Triffin’s Dilemma and the Global Safety Shortage

As noted in today’s WonkBook, financial market participants do not appear to share the DC political class’s obsession with allegedly unsustainable levels of American debt. Real yields on 5-year and 7-year treasury debt have been negative for a long time and 10-year debt was negative throughout the back half of December. This is intimately related, in my view, to a chart about the decline in quantity of “safe assets” available around the world:

David Beckworth made what I think is the smart point about this, which is that we should understand liquid AAA-rated debt instruments as important because they serve as a medium of exchange in the modern banking system. This is the stuff that gets posted as collateral in the repo transactions (read Gary Gorton’s book for how this works and why it matters) that drive the “shadow banking system.” There’s a binary quality to this. Either an asset class counts as a liquid AAA-rated asset that you can pass around “as good as cash” or it doesn’t. Lots of non-AAA or not-so-liquid bonds are still perfectly reasonable things to invest in, but they can’t be used in the same way as a medium of exchange.

This state of the world has created a new form what’s called the Triffin Dilemma. If countries empowered to issue liquid AAA-securities refuse to do so, then the world suffers a shortage in the medium of exchange with dire economic consequences. But excessive issuance of those assets undermines their “safe” status, which is part of the way we wound up with so many asset classes no longer passing as safe.