The end of safe havens

By Felix Salmon
November 11, 2009
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?

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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.

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