The End of Safe Havens

I’m surprised to see this coming from Ryan Avent:

If everyone is certain that crises are going to be bigger and more frequent, and if everyone is certain that governments won’t be able to afford to bail everyone out the next time around, then shouldn’t everyone be busy limiting their exposure to risk? And shouldn’t that then reduce the likelihood, frequency, and cost of future crises?

Firstly, everyone isn’t certain that crises are going to be bigger and more frequent. To the contrary, there’s a strong urge among a large swathe of the markets to dismiss this most recent crisis as a once-in-a-century event and embrace the notion that we’re getting “back to normal”.

But more to the point, as I’ve said many times in the past, the most recent crisis was in many ways a consequence of precisely what Avent is talking about here — everybody being busy limiting their exposure to risk at the same time. The crisis wasn’t a function of too many people taking on too much risk and then coming a cropper — it was much more a function of too many people being incredibly overcautious and demanding limitless quantities of risk-free triple-A-rated paper.

The fact is that if the rest of the world is out there taking risks, then it’s quite easy for an individual investor to limit their risk exposure and be safe. But if everybody tries to be safe at the same time, that creates the biggest risks of all — and yes will increase the severity of any crisis.

Besides, there really isn’t an easy or obvious way for an investor to be highly risk-averse in this market, not when one of the biggest tail risks that people want to protect themselves against is inflation. Big investors can try taking the Taleb approach of buying large numbers of out-of-the-money options and reckoning that a bunch of them will pay off when the next crisis hits, but that’s not a strategy available to most of us. There’s only downside and no upside in lending money to the US government or your local bank at near-zero interest rates, and buying gold at $1,100 an ounce looks like a crazy speculative momentum play more than a flight to safety.

Personally, I’m quite glad that there’s no obvious safe haven these days: it forces investors to come to terms with the fact that investing, by its very nature, must and should involve taking calculated risks. When people try to flee to safety, markets fail.

Comments

[JudeJin:]

gold is the very obvious safe haven. you just don't get it yet.

Nov 11 01:56 AM

[dingding:]

Your argument is based on the premise that one does not have the option of avoiding risk altogether by staying in cash. It's normally referred to as capital preservation, which is always an option with one's own money. For professional money managers or traders using OPM, it's a different story.

Nov 11 03:44 AM

[La Marque:]

For small investors, it seem to me to be municipals for cash preservation and inflation protection. Everything else seems to be overpriced at this time.

Nov 11 09:47 AM

[untrusting ...:]

You mean there's no risk of purchasing power loss by holding dollars? What do you call that risk? The dollar is down about 15% since March/09 against almost every other currency and most assets in the world. If you don't think so, just go to any other country in the world on business or holiday and see how much more it costs you to buy anything there now.


On Nov 11 03:44 AM dingding wrote:

> Your argument is based on the premise that one does not have the
> option of avoiding risk altogether by staying in cash. It's normally
> referred to as capital preservation, which is always an option with
> one's own money. For professional money managers or traders using
> OPM, it's a different story.

Nov 11 11:51 AM

[user396040:]

You make a very good point. At the bottom, even triple A bonds got slammed. At this point, I personally think that the best option is solid, dividend paying equities (e.g.. PG, T, JNJ, MCD, XOM) that provide a reasonable after tax yield and also provide some protection from inflation.

Nov 11 12:44 PM

[Roger Knights:]

"buying gold at $1,100 an ounce looks like a crazy speculative momentum play more than a flight to safety."

Gold, before its recent rise, had been in an 18-month consolidation pattern. This is a breakout, not a bubble. Looking ahead six months to a year, it might pull back by 10%, but looking ahead five to ten years, it's "safe as houses." Safer.

Certainly it should be a portion of a portfolio, due to its beta-blocker tendency.

Nov 11 02:51 PM

[De Graaf:]

Felix,

Unbelievable, just unbelievable you still don't seem to get that our capitalistic system is infected by debt. There is so much leveraged debt that this is not a one time event.

Because of the linear (high) growth prospects of CB's in developed economies and their misaligned regulatory framework by non-enforcement, the next crisis' will be closer to the next one if we continue on this path.

Humans are obviously unable to comprehend the exponential function related with e.g. steady 5% growth. For a developing economy like China there is way more room for high growth then developed economies. Industrialization is different than advanced societal development that should be based on low growth and sustainability. Think about it.

Inflation isn't the solution. Debt-deflation is a result of monetary mismanagement. Its the remedy consequence of a sick economic development from government involvement.

Stop looking at CPI, and take a look at the total money supply.

Fm = Fb + MV(Fc)

Fiat money = Fm
Fiat base = Fb
Fiat credit = Fc (always at market value!)

Austrian economics Felix. Austrian economics should be your next research topic.

Nov 11 04:40 PM

[a fat panda:]

"it was much more a function of too many people being incredibly overcautious and demanding limitless quantities of risk-free triple-A-rated paper."

Felix, you are right, but you seem to forget the catalyst which was the government letting Lehman's debt go to zero while it bailed-out Merrill's equity. Are you seriously surprised that everyone piled out of risk? When the government picks winners and losers on such a large scale, it is only sensible to move to the sideline.

Nov 11 11:50 PM

[a fat panda:]

"The fact is that if the rest of the world is out there taking risks, then it’s quite easy for an individual investor to limit their risk exposure and be safe."

It is easy to limit the risk. Although it is more difficult to eat on the .05% that you are getting paid to take the limited risk.

So I guess that you are glad that 75 year-old retirees have no safe haven which generates a decent return. Do they need to come to terms with the fact that investing, by its very nature, must and should involve taking calculated risks.

If this sounds too maudlin, keep in mind that many of these people had their incomes cut by 75-80% by the Fed's interest rate policy. Imagine what would have happened on Wall Street if the Fed came in and cut their pay on such scales. There is a difference here. The guy on Wall Street can get another job. The 75 year-old simply has to choose what to give-up.

Nov 12 12:08 AM