By Benjamin Cohen*
With equities slumping, exchange-rate volatility increasing, and political risks intensifying, financial markets around the world have hit a rough patch. During times like these, international investors generally grow cautious and prioritize safety over returns, so money flees to “safe havens” that can provide secure, liquid investment-grade assets on a sufficiently large scale. But there are no obvious safe havens today. For the first time in living memory, investors lack a quiet port where they can find shelter from the storm.
Historically, the safe haven par excellence was the United States, in the form of Treasury bonds backed by the “full faith and credit” of the US government. As one investment strategist put it back in 2012, “When people are worried, all road lead to Treasuries.”
The bursting of the US real-estate bubble in 2007 offers a case in point. No one doubted that the US was the epicenter of the global financial crisis. But rather than flee the US, capital actually flooded into it. In the last three months of 2008, net purchases of US assets reached a half-trillion dollars – three times more than that of the preceding nine months combined.
To be sure, some of these dollar claims were due to the fact that foreign banks and institutional investors needed greenbacks to cover their funding needs after interbank and other wholesale short-term markets seized up. But that was hardly the only reason why portfolio managers piled into the US. Much of the increased demand was due to sheer fear. At a time when nobody knew how bad things might get, the US was widely seen as the safest bet.
But this was before the arrival US President Donald Trump, who has managed to undermine confidence in the dollar to an unprecedented degree. In addition to abandoning any notion of fiscal responsibility, Trump has spent his first two years in office attacking international institutions and picking fights with US allies.
To be sure, even before Trump, confidence in the dollar suffered a blow in 2011, when Standard & Poor’s downgraded Treasury securities by one notch in response to a near-shutdown of the US government. That episode was triggered by a standoff between then-President Barack Obama and congressional Republicans over a routine proposal to raise the federal debt ceiling.
Today, however, investors have even more reason to worry about the US government’s credit rating. In 2018 alone, the US government was shut down three times, and it remains in a partial shutdown to this day, owing to Trump’s demand for funds to build a “big, beautiful” wall on the border with Mexico.
Where can investors go if not the US? The eurozone might seem like a logical alternative. After the dollar, the euro is the world’s most widely used currency. And, taken together, the capital markets of the eurozone’s 19 member states are close in size to the US market. But Europe has troubles of its own. Economic growth is slowing, not least in Germany, and the risk of a banking crisis in Italy – the eurozone’s fourth-largest economy – looms on the horizon.
Worse still is the uncertainty over Brexit, which could prove highly disruptive if the United Kingdom crashes out of the European Union without a divorce agreement. Needless to say, Britain, too, can be ruled out as a safe haven, at least until the Brexit fiasco is resolved.
What about the Swiss franc? Though its attractions are obvious, Switzerland’s financial markets are simply too small to serve as an adequate substitute for the US.
That leaves Japan. With its abundant supply of government bonds, it is the biggest single market for public debt outside the US. The question for portfolio managers, though, is whether it is really safe to invest in a country where government debt exceeds 230% of GDP.
For comparison, the public debt-to-GDP ratio in the US is around 88%; and even in troubled Italy, it is no more than 130%. Admittedly, the market for Japanese government debt is more stable than most, owing to the fact that much of it is held by domestic savers (which is to say, it is safely tucked under the mattress). But Japan is an aging country with an economy that has remained almost stagnant for a quarter-century. Investors would be right to wonder where it will find the resources to continue servicing its massive debt overhang.
And then there is China, with the world’s third-largest national market for public debt. Certainly, the supply of assets in China is ample. But the Chinese market is so tightly controlled that it is essentially the opposite of a safe haven. It will be a long time before global investors even consider putting much faith in Chinese securities.
With secure ports becoming scarce, investors will become increasingly jittery. They will be inclined to move funds at the slightest sign of danger, which will add substantially to market volatility. Today’s rough patch is probably here to stay.
Benjamin J. Cohen is Professor of International Political Economy at the University of California, Santa Barbara, and is the author of Currency Power: Understanding Monetary Rivalry. Copyright: Project Syndicate, 2019, and published here with permission.