US Treasuries are Veblen goods

Thorstein Veblen, 1857-1929

Read: The high price of dollar safety

When the Fed tightens, the bond markets infer that a reduction in the supply of safe dollar assets is imminent. As a result of this supply shift, the marginal willingness of global investors to pay for the safety and liquidity of dollar-denominated assets - as measured by the convenience yield on these assets - increases, leading to an appreciation of the dollar in response to this increase in the convenience yield (even when controlling for interest rates). This is similar to how “Veblen goods" behave. Normally, when the price of a good rises, demand for it falls away until the price stabilises. But with Veblen goods, the opposite happens: rising prices feed demand. Veblen goods are typically luxury items to which (rich) investors are attracted because of their scarcity: making them even more scarce raises demand. So it seems DDSAs are luxury financial assets for which investors fiercely compete. And US Treasuries are the most luxurious of all.

What is a Veblen good? Veblen goods are named after American economist Thorstein Veblen, who first identified conspicuous consumption as a mode of status-seeking in The Theory of the Leisure Class (1899).

If you look at the Daily Treasury Yield Curve, you can see that the yields on US Treasuries drop all along the curve, except for at the short end.  The yield on the 30-year has dropped from 2.44% to 1.96% just this month.  You may think that this doesn't make any sense.  Don't investors want higher yield?  And the answer is NO, they don't want higher yield; instead, they want safety.  And because the price of a bond is inverse to its yield, the price, and what they could sell it for, keeps going up, so they get a return on investment that way.  It's kind of like a bubble - since the price goes up, money keeps flowing into it.  And this is money from all over the world.  And since yields elsewhere are so low, the flow of money will continue, and the yields should continue to drop, and thus the price should continue to increase.  And ironically, since the yield drops and the return drops, the return of dollars will become scarcer and dollars will become more valuable.  Will this continue until the return on the 30-year drops to zero (or even below)?  Maybe, because this has happened in other countries.

How do you fix this situation?  Well, the Fed is engaging in QE again, but this doesn't help because this sucks up the Treasury bonds.  It's not dollars themselves that are Veblen goods, but specifically US Treasuries.  I think the only solution is to increase the supply.  The Fed should start selling off its supply of Treasuries, especially at the longer end.  Yes this will suck money out of the system, and specifically the stock market, but it will increase the supply of Treasuries, causing the price to drop and the yield to increase back to a more normal level.  

The other way is for the US Treasury to sell more bonds, even if it doesn't need the cash.  If they can repress the urge to spend it on stupid stuff, they could amass a war chest of trillions, which they could invest in gold and other assets like foreign currencies, maybe the Hong Kong dollar and Swiss franc.  And maybe this would be currency manipulation, but all is fair in a trade war.  And how about this?  How about investing in the housing market, buying up tax liens (and forgiving them in certain cases), and buying up foreclosed properties and default debt (and forgiving the mortgages in certain cases).  I'm sure it would be fun to brainstorm ways to invest trillions of dollars.  The point is that the Treasury could increase the supply.  But until the supply increases one way or another, the bizarre situation we are in will continue.