notes monday nov 24

November 24, 2008 § Leave a comment

Brad delong writes Ben,

let me explain to you what deleveraging is. When you borrow at a low rate to lend at a higher rate, you’re leveraged. Traditionally, banks do that by borrowing short (through taking in deposits) and lending long, making their money from a positively-sloping yield curve. More recently, they tried other ways of doing much the same thing, setting up off-balance-sheet investment vehicles which had triple-A ratings and could therefore borrow at very low rates while lending to riskier credits in sectors such as subprime mortgages. In a deleveraging, those trades are unwound. The riskier, higher-yielding assets are sold, and your own excessive borrowings are paid down. If the assets have fallen substantially in value, the deleveraging can be associated with large losses. As a result, the one asset class which is absolutely safe from global deleveraging is the Treasury market. No one ever borrowed at low rates to invest in Treasuries, because Treasuries are always the lowest-yielding bonds in the world. No one can borrow cheaper than the US government.

Now it’s possible that foreigners will sell their Treasury bonds for dollars, convert those dollars back into their domestic currency, and start spending at home. That would help to stimulate the global economy, and it might weaken the dollar. A weaker dollar, right now, would be a good thing: it would help US exporters, and no one’s worried about inflation, which often accompanies currency weakness…


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