We Have Entered the World of Disaster Economics

Are the bond markets going mad? It is a question that many investors might ask. For as anxiety has erupted in the eurozone, something striking has occurred with respect to US Treasuries and German Bunds.

If you look at the credit derivatives market – the place where investors judge the risk of bond default – government bonds are getting riskier, not just in places such as Greece but in supposed havens such as Germany, too. Two years ago, for example, the credit default spread on a German Bund stood at 40 basis points – meaning that it cost €40,000 to insure €10m of bonds each year against default. Recently, though, the spread has been well above 100bp, and could rise again if Angela Merkel, the German chancellor, opts for more bailouts. US bonds have also become riskier, judging by credit default swap prices, as Congress remains gridlocked on fiscal policy.

Normally this would imply that bond yields should also rise. After all, classic investment theory suggests that bond prices fall (and yields rise) with higher credit risk. That is exactly what has happened with corporate bonds in recent years, not to mention with sovereigns such as Greece. But in Germany and the US government bond yields have recently hit multi-decade lows. Short-term to medium-term bonds are paying negative real returns.

Why? One explanation is that the CDS market overstates default risk. Another – increasingly popular – idea is that bond investors are complacent about Germany and the US. A thoughtful new paper from Joshua Rosner, the investment analyst, predicts that German bond yields could soon rise as investors wake up to the costs of a eurozone bailout. The gap could also be blamed on deflation fears, a liquidity trap or government meddling (i.e. quantitative easing.)

But another intriguing idea that is creating a market buzz has been advanced by economists at Fulcrum Asset Management (including Gavyn Davies in an FT blog post.) This blames a psychological-cum-generational shift among investors around the concept of “disaster”.

During most of the past few decades, Fulcrum argues, investors and economists did not discuss “disaster” much. Little wonder: if you use the definition of “disaster” advanced by the economist Robert Barro – namely at least a 10 per cent decline in national gross domestic product per capita – there were 58 disasters in the 20th century. But crucially, only two of these occurred between 1950 and 2000; most modern investors built their careers in a world without disaster risk.

It would not be any sort of stretch to say that Disaster Economics is the effluent by-product of a government running on the very precipice of financial Armageddon with only something as nearly imperceptible as a higgs-boson keeping it from fallen into the abyss. It doesn't take a rocket scientist to understand that the "gravity" of debt for the money we owe makes our economic liability as financially dense as a black hole, and those that live on the rim of risk in normal times must endure an even riskier death-defying environment as everything is backed up to the hilt to infinity.

It's living within a financial black hole where the economics is as bizarre, strange,unknown as physics within a cosmological black hole. So if we give credit to Obama for 'Disaster Economics' he also deserves the booby prize for Disaster Politics.

He is master of them both.

We Have Entered the World of Disaster Economics

Yes, this most recent version of man's sad record of economic failure started around 1900 when the federal government began to emerge as something other than the protector of our liberties, with Roosevelt's income tax and the intellectual community's "progressivism". The disaster built up steam in the mid 30's with another Roosevelt's government "solutions" to problems caused by government. The trend toward collectivism and socialist tyranny and bankruptcy is now coming into full bloom with Obama. He's only the latest in a long line of proponents of collectivism and a central command and control economy.

Just a short time ago I read an article where some financial “Wizard” was talking about money flowing to the “safety” of US government bonds backed by the full faith and credit of the United States Government! I felt like puking. It sounded as sane as fleeing to the safety of the eye of a hurricane.

"...money flowing to the “safety” of US government bonds...sounded as sane as fleeing to the safety of the eye of a hurricane."

That is one excellent and true simile (like a metaphor but using one of the words, like or as). Well said, and thanks.

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