Failure to conceive the inconceivable is common on the community level and very much a part of business and finance. It’s close company with Delusion as fertile soil for producing odd choices of action in the early stages of a crisis. The interesting part is that “inconceivability” is rarely considered when doing post-mortem analysis of players’ actions, though it should be.
When a major economic downturn happens, it’s almost always a surprise while it’s starting and its great depth is rarely forecast in any meaningful way. This is because something unthinkable has happened. But after-the-fact the Monday morning quarterbacks have a field day explaining what people should have seen, as they did with Bush and his choice to continue reading to schoolchildren for a few minutes at the beginning of the 9-11 crisis.
The real-time results of adapting to previously inconceivable events are always surprising, which is a good indicator that the event really was inconceivable. During the crisis over the US national debt limit in the summer of 2011, the government’s acrimony got so intense that Standard and Poor’s downgraded US debt rating. The surprising response by investors: Put more into US treasuries!
Why? Because US treasuries were always the place to flee to when investing times got uncertain. But this crisis changed that given, and in the six months to follow, all kinds of investing got much more volatile as investors struggled with the implications of this new reality. But a particular event being truly inconceivable happens only once. Investors learned, and the next US budget-oriented showdown will be treated much more rationally by investors.
And that new rationality will be more painful for the US Treasury and the Fed.