Submitted by Plan B Economics, (as a reminder none of the guest posts appearing on Zero Hedge necessarily reflect the views of Zero Hedge or its various spokes)
A Bubble in Conservatism
When one thinks of financial and economic bubbles images of reckless
speculation, lavish galas and luxurious consumables are conjured.
Bubbles are tied to euphoria and new economic paradigms. Bubbles grow
out of the expectation of permanent prosperity.
Individuals are drawn into the euphoria with the assurance they won’t
lose money and that ‘everybody’s doing it’. Nobody wants to see his
neighbour work half as hard and spend twice as much, so jealousy can
motivate the average man to become a speculator.
Eventually, in an effort to out-do one another, individuals begin
taking more risk – such as investing on margin (or $0-down adjustable
rate mortgages) – to achieve bigger returns (or to achieve the same
returns when returns on capital inevitably shrink). During a bubble,
recent asset price returns provide comfort to the few that wonder about
At the point when the speculators are plenty and margin debt is high,
a small change in the economic winds (usually prompted by businesses
scaling back excess capacity) starts a cascade of financial ruin. While
bubbles can take form in unlevered environments, it is debt that takes
bubbles to ruinous proportions and makes the equity held by individuals
so sensitive to otherwise innocuous economic events.
Given that bubbles are classically associated with the pursuit of
prosperity, is there such a thing as a bubble in conservatism? When
individuals are scared about their prospects they act conservatively by
saving and paying down debt. Can a massive wave of conservatism, such as
the one we’re experiencing today, hit a threshold that forces it to
reverse (i.e. the ‘bubble’ pops)?
While a bubble in risk assets leads to a self-feeding spiral of
leverage, overcapacity and low returns on capital that eventually hits a
threshold causing it to self-correct, a bubble in conservative assets
does not need to self correct. True, after a certain amount of time –
months, years or decades – individuals may feel comfortable about their
personal balance sheets and begin to reduce their savings rates and
increase their use of credit. (If starting from a sound base, this
transition can fuel a secular bull market.) But there are no financial
constraints forcing such a change in behaviour.
Let’s take this to the micro level. If you make $10,000 a year and
feel euphoric about the economy you can increase your consumption – by
spending all your earnings, plus borrowing – to a certain threshold.
Once a threshold is hit and the bank starts calling in your line of
credit, your behaviour must change.
On the other hand, if you make $10,000 a year and feel wary about the
economy you can save half your earnings each year. In this case, there
is no threshold that is hit that forces you to start spending again.
Conservative behaviour can continue indefinitely, and has done so in
numerous countries with high savings rates.
Today, many are saying that US Treasuries are in a bubble. I’m not
arguing that the US government doesn’t have fiscal challenges, but I am
arguing that the supply of funds to finance those challenges can continue flowing for a very long time.
The flow of investor (individual, banks, corporate) cash into US
Treasuries is driven by conservatism and not by the misguided pursuit of
wealth. Individuals are not eying their neighbour’s new Porsche with
envy, running to their broker to borrow $100k to invest in government
bonds. Quite the opposite: investors are looking at their unemployed
neighbour, their decimated 401k and their looming ‘retirement’ (whatever
that may look like) and focusing on capital preservation. Wealth
accumulation was so 2000s (or dare I say so 1990s).
The new frugality, the liquidity trap and risk aversion are
funding the US Treasury…and this ‘bubble’ is being driven by cold hard
cash (as opposed to leverage). This is why the flow of funds into US
Treasuries can continue for a very long time.
Perhaps bonds are expensive. Perhaps the US Treasury needs to borrow a
lot of money. Someday (could be sooner, could be later) the US Treasury
trade won’t be a good one. I agree that the US is borrowing extreme
amounts of money and Treasuries may not be a good ‘buy and hold’
long-term investment. I also agree that the US may one day implicitly
default via inflation, and Treasuries may eventually fall in value. So
this is not a commentary on the merits of US Treasuries as an investment
(I’ll leave that to experts like Gary Shilling and David Rosenberg who
both forecast double-digit returns for long bonds). This is a commentary
on the characteristics of a ‘bubble’ – I believe that strong demand for
funds does not necessarily characterize a ‘bubble’.
Bubbles are determined by the exuberant supply of capital, not by the demand
for capital. And, as previously stated, the supply of capital today can
hardly be considered exuberant, as it is generated prudently from
incomes and portfolio re-allocation (not from leverage or irrational
investor enthusiasm). As long as risk aversion remains dead and
US Treasury issuance remains within a digestible flow, US Treasuries
will have a firm bid from conservative individuals, banks and
corporations looking to park their cash.
Yield and returns for US Treasuries will experience ups and downs –
sometimes violent. But throughout those ups and downs, a strong bid for
US Treasuries will remain as long as current macro-conditions prevail.
To call investor demand for relative safety a bubble is to not
understand the definition of a bubble. For there is no such thing as a
bubble in conservatism.