Japanese stimulus, Brexit and Game theory constructs

In a largely rangebound day yesterday for the markets, two news items made the headlines. First one was the announcement of the USD 708 bn (73.6 trillion Yen) stimulus package by the new Japanese PM Yoshihide Suga. The stimulus package will include actual fiscal spending of around 40 trillion Yen. The new package will take the total stimulus so far this year to USD 3 trillion, which included a 100,000 Yen handout to all Japanese residents. Yen trades mostly unchanged at 104 against the dollar. The Dollar Index (DXY) trades around 90.80 up from its 28 month lows of 90.40.

The second headline was around the Brexit negotiations, a topic we will deep dive in much greater detail today. Yesterday the pound sterling nose dived from the levels of 1.3430 to 1.3230, a neat 2 big figure fall. It has since recovered to 1.3320 levels. The chaos started with the news appearing on the wires at the start of the London trading that the British side is looking to walk away from the trade talks. The proceedings got some glimmer of sanity during the one hour call between UK PM Boris Johnson and European Commission President Ursula Von Der Leyen. The call was followed with an announcement of the visit by the UK PM to Brussels, to do what? No prizes for guessing…. to further negotiate.

It is interesting to look at Brexit from the lens of game theory and see what popular game constructs can be applied to the situation here. But we should highlight to the readers at the onset that identifying the game which applies to the current situation doesn’t necessarily improve on the predictive faculties. The first game which comes to mind is the “game of chicken” made famous in the 1955 James Dean movie Rebel Without a Cause. The set up is a duel between two car drivers racing fast towards a cliff end together, and the loser is the one who “chickens” out first. In the Brexit case if we consider the no deal hard Brexit scenario as the cliff, the EU and UK can be considered as the two car drivers. The bet is to find out who will chicken out first and agree to the terms favourable to the other party. Game theorists further build on this game and supplement it with a “mad man theory”, which essentially says that in a mutually destructive duel scenario, the party with an image of being a “mad man” will triumph on most occasions as the other party will try to limit the damage by being rational. But the catch here is that all these theories and information about the game philosophy is known to all the players and hence they will reconfigure their responses accordingly. There is a difference between knowing that one is a mad man and knowing that one is playing a mad man.      

From the EU perspective there is another game construct which is relevant here. Blogger Ralf Michaels introduces this as the Reinhard Selten’s Chainstore Paradox. It goes like this. Lets say that you are a supermarket chain with monopoly presence in many towns. A new supermarket store gets opened in one of the towns. What should be your response? The rational response is to buy out the intruder and not indulge in costly price wars but this essentially signals other new comers to enter other towns and the monopolist trying to buy everyone out will eventually be ruined. Hence the strategy is to scare out the first entrant with a costly and seemingly irrational “lets bleed together” attitude. Just replace the monopolist as the EU and UK as the new entrant (just that the UK is the first one trying to get out). Making it costly for the UK makes it a test case for other nations harbouring such exit thoughts.