In response to my post about how the U.S. federal government can borrow and have a higher debt level than for example Spain while having a borrowing cost that is dramatically lower, one reader asked why that is. Well, there are essentially three different factors involved here:
1) Many countries with large external surpluses (China, Saudia Arabia etc.) peg their currencies with varying degree of rigidity to the U.S. dollar, and the most effective way of maintaining that through asset purchases are by buying dollar assets, creating an artificial demand for such assets.
2) Even more important is the self-fulfilling prophecy factor. If an asset is perceived as a "safe haven" then it will become so regardless of its objective qualities. If dog feces for some bizarre reason was perceived as a "safe haven" then suddenly in times of panic, multi billion dollar fund managers would buy large quantities of it. Given the fact that U.S. Treasuries during the last decades yielded worse than almost all other asset classes, the perception that they are safe in any sense except "safe way to lose money" is not much less irrational than regarding dog feces as "safe haven".
Similarly, if it is perceived that there is a risk that Spain for example will default, then its yields will soar, something that paradoxically will reduce demand for its securities since it increases the perceived risk of default, raising yields further in a vicious spiral. The U.S. government has had the luck of being perceived as a "safe haven" while the Spanish government has had the bad luck of being perceived as "risky", setting in motion self-fulfilling mechanisms.
3) The U.S. government is protected by its central bank, the Fed, which has the power to buy potentially unlimited quantities of its debts, while the ECB has only bought limited amounts of debt securities, and by declaring that the purchases will be very limited has failed to stop the self-fulfilling prophecy mechanism.
The reader then asked if the low yields of the U.S. government was a bubble. This can be answered by going through the 3 mentioned factors again. Could Saudi Arabia and the others stop trying to peg their currencies? Of course they could, but they're not likely to do so anytime soon. Could the perception of U.S. Treasuries as "safe haven" change? That is certainly also possible, but we can't know when that happens. Could the Fed stop its potentially unlimited purchases? Yes, as I explained here
, there is a limit to the extent to which central banks can use "the printing presses" to back up their government, namely when they fear the inflationary consequences more than the effects on the governments ability to borrow and spend. The fact that Hungary has again slipped into a fiscal crisis
despite having retained its own currency (the forint) illustrates that when private demand is too weak and the central bank too fearful of inflation, having your own central bank won't stop a fiscal crisis. That could happen in America too, but it's not as long as "Helicopter Ben" is in charge.