One explanation for the “shortage” of safe assets
The U.S. is the main producer of safe-assets in the world and as such faces a downward sloping demand for US Treasuries. In this paper, Choi et al. analyze whether the U.S. internalizes this downward sloping demand curve and exploits its market power when issuing debt. The authors develop a model of the global economy in which U.S. public debt generates a non-pecuniary value for its holders and analyze a) the equilibrium in which the US government is the monopoly provider of this safe asset, and b) the equilibrium in which the US government acts as a price taker. In order to empirically distinguish between the two models they use variation in estimated demand elasticities for US debt during high- and low-volatility regimes and find that the data reject the price-taking behavior in favor of the monopoly one. Finally, Choi et al. quantified the distortions due to this power and found that they are sizable and give rise to a significant underprovision of global safe assets.
Motivated by the growth of private and other sovereign safe assets, we studied the effects of increasing safe-asset competition. One implication of our analysis is that increased competition will alleviate the safe-asset shortage. We also found that while the US issuance of debt is relatively unchanged, the cost of servicing this debt rises sharply. Therefore, increasing safe-asset competition can have significant implications for the sustainability of US public debt.
The Macroeconomic Implications of US Market Power in Safe Assets
Authors: Jason Choi, Rishabh Kirpalani, Diego J. Perez
From: University of Wisconsin-Madison, New York University
The dollar exchange rate and U.S. safe assets
In this paper Jiang et al. develop a two-country, incomplete-market economy where investors in both countries derive convenience utility on their holdings of U.S. Treasuries. Markets are not segmented. All investors can buy U.S. Treasuries and foreign risk-free bonds, while the financial markets for other contingent claims may or may not open, which allows the authors to model a flexible degree of market incompleteness. The convenience yield on dollar bonds enters as a stochastic wedge in the Euler equations for exchange rate determination. They report four findings:
First, the wedges introduced by convenience yields mitigate the pass-through of shocks from the stochastic discount factors (SDF) to exchange rates. As a result, the model-implied exchange rates are not as volatile as in the complete-market model. Second, the covariance between shocks to the bond convenience yield and the SDFs substantially reduces the counter-cyclicality of exchange rates. Third, the bond convenience yield also affects the dollar’s currency risk premium, and as a result generates an unconditional currency expected return that is in line with the data. Fourth, we uncover a connection between quantitative easing and exchange rates via convenience yields, which is distinct from the portfolio channel studied in Gourinchas, Ray, and Vayanos (2021); Greenwood, Hanson, Stein, and Sunderam (2020).
Beyond Incomplete Spanning: Convenience Yields and Exchange Rate Disconnect
Authors: Zhengyang Jiang, Arvind Krishnamurthy, Hanno Lustig, Jialu Sun
From: Northwestern University, Stanford University
