Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas write,
For the last few decades, with minor cyclical interruptions, the supply of safe assets has not kept up with global demand. The reason is straightforward: the collective growth rate of the advanced economies that produce safe assets has been lower than the world’s growth rate, which has been driven disproportionately by the high growth rate of high-saving emerging economies such as China. If demand for safe assets is proportional to global output, this shortage of safe assets is here to stay.
The signature of this growing shortage is a steady increase in the price of safe assets, necessary to restore equilibrium in this market. Equivalently, global safe interest rates must decline, as has been the case since the 1980s. Simultaneously, we observed a surge in cross-border purchases of safe assets by safe asset demanders—many of them located in emerging economies—from safe asset producers, mostly the United States.
I get their point, but I do not like the idea of talking about the quantity of safe assets as the problem. Remember my view of finance: people want to issue risky, long-term liabilities and hold riskless, short-term assets. Financial intermediaries accommodate this by doing the opposite. Hence these thoughts:
1. What my framework suggests is that if there are too few riskless, short-term assets, then there must also be too few risky, long-term liabilities. That is, there is a general shortage of financial intermediation.
2. There does not appear to be a general shortage of financial intermediation. Relative to the economy, the financial sector has been growing, not shrinking.
3. In the “safe assets” framework, government helps to solve the problem of safe-asset scarcity by printing more money and issuing more short-term debt. In my framework, more government liabilities are not helpful. Government’s short-term, riskless liabilities are not backed by long-term risky assets.* So government is not increasing the amount of financial intermediation. Government instead is crowding out financial intermediation.
*You could say that the government’s risky, long-term assets are future tax revenues. But it is not the case that governments are raising money in order to invest in projects that will lead to increased future tax revenues. They are mostly making transfer
payments.
4. In fact, a lot of financial activity is associated with funding the government. So it could be that what I think of financial intermediation has declined even though financial activity has increased.
5. In other words, perhaps the financial sector is growing but not increasing its holding of risky, long-term assets. If so, this could be due to many things, but I think that the political assault on banks (regulations, “settlements” with prosecutors) comes to the top of my mind. Politicians bash the financial sector as being unproductive even as they increase the intensity of their utilization of the financial sector to channel money toward political ends.
6. The interest rate on safe assets is not a good measure of where interest rates are relative to some Wicksellian natural rate. In other words, don’t worry about the interest rate on safe assets being too low. Worry about the interest rate on a typical risky, long-term asset being too high relative to its natural rate. But changes in any given market interest rate on long-term, risky assets get confounded with changes in expected inflation and in risk perception.
The link to the paper is broken.
I don’t understand why the velocity of safe assets can’t increase. Shouldn’t there be a profit incentive to decrease settlement time, increase netting, and otherwise reduce the quantity of and need for safe safe assets? Is there evidence of agents availing themselves of this opportunity?
How can there ever be a “shortage of safe assets” when cash is always an option? There is a shortage of yield (is there ever “adequate yield?”)…or put differently, an “excess of wealth.”
Given that central banks only tool is pushing up “wealth” among those with low propensity to spend, in hopes of generating demand…i’m voting for “excess of wealth.”
depends how you define safe. Treasuries are safe because you get your money back but are vulnerable to inflation . If risk=duration, demand has done up as evidenced by record-low yields on long-term corporate and treasury bonds
This has been the long term effort of the Fed to lower inflation, consider inflation only a cost and allow asymmetry in their target. Long term risk adjusted rates are higher because investors can’t expect inflation to bail out themselves or the economy. Inflation below target is as costly as inflation above target, making it more difficult to grow and repay debt.
I do not like the idea of talking about the quantity of safe assets as the problem.
I tend to think this is a symptom of other issues not necessarily the major problem. (Although you could argue the huge size of US housing bubble could get so much capital because there was a shortage of good safe assets.)
1) I assume the primary reason why we need less investment is:
1a) Population slowdowns which limits the need for more infrastructure. Or housing stock which is one reason why we are building less houses. We are going to build as many houses as in the past.
1b) Businesses focus investment on tech improvements which both less expensive but not as safe.
1c) One aspect not as measured is durable good quality. In reality, the US has had ~15 – 16MM cars sold for the last 30 years. (It is growing to 17M but not to the size of the population.) So durable goods are lasting longer.
4) There probably is a lot digital replacing physical goods.
2) Yes China is still following the Japan 1980s model and crowding out manufacturing investments elsewhere.
The borrow short lend long model is just a product of anachronistic regulations. There are trillions of dollars invested directly in, say, MBS without that sort of intermediation. There is no reason for supply and demand not to be mediated through price.
One really good source of low risk savings, by the way, is to invest in cubes of steel, wood, and gypsum, where they can be sold as long term shelter at values roughly equal to their cost or higher. How many trillions of dollars of safe savings do we need? I have an idea where a few trillion could be created.
Don’t forget the relative attractiveness of government securities as reserves. RBC factors are a huge driver for insurer and bank holdings.
>That is, there is a general shortage of financial intermediation.
An alternate view is that maturity transformation (of the type practiced by ye old US/English banks) is simply too risky for private actors unbacked by the Fed’s printing press.
Would you lend money to a bank that had no FDIC insurance and a (magical) iron-clad guarantee of no government bailouts under any conditions?
Not when that bank has nearly the same interest rate as other banks that are de facto subsidized by the government with FDIC and explicit and implicit bailout.
Do we need more synthetically “safe” assets that are really just shifting risk, or do people need to learn to invest in risky investments?
What are legitimate, value-adding examples of ” people want to issue risky, long-term liabilities and hold riskless, short-term assets. Financial intermediaries accommodate this by doing the opposite.”?
What are the illegitimate, shell-game examples?
Are there ways for this theory of financial intermediation to be accomplished aside from simply pretending that people can accomplish this seeming contradiction of selling risky and illiquid debt in exchange for liquid and riskless assets?
Then you have the case of net creditor countries with Sovereign Wealth Funds like Singapore, where the proceeds from the sales of short term assets actually are used to fund long term risky investments. For example, proceeds from SSBs cannot be used to fund Singapore government expenditure, but must be used for investment or servicing other government debt, which in practice means the bonds are a cheap source of funding for the country’s two hedge funds aka SWFs.
Simultaneously, we observed a surge in cross-border purchases of safe assets by safe asset demanders
I don’t see how it makes sense to say there is a shortage of something when purchases of it are “surging”. Supply is still keeping up with demand; there aren’t unusual lines of people at FDIC banks waiting for the “production” of new safe assets by these banks.