Posts
A big debate is going on between Mankiw, Paul Krugman, and others about the existence and characteristics of market failures involved in banking. DeLong weighed in and made the following comment:
Back before the industrial revolution [bankers could give back the investment when asked], for the capital stock of the economy was overwhelmingly composed of consumption goods of one sort or another. If Antonio, Renaisssance-era merchant of Venice, faces a sudden shift in his investors' portfolio preferences as they want more safety and liquidity, with a sigh he unloads the silks of China, the spices of Indonesia, and the perfumes of Arabia from his ships and distributes them to his investors. But once you get canals, railroads, and cotton mills on a large scale you cannot do that anymore--you cannot deleverage the economy as a whole rapidly by consuming your existing capital. That is why it is no accident that the modern market-driven financial crisis and the industrial business cycle start in 1825, as the British Industrial Revolution enters its heyday.
The full article can be found at his blog (http://delong.typepad.com/sdj/2010/03/the-maturity-transformation-and-liquidity-transformation-and-safety-transformation-industtry.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+BradDelongsSemi-dailyJournal+%28Brad+DeLong%27s+Semi-Daily+Journal%29&utm_content=Google+Reader).
DeLong's point is that there is no truly safe asset anymore. In theory, the safe asset (government bonds) is used as a measuring rod for risk for all other assets. He says that this is a market failure that requires the government to act as the lender of last resort. I like the history but I am uncomfortable with the argument. What do you think?
Subscribe to:
Post Comments (Atom)
I have two quick observations:
ReplyDelete1) Perceptions of what a safe asset is certainly has changed. Growing up, I remember always hearing that your home is the safest bet there is, real estate values will always go up. Obviously we know that is not true anymore. I'm not so sure that there is a truly "safe" asset, there is risk with anything.
2)Our system needs credit and loans to function. Without any of that, the system freezes. When banks stop giving out any kind of loan, do we have much choice to turn to the only lending body, in his argument, the government? There has to be some way to get credit or a loan.
I agree with Noah, he makes a very significant point on how the system would freeze if people didn't have the options of credit and loans.
ReplyDeleteAlso, I do believe there still are "safe" assets, and specifically one in particular being an Inflationary Bond, which are supposed to cut the inflation risk of an investment.
PS. It is Rob Lindens Birthday Tomorrow, April 1st. Lets all wish him the best.
Like Noah says it is important to remember that there is risk with anything. Even though we as consumers are often making poor decisions because we do not have the proper knowledge of these financial tools, we are in a situation where people have become incredibly stingy and careful with their money. In some ways this is a problem itself if we are not taking risk at some point.
ReplyDeleteHowever, it can be hard not to buy stock or at least save when we can't even get a loan and the dollar is performing weak against other currencies especially the euro. Gold right now may be our only strong asset. I remember when my parents were taking a trip to Paris and it wasn't hard to hedge the dollar against the euro. Even though inflation has been a problem it was so much cheaper for them to take a trip as the dollar wasn't as weak. I guess my point is that the dollar (having been roughly cut in half since 2000) is not a strong asset and we may have further future issues with inflation embedded in it. My question is what will policymakers due to help save the dollar and rid the inflation problem? certainly raising the interest rate high enough to rid some of the inflation could be detrimental to our economy, thoughts?
In the current state of the economy I feel like its hard to pick a "safe asset". Last year while in Dr. Moffit's class government bonds were providing negative returns. If you cant invest in a government backed bond and get your full return then how can you expect to feel like any investment is safe.
ReplyDeleteThere have to be safe assets or there would be no way to measure how risky other investments are, similar to what Ben was saying. Also, on the note of lending coming to a stop - that is what I wrote my SIP on and the outcome is not great. But at some point, you have to side a little with the banks. The delinquincy rate on loans sky rocketed in 2009, so there is a lot of risk involved for banks when giving loans. They do not want to have to be bailed out again, and they are just trying to protect themselves similarly to consumers who are no longer taking high risk investments.
ReplyDeleteI find that people often look at the past in romantic terms. That is to say the claim that "there is no truly safe asset anymore," assumes there ever was a "safe" asset. Since there has been money and investing there has been risk and that is no different today. The difference is that the markets are so much more complex that the risk is much harder to perceive and the real value of assets is sometimes even harder to see.
ReplyDeleteUltimately I have no problem with the government being willing to act as a lender of last resort as long as their lending is that, lending, and not giving. I have no concerns at all with the government providing fair competition in markets that have failed on a large scale as long as they play by all the rules of capitalism and the law and compete fairly.
--Tommy Turner