The flight to quality: why U.S. Treasury bonds are so beloved.

• Author: Delong, J. Bradford

In late May, the yield to maturity of the thirty-year U.S. Treasury bond was 4.07 percent per year--own a full half a percentage point since the start of the month. That means that a thirty-year Treasury bond had jumped in price by more than 15 percent. So a marginal investor was willing to pay more than 15 percent more cash and more than 30 percent more equities for U.S. Treasury bonds at the end of the month than at the beginning. This signals a remarkable shift in relative demand for high-quality and liquid financial assets--an extraordinary rise in market-wide excess demand for such assets.

Why does this matter? Because, as economist John Stuart Mill wrote in the first half of the nineteenth century, excess demand for cash (or for some broader range of high-quality and liquid assets) is excess supply of everything else. What economists three generations later were to call Walras's Law is the principle that any market in which people are planning to buy more than is for sale must be counterbalanced by a market or markets in which people are planning to buy less.

We have seen this principle in action since the early fall of 2007, as growing excess demand for safe, liquid, high-quality financial assets has carried with it growing excess supply for the goods and services that are the products of ongoing human labor. This is true to such an extent that there is now a 10 percent gap between the global economy's current output and what it would be producing if it were in its normal relatively healthy state of near-balance.

And global financial markets are now telling us that this excess demand for safe, liquid, high-quality financial assets has just gotten bigger.

To some small degree, a change in investor sentiment has induced the rise in excess demand for such assets. After all, we can assume that the animal spirits of investors and financiers has been further depressed as a psychological reaction to the exuberant belief just a few years ago in the powers of financial engineering.

But most of the recent shift has come not from an increase in demand for safe, liquid, high-quality financial assets, but from a decrease in supply: six months ago, bonds issued by the governments of southern Europe were regarded as among the high-quality assets in the world economy that one could safely and securely hold; now they are not.

The argument six months ago in favor of those bonds seemed nearly airtight. Yes, the liabilities of southern Europe's private...