This chart, which comes from Credit Suisse’s 2012 Global Report and was brought to my attention by FT Alphaville’s Cardiff Garcia, illustrates the impressive contraction of safe assets available to investors.
It goes without saying that this decline has not been driven by a lack of demand for safe assets. In fact, the demand for safe assets most likely remains close to its long-term, post-war historical trend of about one-third of all assets.
Viewed in this light, there is no contradiction or mystery at all to falling Treasury yields. Investors are buying the stock of safe assets even faster than the world can produce them. The evidence of negative real rates on some issuances of German bonds, for example, points toward a shortage of safe-assets.
This is an area where fiscal and monetary policy tend to blend in confusing ways. Because safe-assets perform money like functions for financial institutions and sophisticated investors—supplying collateral for trades, being highly liquid and very safe—contractions of safe assets act much like monetary contractions. A reduction in deficit spending (or, more specifically, a reduction in the issuance of bonds that accompany deficit spending), in other words, is a reduction in the outstanding pseudo-monetary supply for the global economy.
Getting this right is important for understanding fiscal and monetary policy. We’re living through a great contraction of safe assets, which puts enormous strain on a financial system heavily reliant on collateralized trading between counter-parties. Any program that threatens to reduce, say, the amount of debt issued by the U.S. government should at least take into consideration the likely effects of further contraction.
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