Flight to U.S. Treasury Bonds Is Bad News for the Economy
Tuesday, December 2, 2008
If Americans had mattresses big and secure enough to stuff hundreds of billions of dollars into, they wouldn't have to buy U.S. Treasury bonds to keep their money safe.
Instead, nervous investors have fled from stocks, corporate bonds and municipal bonds and run to the safety of the U.S. government, buying Treasury bonds and driving their yields to record lows.
The returns are so low that risk-averse Americans, and many foreigners, are willing to lend the U.S. government money for practically nothing, just to know that they won't lose money by buying something else. The annual yield on two-year Treasury notes declined to 0.91 percent, falling further below the 1 percent level it breached for the first time ever on Nov. 20.
That may be good news for government borrowing, but it's terrible news for the economy, which relies on people's willingness to invest and lend money. And the flight to Treasurys despite low yields means that it will be tougher for the Federal Reserve to encourage new borrowing simply by lowering interest rates.
"The simplest way to think about this is that nobody wants to hold any risky assets," said Adam Posen, deputy director of the Peterson Institute for International Economics. "It's not just the banks hoarding money. Anybody who has money is putting it into Treasury funds."
That is what is making it difficult for the Federal Reserve to revive the economy. "You can cut rates all you want, but if nobody wants to take any risk, no matter how attractive an investment seems to be, no one will put up the capital for it," Posen said.
"It means bad things," said Tim Duy, a former Treasury economist who is now director of the Oregon Economic Forum at the University of Oregon. "Many people would have thought rates this low would be inconceivable because it signals economic conditions far worse than what anyone had ever expected."
Japan went through a similar crisis in the 1990s, when interest rates on government securities plunged and the central bank's lending rate fell to zero in an effort to stimulate private investment. In both Japan then and the United States today, investors' faith in the government's ability to pay its debts made the short-term job of getting them to invest in other things more difficult.
But Posen pointed out that there are differences. The Bank of Japan, fearful that expansionary fiscal policy and expanding money supply could have fueled inflation, was slow to pump up the economy, he said. The Federal Reserve, by contrast, is moving more aggressively and is focusing on creating credit.
Fed Chairman Ben S. Bernanke, who was once derided as "helicopter Ben" for a comment he made about the Fed's ability to drop money from helicopters to prevent deflation, has been spreading money through the economy as if by helicopter, transport planes and freight trucks.
Another difference is that in Japan 15 years ago, savings rates were very high, while in the United States today the savings rate is very low.
"So the issue," said Posen, "is more about trying to convince people that if they're going to save to put the savings back into more risky assets."
One way to do that is to make government securities look like a less-attractive alternative. That was what Bernanke was doing yesterday by announcing that he would buy Treasury securities. Big Fed purchases would drive up Treasury prices and drive down the yields.
One silver lining, Duy said, is that investors' appetite for Treasury bonds makes it cheaper for the federal government to borrow new money to pay for a stimulus package.
Posen agreed. "This is the ideal circumstance for going on a public spending binge."
Staff writer Peter Whoriskey contributed to this report.