LOOKING FOR SAFETY IN THE WRONG PLACES / THE WALL STREET JOURNAL ( RECOMMENDED READING )

HEARD ON THE STREET

MAY 20, 2010, 12:32 P.M. ET.

Looking For Safety In All The Wrong Places .

By Richard Barley

What price illusory safety? The spreading euro-zone debt crisis is driving cash into traditional safe-haven assets: the U.S. dollar and Treasurys, U.K. gilts, German bunds and gold. But many of these assets face the same underlying problems as the supposedly risky securities investors are fleeing. And their price levels, with yields on two-year notes in some countries at or close to record lows Wednesday, make them look decidedly vulnerable. Can alternatives be found?

Relative shifts are already underway. Some investors are moving out of euro assets in general, including bunds, and into gilts and Treasurys. In the foreign-exchange markets, Nomura suggests the Canadian and Australian dollars, the Swedish crown and even the Israeli shekel look like better fundamental candidates as safe havens than the U.S dollar, euro and Japanese yen. Some of these countries are now in rate-raising mode, suggesting they have weathered the global financial storm in good enough shape to reengage with normal monetary policy.

But safe havens aren't just defined by their relative riskiness: there is also investor behavior to consider. Today's safe-haven flows are hard-wired into the system, encouraged by the sheer size and liquidity offered by U.S. debt markets and the dollar's global reserve-currency status. While investors may be able to make a cogent case that, say, Brazilian bonds or even equities offer a shelter from a storm elsewhere, those investments will suffer if liquidity in less-developed markets dries up. Liquidity is one of the key attractions of a safe-haven, or "near-money" asset. Another is a market's track record; emerging-market policymakers have a chance to burnish their reputations on this front.

Furthermore, assets deemed "risk-free" play a central role as the benchmark against which other securities are priced. Without safe havens, the cost of capital for companies might rise, with implications for economic growth. True, safe havens may sometimes appear to exacerbate problems precisely because they act as a magnet for liquidity during a crisis. Without them, investors might choose, or be forced, to ride out volatility in their existing holdings, reducing seemingly indiscriminate selling. But without the availability of liquid alternatives to turn to in times of turbulence, investors might not risk putting their cash in equities or high-yield bonds in the first place.

The last time a debate arose over the future of safe havens was a decade ago, when markets feared the supply of U.S. Treasurys could dry up as U.S. budget surpluses stretched into the future. Back then, suggested potential replacements included bonds of Freddie Mac and Fannie Mae, or high-quality tranches of asset-backed securities. No doubt some of today's mooted alternatives will prove equally illusory. But given the risks now posed by an overabundance of U.S. Treasurys and other public debt of advanced countries, investors will rightly wonder if there are no safe havens any more.

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