John Ioannidis states that analysis of the outbreak on the Diamond Princess cruise ship suggests the virus is much less of a danger to life than commonly assumed. Also drawing on the cruise experience, Michael Levitt, the Stanford biophysicist and Nobel laureate, makes a similar point. “What we need to control is the panic,” Levitt told the Los Angeles Times. “We’re going to be fine.”

This calls to mind Franklin D. Roosevelt’s words to the American people in his first inaugural address at the depth of the Great Depression in 1933: “The only thing we have to fear is... fear itself – nameless, unreasoning, unjustified terror which paralyses needed efforts to convert retreat into advance.” When the history of this pandemic is written, it may become a postscript to the ever-expanding volume, “Extraordinary Popular Delusions and the Madness of Crowds”, first published in 1841.

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