Tyler Cowen has written a fascinating and in-the-whole recommendable post on the mess of the everything-old-is-new-again financial system of the modern era. But in there he does say this:

Another feature of this new order is that more and more financial transactions will be collateralized with the safest securities possible: United States Treasuries. Demand for them will remain high, and low borrowing costs will ease our fiscal problems. Still, the resulting low rates of return serve as a tax on safe savings, encourage a risky quest for yield and redistribute resources to government borrowing and spending. It isn’t healthy for the private sector when investors are so obsessed with holding wealth in the form of safe governmental guarantees.

If I were feeling less than judicious I would just let Karl Smith have the final word on this:

The only thing that irks me as much as this, is the “search for yield” meme. When people want to claim that because interest rates were so low we had to go out and look for ways to make yield.

Really? Because normally you just let ways to earn yield pass you by?
If someone honestly told me that he threw my money away because “well we were already earning a descent return as it was” I just can’t imagine what I would do that person. I’m enraged just writing about the hypothetical possibility.

But since I’m feeling a little more judicious, I will say this:

The price of the debt issued by a government that issues its own currency should, by natural law of supply and demand, be exactly equal to expected inflation over the life of the bond. Why? Because it is, essentially, riskless; or rather, the only risk should be inflation risk. Therefore you should never be looking to US government debt to make yield; it should only be a hedge against inflation.

Now, what if there’s a situation where that doesn’t wash, where Treasury debt rates are below inflation? You’d have to be looking at some situation of either inelastic supply, ie, the US government isn’t issuing enough debt to meet demand, or inelastic demand, where the financial system for some reason is demanding a fixed amount of T-Bills regardless of supply. I think this is the story Tyler is trying to tell, something about Treasuries becoming the universal currency of the international financial markets locking in a large amount of demand unresponsive to dropping yields from low inflation/growth expectations, higher oil prices (which drives up demand for Treasuries) or the Fed scooping up more debt in open market operations. But none of this has anything to do with whether there is a "risky quest for yield" – everybody should want more yield than Treasuries at all times.

There is a more charitable take I could give on this that I actually wanted to spell out in a later post, regarding the weird power that the concept of zero and the cusp between positive/negative have over the human psyche, that I think makes Tyler’s statement here make a little more sense, but as I said there’s a later post.

Also, if low rates on Treasuries are redistributing resources to debt-financed government spending, why has the political apparatus responded with a massive, market-shaking fight not over whether but how to drastically reduce borrowing? Why isn’t the political system responding with a massive, market-shaking fight over the trillion-dollar debt-financed tax cut vs. the trillion-dollar debt-financed nationwide HSR system?

Advertisements