Known and Unknown Unknowns

Chief Economist Scott Brown discusses current economic conditions.

There are a number of uncertainties heading into the November 4 election and many more as we look ahead into 2021. There’s a long held belief that the stock market abhors uncertainty. There’s also an old adage that says the market often climbs a wall of worry. We can lay out a number of scenarios for the election results, the pandemic, and so on, but it’s typically what you don’t see coming that matters most.

“Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don't know we don't know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.”

– Defense Secretary Donald Rumsfeld, DoD news briefing, February 12, 2002

Rumsfeld said many controversial things during his second stint as U.S. Secretary of Defense, but the above quote seemed to be the most ridiculed, even though it makes perfect sense to anyone who has studied logic.

We don’t know who will win the White House. We don’t know which party will control the Senate. The results of some of these races may be contested and it may take some time before we know who won. We don’t know if a vaccine will be available for COVID-19, how effective it will be, if people will take it, or whether people will resume their pre-pandemic spending habits if an effective and widely distributed vaccine is available.

We can run scenarios, of course. If Biden wins the White House and the Democrats gain control of the Senate and keep the House, we can expect more fiscal stimulus, including a major infrastructure package. An increased likelihood of a Democratic sweep appears to be the main reason behind the recent uptick in bond yields. In the past, when in control, Democrats have instituted pay-go rules, which say that additional spending should be deficit neutral. That is, if you want to spend more on something, you have to raise taxes or find some other spending to cut. Republicans let these rules expire once they are in charge. Pay-go rules don’t apply during periods of economic weakness, but we would likely see some internal debate within the Democratic Party, and (at this point) these rules appear unlikely to be re-adopted. There would be some infighting between the moderate and progressive wings on a number of issues in the Democratic sweep scenario, but tax increases would be on the table. Republicans would fall back to being deficit hawks, but draw the line on tax hikes.