With equities slumping, exchange-rate volatility increasing, and political risks intensifying, financial markets around the world have hit a rough patch. During times like these, international investors generally grow cautious and prioritize safety over returns, so money flees to “safe havens” that can provide secure, liquid investment-grade assets on a sufficiently large scale. But there are no obvious safe havens today. For the first time in living memory, investors lack a quiet port where they can find shelter from the storm.

Historically, the safe haven par excellence was the U.S., in the form of Treasury bonds backed by the “full faith and credit” of the U.S. government. As one investment strategist put it back in 2012, “When people are worried, all road lead to Treasuries.”

The bursting of the U.S. real-estate bubble in 2007 offers a case in point. No one doubted that the U.S. was the epicenter of the global financial crisis. But rather than flee the U.S, capital actually flooded into it.

In the last three months of 2008, net purchases of U.S. assets reached a half-trillion U.S. dollars – three times more than that of the preceding nine months combined.

To be sure, some of these U.S. dollar claims were due to the fact that foreign banks and institutional investors needed greenbacks to cover their funding needs after interbank and other wholesale short-term markets seized up.

But that was hardly the only reason why portfolio managers piled into the U.S. Much of the increased demand was due to sheer fear. At a time when nobody knew how bad things might get, the U.S. was widely seen as the safest bet.

But this was before the arrival U.S. President Donald Trump, who has managed to undermine confidence in the dollar to an unprecedented degree. In addition to abandoning any notion of fiscal responsibility, Trump has spent his first two years in office attacking international institutions and picking fights with U.S. allies.

To be sure, even before Trump, confidence in the U.S. dollar suffered a blow in 2011, when Standard & Poor cut the long-term U.S. credit rating by one notch to AA-plus in response to a near-shutdown of the U.S. government. That episode was triggered by a standoff between then-President Barack Obama and congressional Republicans over a routine proposal to raise the federal debt ceiling.

Today, however, investors have even more reason to worry about the U.S. government's credit rating. In 2018 alone, the U.S. government was shut down three times, and it remains in a partial shutdown to this day, owing to Trump's demand for funds to build a “big, beautiful” wall on the border with Mexico.

Where can investors go if not the U.S.? The eurozone might seem like a logical alternative. After the dollar, the euro is the world's most widely used currency. And, taken together, the capital markets of the eurozone's 19 member states are close in size to the U.S. market. But Europe has troubles of its own. Economic growth is slowing, not least in Germany, and the risk of a banking crisis in Italy – the euro zone's fourth-largest economy – looms on the horizon.

Worse still is the uncertainty over Brexit, which could prove highly disruptive if the UK crashes out of the European Union without a divorce agreement. Needless to say, the UK, too, can be ruled out as a safe haven, at least until the Brexit fiasco is resolved.

What about the Swiss franc? Though its attractions are obvious, Switzerland's financial markets are simply too small to serve as an adequate substitute for the U.S.

That leaves Japan. With its abundant supply of government bonds, it is the biggest single market for public debt outside the U.S. The question for portfolio managers, though, is whether it is safe to invest in a country where government debt exceeds 230 percent of GDP.

For comparison, the public debt-to-GDP ratio in the U.S. is around 88 percent; and even in troubled Italy, it is no more than 130 percent. Admittedly, the market for Japanese government debt is more stable than most, owing to the fact that much of it is held by domestic savers (which is to say, it is safely tucked under the mattress). But Japan is an aging country with an economy that has remained almost stagnant for a quarter-century. Investors would be right to wonder where it will find the resources to continue servicing its massive debt overhang.

And then there is China, with the world's third-largest national market for public debt. Certainly, the supply of assets in China is ample. But there are suspicions about China's control over its domestic market, which has dampened global investors' faith in Chinese securities.

With secure ports becoming scarce, investors will become increasingly jittery. They will be inclined to move funds at the slightest sign of danger, which will add substantially to market volatility. Today's rough patch is probably here to stay.

Copyright: Project Syndicate, 2019

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