Except that this is not what I mean by a safe asset.





I'm not even sure how to precisely define what I mean by safe asset. Loosely speaking, I'm thinking about an asset that people flock to in bad or uncertain economic times. In normal times, it's an asset that is held despite having a relatively low rate of return, perhaps because of its use as a hedge, or because of its liquidity properties.





U.S. dollars (USD) and U.S. treasuries (UST) are examples of safe assets today. Now, you might think that they're safe because they're close to risk-free in terms of what they promise in the way of a nominal rate of return. A paper USD promises a zero nominal interest rate and you'll be sure to get that if you hold on to the note over time (USD in the form of central bank reserves presently earn 1/2%, but only depository institutions get this rate.). A UST bill also promises zero nominal interest and you can be sure to get that with full principal repayment upon maturity. The coupon payments associated with a UST bond are virtually risk-free.





But that's not a complete way to think about the risk associated with a security. First, economists (rightly) focus on the real rate of return on an asset. Investors don't care how many paper dollars are promised to them in the future. They (presumably) care about the purchasing power of those future dollars. If inflation turns out to be high, that future purchasing power will be low. The opposite holds true if inflation turns out to be low.





As for the "risk free" UST bill, its market price will generally fluctuate between the issue date and maturity date. This is sometimes called "interest rate risk." If you buy a bill that promises $100 a year from now for $99, you will make about 1% if you hold the bill to maturity. But if market interest rates spike up in the interim, and if you are forced to sell your bill to raise cash, you're likely to realize a substantial loss.





That's the thing about a safe asset. It's return can appear to be stable for long periods of time and then--bam--something happens. (Something always happens.) Interest rates may spike up--a sudden sell-off in bonds may occur. What might trigger such an event? All sorts of news. Foreign banks may need to liquidate their foreign reserves consisting of USTs for political or economic reasons. A sudden increase in inflation expectations would lower the expected real rate of return on nominal bonds, inducing a sell-off. A bond sell-off might even be triggered by a good news event. An increase in productivity growth increases the expected return on private capital investment, inducing portfolio substitution out of bonds, for example.









Another thing to keep in mind is that the asset classes that constitute safe assets can change over time. In my recent piece on secular stagnation , I noted that a "flight to safety" seems to occur near regime changes that imply productivity slowdowns. In 1974, investors flocked to gold and real estate--they ran away from USD (rapidly rising price-level) and UST (rapidly rising nominal interest rates). In 2008, the situation was quite a bit different--both USD and UST were highly sought after safe havens (with investors fleeing real estate).

The observations above suggest that the monetary policy regime matters a great deal for whether a fiat currency is perceived to be safe or not. When Nixon and his advisers chose to abandon the gold standard (against the recommendation of Fed chair Burns) in 1971, monetary policy appeared to lose its nominal anchor. So when the oil price shocks and productivity slowdown hit in the early 70s, investors ran away from cash. Gold is often credited as being a safe asset because of its supply "policy." But there must be more to it than this because, like gold, the supply of real estate is not very elastic. And yet real estate was not a safe asset in 2008.





Patience, Grasshopper . I will get to Bitcoin soon. Before I do, I want to ask "what makes an asset safe?" According to Gary Gorton , it has a lot (perhaps everything) to do with information asymmetry

A "safe asset" is an asset that can be used to transact without fear of adverse selection; that is, there are no concerns that the counterparty privately knows more about the value of the asset. (Safe Assets, Working Paper, March 2016).