Disaster Economics: Why “Up” is Now “Down”

By Shlomo Maital      


     In physics, matter behaves differently at very high pressure and temperature.  Apparently, in economics, too.

   Writing in the  Financial Times today (July 24), Gillian Tett says “we have entered the world of disaster economics”, where the normal laws of economics move in the wrong direction.  Today, what was “up” is now “down”, and vice versa.

   Tett observes that judging by credit default spreads (a measure of risk), bond markets judge that not only Greek and Spanish bonds are risky, but also German and US bonds.  When bonds are riskier, that should mean that they bear a higher risk premium, i.e. interest rate.  And the higher the yield on bonds, the lower their price.

  Except – that’s not happening.  German and US bond yields have hit multi-year lows, and their price has gone way up.   If risk is up, how come yields are down?  What is going on?

    Tett has a simple explanation.  In normal times, and in normal economics, bond buyers look for a return on their money and seek higher yields.  In abnormal times, like the times we live in now – when it has dawned on the world that there isn’t enough money in all of Germany to bail out Spanish banks, when they fail, not to mention the Italian banks that the failure of Spanish banks will topple, too —  investors are not looking for return or interest, they’re looking for SAFETY of their principal!  And German and US bonds seem safe from default in a global meltdown.  We are seeing an extreme panic and flight to safety, when the laws of economics are suspended. This creates demand for safe bonds, raises their price and lowers their yield, even if they are perceived as riskier day-to-day but safer in case of disaster (global collapse). 

    I find this scary, don’t you?  If the world is built not on money, but on trust, and if fundamental trust is evaporating,  how will the global economy run?  If we don’t trust one another, how will we do business with one another?  And how in the world will lost trust ever be rebuilt?