Why are folks buying today’s very low paying bonds or depositing cash at negative real interest rates?   It’s true they’ll be better off with cash if there’s another market collapse.  It’s possible they can sell bonds to a “bigger fool” at an even higher price in future.  But by avoiding the risk of sudden loss they guarantee getting wiped out gradually by even moderate inflation, and most of them will not in real life sell their bonds before the price collapse when interest rates rise.  Fear is preventing them from a rational assessment of risk, fear alone in the case of cash, greedy fear in the case of bonds.

In his 1936 “General Theory of Employment, Interest and Money” Keynes wrote: “If we speak frankly, we have to admit that our basis of knowledge for estimating the yield 10 years hence of a railway, a copper mine, a textile factory, [or etc] amounts to little and sometimes to nothing” and “If human nature felt no temptation to take a chance, no satisfaction (profit apart) in constructing a factory, a railway, a mine or a farm, there might not be much investment merely as a result of cold calculation.”

We cannot eliminate risks, only choose which ones to take.  When we are consumed by fear, we underestimate the impact of avoiding short term risks and of failing to take longer term ones.

How is our government (and others) responding to the current bubble in fear?  With monetary policy, specifically quantitative easing.  By raising the cost of holding safe, liquid assets they hope to encourage investment in more productive and riskier ways because safe assets are, as a result of QE, guaranteed to lose money in the long term.

But Keynes said, and we are now living in such a time, monetary policy can not always overcome a bubble in fear.  If private investors will not invest, he said, governments must.  Because they can spread risk across the whole of society, governments can accept higher risk.  They will not necessarily make better decisions, Keynes said, but state-led investment is necessary for an economy paralyzed by fear.  I cannot fault his logic.  I introduced what looks like the best candidate for such investment, renewable energy, in a previous post about monetary policy and will return to it in more detail.