Treasury Demand and the Role of Stablecoins
The American people realize numerous benefits from the US Dollar being the world’s reserve currency. Because of this status, interest rates are not just lower for the US government, but also for the American people on mortgages, car loans, and other consumer borrowing. Additionally, as demonstrated by recent actions taken against Iran, limiting access to US dollar markets induces other nations around the world to cooperate with the US in economically isolating our adversaries. Reserve status grants the US another tool in its foreign policy arsenal to restrain bad actors, limit national security harms, and restrict illicit finance.
Maintaining this status requires the US to continuously upgrade its systems and regulations to ensure our capital markets are the most liquid, transparent places for international financial institutions to manage risk and store value. It requires creating an environment where companies and countries engaging in trade want to invoice their transactions in US dollars. Despite the US being a counterparty to just ten percent of global trade, nearly fifty percent of such trade is invoiced in US dollars.
For decades, the systems that facilitated dollar-based trade have been networks of correspondent bank relationships and the SWIFT messaging system that accelerates the recognition of transactions by financial counterparties. More recently though, the creation and expansion of blockchain technology has generated a faster, cheaper, more secure mechanism for clearing international trade and facilitating foreign remittances. As Congress demonstrated with the bi-partisan GENIUS Act, policymakers are committed to ensuring that new payment systems continue to be denominated in US dollars.
At the same time, the aging of our population, the global financial crisis, and the COVID-19 pandemic all led to significant increases in federal budget deficits. The US national debt recently passed the $40 trillion mark, with forecasts of multi-trillion deficits necessitating even more borrowing by the US Treasury. While Congress must ultimately address the unsustainable fiscal path by getting deficits below the three percent of GDP threshold Secretary Bessent has called for, elevated debt levels are likely to continue for the foreseeable future.
Development of the stablecoins ecosystem in a way that reinforces the US dollar as the world’s reserve currency and results in a further increase in global transactions denominated in US dollars will provide additional demand for US Treasuries exactly when our fiscal situation necessitates ever greater funding.
How the Treasury market has evolved.
Since the global financial crisis (GFC), federal spending and deficits have climbed significantly. The result, as seen in the figure below, is an increase in the Federal Debt held by the Public to US GDP ratio that now approaches 100 percent, a level not seen since the end of World War II. In dollar terms, the debt held by the public was $5.3 trillion at the beginning of 2008; today it stands at $31.5 trillion.
Source: Federal Reserve Bank of St. Louis
Treasury follows a policy of predictable issuance for long-term Treasury bonds so during times of economic shock necessitating immediate increases in Treasury borrowings, the mix of debt issuance becomes significantly weighted towards T-bills. During both the global financial crisis and the COVID-19 pandemic, new borrowing was almost entirely T-bills, greatly reducing the weighted average of outstanding debt maturity. Following those events, Treasury later increased coupon bond issuance and termed out the debt such that the average maturity today is approximately 71 months (compared to approximately 48 months during the GFC).
There are different clienteles for varying maturity of Treasury issuance. Pension plans and insurance companies are natural holders of long-term bonds whereas US financial institutions and global central banks hold significant T-bills that facilitate international trade conducted by clients of their domestic banks. This practice serves as a form of duration risk management considering that the obligations of pension funds and insurance companies are multi-decade promises whereas institutions offering near-money claims that are immediately demandable require risk-free, highly liquid, short-term reserve assets.
Essential to retaining demand for US Treasury securities is the role of the dollar in international trade. Central banks hold reserve assets intended to hedge their exposures to currency fluctuations arising from providing exchange services to companies and individuals in their countries engaging in trade. A recent Federal Reserve study shows that the portion of international payments in dollars has remained remarkably stable over the past 15 years.
Source: Board of Governors of the Federal Reserve System
That same study demonstrates that the portion of foreign denominated central bank reserves held in US dollars has held around 60 percent for the last 30 years.
Stablecoins and where they are going.
As the global payment system evolves towards blockchain technology, away from correspondent banks, classic money and banking issues arise. Many of the digital currencies that inhabit blockchains are not issued by governments. Users will appropriately question the value and convertibility of digital currencies unless they are sufficiently reserved. Last year, Congress passed legislation requiring US dollar denominated stablecoins that are issued to US consumers be fully reserved by Treasury bills of 93 days maturity or shorter, US currency, deposits at insured institutions, repos, or other like claims.
The two largest issuers, Circle and Tether, hold approximately 85 percent of their reserve assets in T-bills or reverse repos as they generally realize higher yields than currency or demand deposits at banks. To facilitate potential redemptions, the remaining 15 percent is held as deposits at systemically important financial institutions. Even though their cash balances are well above the deposit insurance threshold, they purposely choose banks who in the event of failure, would most likely have deposit insurance extended to all balances.
For stablecoins issued to non-US customers, GENIUS reserve requirements do not apply. They are outside the jurisdiction of the US government and therefore it is left to the regulators of the home country to impose standards. Absent standards, it is left to the potential user of the stablecoin to validate reserve holdings. Recognizing that stablecoins are near-money claims, sophisticated users will require unregulated stablecoins to nevertheless be backed by high quality liquid assets issued in the same currency as the stablecoin’s denomination. Thus foreign issuers of US dollar stablecoins, while not mandated to hold Treasury bills, will still likely hold a significant fraction in them.
Stablecoins and US Debt.
Stablecoins will not alone solve America's fiscal challenges. With an aging population and a Congress unwilling to reform mandatory spending programs that are running massive deficits, Treasury’s need for additional purchasers of its debt is rising. Current holders of the debt cross a number of categories. As compiled by the Peterson Foundation using Treasury data, the current mix of Treasury security buyers include:
Source: Peter G Peterson Foundation
The US Treasury competes with other countries to provide liquid, high quality assets. Demand for that debt arises from their strength as a store of value providing a competitive yield, the ease of trading the securities, facilitating dollar denominated trade, strength of our rule of law, and trust that the assets will not be seized. As a result of our history of conservative fiscal stewardship, the size and strength of our economy, a well-functioning judicial system, and well-capitalized financial institutions, the US has the pre-eminant financial markets in the world.
However, that position is not pre-ordained and will only be sustained if we continue to engage in these practices. Growing debt and geopolitical challenges that result in sanctions are resulting in some investors, particularly China and Russia, moving reserve assets away from US dollar denominated securities. Potentially offsetting declines from those countries is the growing use of stablecoins as safer, faster, cheaper means of international commerce that would create new demand for stablecoin reserve assets. However, that requires ensuring that dollar denominated stablecoins are widely adopted for international transactions like paying trade invoices and foreign remittances. Stablecoins must be seen as an attractive option for users, compared to other payment mechanisms, and rewards are part of that.
Payments evolution is also a national security question.
The dollar's reserve role is an instrument of American power. As Treasury's recent Iran actions demonstrate, sanctioning foreign actors to stop funds flowing to our adversaries can compel changes in behavior. Those sanctions only have bite if the sanctioned entity holds assets at institutions willing to comply with our sanctions or values having access to the financial and goods markets of the west.
For decades, the global financial plumbing was dominated by US institutions transacting in US dollars. Russia’s invasion of Ukraine and sanctions evasion by Iran’s trading partners has resulted in payment infrastructure now being contested. Countries like China may be motivated by reducing US influence on the global economy. Their construction of a global payment system on more modern technology potentially challenges US hegemony. That is why the US must counter the development of updated payment rails by likewise modernizing our financial infrastructure, and GENIUS was the right step: faster, cheaper, safer payments on platforms the United States supervises.
Foreign demand for American-issued stablecoins.
Arguably, there are three important use cases for stablecoins: remittances, international trade settlement, and dollarization in countries poorly served by their own central banks. Moving money abroad for either settlement of trade invoices or sending money to family who are overseas has historically been slow and expensive. Using a system of correspondent bank relationships and secure messaging on SWIFT, banks enable individuals to get money to others in a timeframe of hours to a couple of days, often paying fees of three to five percent of the transaction amount. Modern blockchain technology will do the same thing in minutes at a fraction of the cost. The potential benefits of stablecoins to consumers needing to send money out of the country are enormous.
Similarly transformational, consider a country with a poorly functioning central bank where inflation is rampant. When commerce is conducted in person using fiat money, there is often no choice but to use the domestic currency, despite its poor performance as a store of value. However, as commerce moves digital where even in person transactions are conducted using digital money, the monopoly of the local currency need not exist. Merchants and consumers could readily agree to denominate purchases in a variety of alternative currencies since the transaction isn’t conducted with physical currency. Whereas dollarization of a foreign economy would have previously required transporting physical dollars into the country, today it is accomplished by simply changing the point of sale device at the cash register. Wide adoption of US dollar denominated stablecoins offers billions of people around the world a more stable store of their wealth than their home currency.
Growing utilization of US stablecoins for any of these purposes means more demand for the reserve assets underlying the stablecoins. Transactions that currently occur in Argentinian pesos or Brazilian Real generate no demand for US T-bills. Were those transactions to move to US dollar stablecoins and balances would therefore sit in US dollar stablecoin accounts, that is an entirely new source of borrowing for the US Treasury.
Another use of stablecoins is domestic transactions. While the current US payment system is already fast and relatively inexpensive, stablecoins will compete with existing systems. However, this will likely not generate significant new demand for US securities. Most domestic transactions are conducted using US deposits that are already invested in domestic loans and US securities. Whether those transactions stay on the current networks or move to stablecoins, they do not generate a significant source of new capital for the Treasury to access.
Rewards encourage adoption.
In the current payment architecture, consumers are encouraged to use particular payment vendors because they receive interest on balances (Money Market accounts for instance) or rewards for transactions (credit cards). To be competitive, stablecoins must likewise offer something to users selecting what method of payment to use for their transactions.
While the GENIUS Act outlawed payment of interest, it was silent on compensating stablecoin users with rewards for engaging in transactions using them. Much like banks who pay points or miles on transactions that use their credit cards, some exchanges who enable stablecoin payments likewise reward their users. Lawmakers and regulators must let that competition take place if we are going to have a level playing field where consumer surplus is optimized. Market factors like cost, speed, and security should determine the mix of payment options utilized, not arbitrary market barriers.
The Durbin precedent.
We know what happens when Congress arbitrarily intervenes in the payment system. When the Durbin amendment capped debit interchange fees, debit card transaction rewards were gutted and free checking accounts largely disappeared with them. Roughly 30 percent of debit issuers eliminated or reduced rewards within a year, and most never brought them back. Despite some support in Congress for banning credit card fees, it has not done so exactly because the American people value the rewards programs they are enrolled in. For the exact same reason, Congress should not ban stablecoin rewards.
CLARITY finishes the job.
The GENIUS Act provided a statutory structure for stablecoins that provides confidence to the American people that transacting with stablecoins will be a safe environment for conducting commerce. While the CLARITY Act primarily focuses on non-stablecoin digital assets, the current draft legislation provides statutory confirmation that rewards programs will not be arbitrarily eliminated or restricted by a future administration. In order to fully realize the potential of this new technology, such confirmation in law would greatly enhance confidence in how this new payment system will operate into the future
Conclusion.
Stablecoins are an exciting innovation in the global payment system. By deploying advanced technology, the potential exists to greatly reduce transaction costs around the world, enhancing access and increasing financial security for billions of people. By leading in stablecoin deployment and adoption, the potential exists for creating vast new demand for the reserve assets that back stablecoins. At a time the US is running large budget deficits and some reserve banks are moving away from US holdings, we would benefit from the increase in demand for Treasury bills that would arise from more foreign transactions moving to US dollar denominated stablecoins. Foreign remittances, international trade, and dollarization of poorly managed currencies represent an opportunity for more dollar based economic activity. Backing those transactions would be reserve accounts holding US Treasuries. It is critical that Congress continue creating the statutory architecture for realizing this potential and ensuring that issuers can offer rewards is a critical part of that architecture.
Michael Faulkender
Former Deputy Secretary of the US Treasury
William Longbrake Professor of Finance, University of Maryland