Ahhh, the simple scientific world of René Descartes! Single cause, single effect. In the economic world however, this unfortunately is not the case. One cause can even bring about two opposite effects.
A devaluation, for example, usually produces a deterioration in the external accounts first and then an improvement second. Economists call this phenomenon the “J-curve.”
However for more than 20 years, the financial policies of developed economies have turned the page upside down. The “J” has become an “η.” Immediate relief and pain for tomorrow.
The tapering in view of the US Federal Reserve now raises the question: Would “tomorrow” be the end of the summer?
Are there laws in economics as well as in physics? We say yes, absolutely. Just like gravitation, classical mechanics, thermodynamics, and even quantum mechanics.
To understand this phenomenon requires a bit of imagination. In particular, a new status of law, which does not find its foundation in an external Platonic world but rather the self-organization of individuals. Here, we state a new scientific law governing a living society: rats in a cage, or «The Law of Diving Rats.”
This example introduces Econophysics.
Two weeks ago, a friend of mine lost his tennis racket on the highway. The racket fell right out of his bag attached to the back of his motorcycle. He quickly took the first exit, returned to the spot, pulled his motorbike into the emergency lane, and spotted his racket lying there on the highway. Did he end up crossing the road to retrieve it?
Managing risk does not mean forecasting.
Will the financial market crash?
This is anyone’s guess; the future is unpredictable. But what about the risk?
Given the inflationary shock on oil developing month after month, the odds of a 50% drawdown on the S&P 500 have been multiplied by a factor of 100.
For seven months in a row, Gavekal-IS macro, monetary, and behavioral models remained very equity-friendly, serene as a Tibetan monk. In the meantime, Gavekal-IS publications displayed a series of macroeconomic warning signals building up for a potential climax around August or September. See for instance February’s “Inflation: The Equity Nightmare,” and “US PE Expansion: Game Over!” publications, and May’s “Economic Boom and Financial Bust.”
Today, Gavekal-IS models crossed the Rubicon: criticality is ahead, risk-off!
Countries that have found the optimal balance between freedom and equality benefit today from the highest revenue per capita, as shown in our last publication, “Equality vs. Freedom.” They are all located in Northern Europe, slighting extending to Switzerland, the Netherlands, and Luxembourg as well.
What is their secret?
Our previous publication, “The Equation of Willingness,” highlights a missing equation from the Modern Portfolio Theory driving economic performance. The equation balances economic freedom and market integration. The first term favors a Schumpeterian growth, while the second, a Ricardian growth.
In this letter, we experiment with the equation throughout the world to identify countries and economic zones that have found the optimal trade-off for value creation.
And the winner is… Northern Europe.