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US Treasuries Are A Giffen Good


Technically this isn't true. But it's the exact same dynamics: a secondary effect of treasury markets is superseding what you'd think the primary effect would be.

This Business Week article is what originally got me thinking about this. This is what it says happened to treasuries after yesterday's sell off:

Some analysts had worried that Treasury yields would surge after S&P's downgrade. That would happen if investors demanded higher returns to compensate for their risk.

The opposite happened. Treasury yields fell Monday to their lowest level of the year as investors sought a safe place for their cash. Their actions showed continued confidence in long-term U.S. debt.

This got me immediately thinking of the example always used for Giffen Goods. People eat rice and meat. The price of rice goes up. You'd expect less people to buy less rice because of this. But meat is a luxury while rice is an inferior good, and the rise in price of rice makes people so much more comparably poorer that they eat more of the inferior good: rice.

US treasuries are indeed an inferior good. They're seen as a safe haven investment when risk is too high in other markets. This "risk effect" can be compared to the income effect. The S&P downgrade of US treasuries can be compared to the price going up. Under normal circumstances, a downgrade would cause less people to invest in a country's treasuries. But, this downgrade ended up jolting markets so much and rising risk everywhere that people wanted to rush to the safer investment: US treasuries.

To make the comparison clearer I'll bring it back to food. Assume people eat only two things: bread and sushi made from a small, safe, and tasty sliver of an otherwise deadly poisonous blowfish. Now consider what happens if a small percentage of bread is found to be poisonous. You'd expect people to eat less bread now that it's less safe. But, this got people thinking about how much risk they should be taking in their food, and all of a sudden it doesn't seem like such a great idea to be risking your health on deadly blowfish if even BREAD can kill you.

So, paradoxically, as bread becomes more dangerous, people will eat more bread. Giffenish behavior if you ask me!

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