Sunday 2012-12-23

The Economist has a piece on The Safe Asset Shortage, which scratches the surface of a major global problem, if I may be so bold as to count the worldwide banking system as a problem.

Almost every major global problem can be reduced to a question of how we organize ourselves: what rules we play by, and who enforces those rules. The Occupy Wall Street movement has done at least one good thing in reminding us that these rules are always up for debate, and we can (and sometimes must) change the rules mid-game.

For the last two decades, we have been slowly changing the rules for banks. For better, we have homogenized our expectations of banks. For worse, we have required them to keep defined percentages in certain "safe" assets.

Therein lies the rub. As long as "safe" assets are under- or fairly-priced, this policy will work. However, with today's ultra-low interest rates and correspondingly high prices, one could argue that these assets are actually unsafe.

Still others would argue that these assets were unsafe to begin with, for precisely the same reason that the Economist argues that they are safe. I.e. any government with control of its money supply can debase its currency and destroy the value of its debt.

Safe assets are both readily sellable and retain their value relative to that which we need to buy. The primary function of savings is to move the value of the extra work we have done in the past into the present, preserving (or possibly improving) the ratio at which we exchange that work for that which we need.

In this, inflation is not our great ally keeping our assets "safe" as the Economist implies. Instead, it is one of our greatest enemies.

Keeping this in mind, we should not require our banks to hold certain asset classes when banks can make the claim that other assets would serve them far better. Unfortunately, under the current rules, the regulators seem biased as they are both issuing the "safe" debt, and then requiring their banks to hold that debt.

Perhaps to some these rules seem judicious and sage. Of these, I wonder how many have significant portions of their wealth held in bank stocks.