"The Flight to Quality"

Brad DeLong argues the world wants more safe financial assets, and that governments ought to provide them:

The Flight to Quality, by J. Bradford DeLong, Commentary, Project Syndicate: In late May, the yield to maturity of the 30-year United States Treasury bond was 4.07% per year – down a full half a percentage point since the start of the month. That means that a 30-year Treasury bond had jumped in price by more than 15%. ... This signals ... an extraordinary rise in market-wide excess demand for such assets.

Why does this matter? Because, as economist John Stuart Mill wrote in the first half of the nineteenth century, excess demand for cash (or for some broader range of high-quality and liquid assets) is excess supply of everything else. What economists three generations later were to call Walras’s Law is the principle that any market in which people are planning to buy more than is for sale must be counterbalanced by a market or markets in which people are planning to buy less.

We have seen this principle in action since the early fall of 2007, as growing excess demand for safe, liquid, high-quality financial assets has carried with it growing excess supply for the goods and services... And global financial markets are now telling us that this excess demand for safe, liquid, high-quality financial assets has just gotten bigger. ...

But most of the recent shift has come not from an increase in demand for safe, liquid, high-quality financial assets, but from a decrease in supply: six months ago, bonds issued by the governments of southern Europe were regarded as among the high-quality assets in the world economy that one could safely and securely hold; now they are not. ...

When there is excess demand for safe, liquid, high-quality financial assets, the rule for which economic policy to pursue – if, that is, you want to avoid a deeper depression – has been well-established since 1825. If the market wants more safe, high-quality, liquid financial assets, give the market what it wants.

After all,... a market tells us which things are valuable and thus gives us the signal to make more of them. ... So those governments whose credit is still unshaken ... should be creating a lot more of them. ...

How much should they do? As long as there is a clear global excess supply of goods and services – as long as unemployment remains highly elevated and inflation rates are falling – they are not doing enough. And the gap between what they should be doing and what they are doing grew markedly in May.

This isn’t rocket science or capping deep-sea oil blowouts. These are problems that we have long known how to solve.