NY Times, December 10, 2008
Investors Buy U.S. Debt at Zero Yield
By VIKAS BAJAJ and MICHAEL M. GRYNBAUM
When was the last time you invested in something that you knew wouldn't make money?
In the market equivalent of shoveling cash under the mattress, hordes of buyers were so eager on Tuesday to park money in the world's safest investment, United States government debt, that they agreed to accept a zero percent rate of return.
This got me thinking DeLong's essay earlier this week. People parking assets in zero percent treasury bonds is a good example of what DeLong says of the major hang up in the
world economy at the moment:
[Default Discount] and [Liquidity Discount] together can only account for [$3 trillion of the $20 trillion] decrease in market value. The rest of that decline in the value of global capital — all $17 trillion of it — thus comes by arithmetic from (5): a rise in the risk discount. There has been a massive crash in the risk tolerance of the globe's investors.
Thus we have an impulse — a $2 trillion increase in the default discount from the problems in the mortgage market — but the thing deserving attention is the extraordinary financial accelerator that amplified $2 trillion in actual on-the-ground losses in terms of mortgage payments that will not be made into an extra $17 trillion of lost value because global investors now want to hold less risky portfolios than they wanted two years ago.
[. . . .]
Our models predict that in normal times, with the ability to diversify portfolios that exists today, the risk discount on assets like corporate equities should be around 1% per year. It is more like 5% per year in normal times — and more like 10% per year today. And our models for why the
risk discount has taken such a huge upward leap in the past year and a half are little better than simple handwaving and just-so stories. Our current financial crisis remains largely a mystery: a $2 trillion impulse in lost value of securitized mortgages has set in motion a financial accelerator that we do not understand at any deep level but that has led to ten times the total losses in financial wealth of the impulse.
In reading this I was reminded of John Maynard Keynes' discussion of the role of investors in the economy--and of relying on investors for the economy to prosper. In Chapter 12 of his General Theory of Employment, Interest and Money he speaks about the need for "spontaneous optimism" which he terms "animal spirits" for anything to get done. This is akin to the "irrational exuberance" that Greenspan spoke of in the late 1990s. I don't know if this is similar to what Friedman, in his new book, discusses in terms of a "green bubble" to restart investment. In the latter case, I think there would have to be some role for the federal government--and in any case, it is funny to think that all the talk about rationality in markets is overlooking their most important characteristic: irrationality. I thought this passage from Keynes was useful so I'll leave off with it.
Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South
Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before.
It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death. This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively
dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent;—it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends.
We should not conclude from this that everything depends on waves of irrational psychology. On the contrary, the state of long-term expectation is often steady, and, even when it is not, the other factors exert their compensating effects. We are merely reminding ourselves that human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist; and that it is our innate urge to activity which makes the wheels go round, our rational selves choosing between the alternatives as best we are able, calculating where we can, but often falling back
for our motive on whim or sentiment or chance