Key drivers and challenges of safe assets creation – the special role of public debt

Abstract

Background: Safe assets are defined in a number of ways, emphasizing different attributes and functions. Most commonly, a safe asset is defined as a simple debt instrument that is expected to preserve its value during adverse systemic events (especially in periods of financial turmoil). Due to its characteristics, public debt is recognized as best fulfilling the role of a safe asset. However, as a consequence of both demand and supply-driven factors, the problem of safe asset scarcity in the global economy emerges. The possibility of increasing the supply of safe assets is limited by the fiscal capacity of main global suppliers, namely the USA.

Research purpose: The question then arises how to provide the global economy with the required amount of safe assets while maintaining the sustainability of public debt of their issuers and the required level of safety. These considerations are the main focus of the article.

Methods: Theoretical analyses of safe assets were conducted. We review the recent economic literature on safe assets paying particular attention to public debt as the key determinant of their creation. We discuss attributes of safe assets and show that only public issuers (as opposed to private ones) can provide real safety. By conducting descriptive analysis of key macroeconomic/ fiscal indicators, we show that the capacity of reserve currency issuers, including the United States, to provide safe assets is not limitless.

Conclusions: The results of the research lead to the following conclusions. First, the public sector plays a dominant role in creating safe assets due to their specific functions and attributes. For this reason, the main suppliers of safe assets are countries that issue reserve currencies, the USA in particular, due to its monopolistic position in the international monetary system. Second, the potential of these countries to issue safe assets is limited. This is evidenced by both theoretical considerations (Laffer curve for safe assets, Triffin’s dilemma) and their rising levels of public debt. Third, to maintain global financial stability, it is necessary to replenish the pool of safe assets. China and the euro area could potentially play an important role in this process.