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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Pretty Game Theory

This is a really great article about sea slugs. The below point however got me thinking about how they became so beautiful:

Many mobile nudibranchs - vulnerable as they move in daylight between feeding spots—announce their weapons with garish color designs, a palette millions of years in the making. Contrasting pigments make them highly visible against a reef's greens and browns, a visual alarm that turns predators wary—bold nibblers quickly learn to avoid the color patterns that announce unpalatable flesh. Animals able to mimic the designs, including nontoxic nudibranchs and other invertebrates like flatworms, are similarly left alone.

That last sentence made me wonder how free-riders can exist in an evolutionary sustainable equilibrium with the nudibranchs, which in turn made me think about what sort of evolutionary game they must be playing.

There are costs associated with any of these strategies: costs for being poisonous and costs for distinguishing yourself physically. If it is already "known" among predators that a certain body form is poisonous, then there is an incentive for all slugs (and free-riding flatworms) to assume that body plan. However, it becomes similar to the prisoner's dilemma: the more free riders there are, the less chance there is for a predator to pick a poisonous animal of a specific body type. Therefore, predators will begin to start eating those types of animals.

On the surface, it would seem that the evolutionary equilibrium would not really hold in this way. It would not make sense to expend the costs on complex body plans to serve as a signal to predators, since the free-riders would end up watering down that signal and making it useless. Everyone would adopt the lowest cost form and only some would be poisonous.

However, there is another way out of this. If the poisonous nudibranches were to constantly change their body into new and unique forms, then the signal would remain effective. Starting from a point where all slugs look the same and are eaten with the same frequency, their body plans begin differentiating randomly. Those body plans associated with the "poison" genes will begin getting eaten less and less by predators, as predators evolve to avoid certain types of animals. Once the body plan becomes safe, non-poisonous slugs will begin assuming this poisonous body plan. Predators will now start to lose their evolved fear of this type of the poisonous-looking slug. A few poisonous slugs evolving their looks randomly that look even more unique will start this whole process over again.

In short, the evolutionary incentive of the slug is to just get more and more weird and unique. This sort of evolutionary path IS sustainable, and can continue as long as the slugs don't gather too many competitive disadvantages as a result of their accouterments.

Think about that. It's one thing to see the odd things that arose in nature. Imagine knowing that a certain weird animal is only going to continue to get more bizarre. How beautiful is that?

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