Fair warning: this article assumes some technical knowledge of the Fed’s operating framework. If you want to get up to speed on that, I recommend checking out this short primer.

IORB: Subsidy to the banking industry?

Fact or fiction: Since the Fed pays interest on reserves balances of commercial banks, and those reserves are risk-free, isn’t the Fed providing a subsidy to the banking sector, insofar as it’s essentially handing out risk-free revenue to commercial banks? Moreover, it doesn’t have to do this—the Fed operated zero interest on reserves policy (ZIRP) for the vast majority of its existence. Worse still, since interest payments on commercial bank reserves are a cost/expense to the Fed, mechanically reducing what it pays to the Treasury, doesn’t it then follow that taxpayers are indirectly paying for this banking sector subsidy?

Answer: Fiction (given the bank capital requirements that exist).

Many people, including some senators, are very upset about this arrangement. I have heard interest on reserve balances (IORB) described in vivid terms as a serious subsidy to the banking sector at taxpayer expense. This argument is popular, but misguided.

First, paying interest on reserves does not obviously result in a cost to the Treasury. IORB is an expense on the Fed’s income statement, mechanically reducing profits flowing to the Treasury in an accounting sense. By this logic, indeed IORB does cost the Fed. Alas, one must consider the alternative: because banks must, for regulatory purposes, hold High Quality Liquid Assets (HQLA), and there are no binding reserve requirements, banks would need another risk-free HQLA asset with positive yield to hold for regulatory purposes—Treasury securities. In other words, removing IORB would go hand-in-hand with a return to a scarce-reserves framework,1 in which banks would hold Treasury securities instead of reserves, which would shrink the Fed’s balance sheet. Short-term Treasury securities yield about the same—typically a bit more—than reserves at the Fed:

In this sense, the fiscal cost would be the interest on Treasury securities, a direct taxpayer cost. It would likely be a wash, but if Treasury yields are higher than IORB (in other words, in an upward-sloping yield curve world), then the fiscal cost would in fact increase, not decrease.2 This is a fact that even Stephen Miran, a Trump appointee to the Board of Governors and frequent Fed critic, acknowledged in a recent speech at the Bank for International Settlements, noting that it is only optics that differ with respect to IORB (emphasis added):

A consequence of the Fed’s large balance sheet is significant payments of interest to the banking sector. Now, this is little different for banks’ income than if they held Treasurys directly, as would occur in a scarce-reserves regime. In fact, an upward-sloping yield curve would suggest banks would earn more from holding Treasurys rather than reserves. Regardless, the optics differ. Large interest on reserve balances (IORB) outlays may appear like the Fed is unfairly subsidizing the banking system with billions of dollars, even if that’s not the case. These perceptions can affect the Fed’s credibility and thus its effectiveness. Several times now, the Senate has debated whether the Fed ought to be stripped of its statutory authority to pay IORB despite its necessity as a tool for managing the federal funds rate.

Governor Miran has identified the primary challenge of IORB in the political economy arena: it creates the perception that IORB creates a net taxpayer cost, even while in economic fact it makes little difference (and in the long run probably costs the taxpayer less). There is also a relationship between IORB and the Fed’s net profit margin related to its income-producing assets. While the Fed’s profits (or losses) are an incomplete unit of analysis for net fiscal cost, this mechanism is worth considering. Reserves represent one of the Fed’s sources of balance sheet funding. If IORB is lower (higher) than the yield on assets it owns, then it supports positive (negative) net interest margin for the Fed and drives profits (losses). In the long run, this net interest margin should average to around zero (as the Fed holds assets whose maturities approximate its liabilities) or moderately positive.3 If for whatever reason policymakers wished to lower the Fed’s interest expenses on IORB, they could do so without jettisoning an effective monetary policy implementation tool by adopting a tiered reserves system (as numerous central banks currently do) and remunerating only reserves above a certain threshold.

Second, paying interest on reserves does not obviously create a windfall for banks. Banks have to fund reserves with deposits or other borrowing, as they do for all other assets; short-term borrowing costs are little different from IORB. This of course varies over time. In Q4 2025, per the FDIC’s Quarterly Banking Profile, the average US bank cost of funding earning assets was 2.15% versus IORB which averaged 3.92% during that period. However, in Q4 2021, the average funding cost was 0.17% versus IORB of 0.15%. In the long run, banks’ average cost of funding should be moderately higher than IORB since their average funding cost represents a weighted average cost of funding that will be persistently above an overnight maturity and involves credit risk. In other words, while there will be intertemporal variation, in the long run, it should be close to a wash. It is therefore no mystery that while the Fed’s IORB payments soared, banking system profits were more or less unchanged.

Forcing banks to hold reserves and not remunerating them during ZIRP was an implicit tax on banks. To be sure, banks do use and benefit from Fed services (e.g., payments clearing), so this implicit fee may be a reasonable fee to levy, but we should be clear that that’s what it is. This implicit tax was presumably passed along to consumers, who are normal taxpayers like individuals and businesses, and also resulted in distortive and wasteful bank behavior to avoid the tax. In addition to better monetary policy implementation, these were among the reasons that the Fed moved away from ZIRP.4

The bottom line is that a move away from IORB would result in just as much, if not likely more, fiscal cost than IORB, given the alternative scarce-reserves framework and existing regulatory environment. It is the regulatory environment that is the binding constraint, a phenomenon that Governor Miran has termed “regulatory dominance” of the Fed’s balance sheet. So long as liquidity and capital regulations are more or less unchanged, there will be some “fiscal cost,” if you wish, to the implementation of monetary policy. Moreover, a move away from IORB would not obviously represent a cost to banks, which would likely find their net interest margins unchanged.

QE: Taxpayer losses?

Fact or fiction: Since the Fed (1) bought a bunch of assets in QE that it has now made losses on; and (2) pays more (at least until recently) on its liabilities than it does the assets it acquired in QE, thereby making income losses, isn’t it the case that QE has been a net fiscal cost to the taxpayer because of the valuation and income losses the Fed has suffered because of it?

Answer: Almost certainly fiction (but the magnitude is hard to quantify).

QE is a lot of things, but it should certainly win the award for most controversial Fed (or central bank in general, really) policy in recent decades. There’s a lot to talk about with QE, but I’ll focus here on the question of whether QE-induced Fed losses are a net fiscal cost to the taxpayer.

The narrative for why it would be a fiscal cost is laid out above. In short, the Fed has made losses, through two channels: First, it bought assets when rates were low,5 so as interest rates rise, it suffers mark-to-market valuation losses. Second, the Fed pays interest on reserves at a higher rate than it receives interest on the assets it owns (again, by construction), so this results in negative net interest margin.

The total fiscal calculus of QE, though, must account for the three primary fiscal channels through which it works: (1) the effect of Fed losses (or profits) it remits to Treasury; (2) the reduction in Treasury debt servicing costs it creates; and (3) the stimulation of economic activity it engenders (which raises tax revenues). This is not to say that fiscal calculus is straightforward, but it does outline the necessary ingredients for a thorough analysis: a consolidated government balance sheet view.6

An analysis by the nonpartisan Congressional Budget Office (CBO) in 2022 entitled How the Federal Reserve’s Quantitative Easing Affects the Federal Budget, authors conclude (my emphasis):

The net budgetary effects over time of the combined QE and QT [quantitative tightening] policies are uncertain . . . . the effect of QE on the budget in the short run depends on the gap between economic output and potential output. The net effect of balance sheet expansions on the nation’s finances over the long run is difficult to assess and may be positive, negative, or neutral.

Specifically on the question of mark-to-market losses on government bonds (the vast majority of assets purchased by the Fed during QE), we’re again back to neutral on the consolidated government balance sheet. Enter Cecchetti and Hilscher (2024) (my emphasis):

Losses from mark-to-market declines in the value of its government bond holdings do not appear on the consolidated balance sheet of the government. The losses of the central bank are the gains of the fiscal authority, so they are an internal government transfer.

So, we’re left with two countervailing forces here. First, QE losses from government debt assets (substantially all of them) are a wash for the consolidated government, so the magnitude of losses (or gains for that matter) don’t enter into fiscal cost calculus at all. Second, whatever real negative income costs the Fed suffers need to be offset against (1) the growth in the economy QE engenders, and (2) the reduction in Treasury financing costs QE engenders. The CBO study concluded that QE episodes in response to the Global Financial Crisis and the COVID-19 pandemic “initially reduced federal deficits” (emphasis added), while noting that the long-run effects were more uncertain. In other words, it’s very difficult to say.

One must adopt heroic faith in dynamic stochastic general equilibrium models and/or ex post causal inference techniques to have strong convictions on the net budgetary effects of QE in either direction. Simply not knowing the net budgetary effects of QE is perfectly acceptable—indeed the CBO implicitly said that estimating it was too thorny a causal inference problem to tackle. The honest answer about the exact fiscal impact of QE is that we’re not 100% sure, but it’s almost certainly not a net cost.

TGA: Taxpayer subsidy to the Fed?

Fact or fiction: Since the Treasury parks its money at the Fed (instead of at commercial banks) and earns no interest on its deposits, isn’t it providing the Fed a windfall zero-cost liability, essentially loaning the Fed money interest-free, which is a form of subsidy?

Answer: Fiction.

It is true that the Treasury General Account (TGA) is a cost-free liability to the Fed, and cost-free liabilities do mechanically reduce losses in an accounting sense (by simply lowering expenses). So, it is tempting to see the TGA as a backdoor bailout for the Fed. But that is a misleading picture.

From the standpoint of the consolidated balance sheet of the government—the unit of analysis for net fiscal cost—it’s a wash: paying interest on TGA reserves would just be one part of government paying another. This is a point recently made by Governor Miran when discussing the idea of paying interest on the TGA: “it’s a wash on the consolidated government balance sheet; reducing the Fed’s net profits also reduces remittances to Treasury.” Put another way, the Treasury paying interest on the TGA would just be the left hand paying the right. Adding interest to the TGA would be a trivial accounting exercise with no impact on the consolidated government’s balance sheet.

This might matter for optics, but in economic reality paying interest (or not) on the TGA makes no difference to the fiscal-cost calculus.

Fed-Treasury Relationship: Debtor-Creditor?

Fact or fiction: Since the Fed has been running losses and not making remittances to the Treasury, but continues to pay IORB as well as operating expenses (pensions, salaries, etc.), isn’t the Fed essentially borrowing money from the Treasury to stay afloat?

Answer: Mostly fiction, although there’s something to this view.

This would only be effective borrowing if the Treasury were “owed” those remittances and was extending a line of credit to the Fed. When the Fed makes negative profits, it is not functionally borrowing from the Treasury. It does not have a legal requirement to make unconditional remittances; therefore, no money is owed and, as a result, no effective borrowing takes place. It’s simply not making remittances. The law on this issue is clear: the Federal Reserve Act (as amended) (§7a) simply indicates that the surplus of the Reserve Banks over a threshold ($6.825 billion) must be transferred to the Treasury; it says nothing at all about any legal requirement that the Fed provide surpluses above that threshold or indeed operate with any surplus at all. An accurate description of the Fed’s (contingent) liability to the Treasury is a stepwise function: if the Fed makes negative profits, there is no liability toward the Treasury; if the Fed makes profits but those profits accrue to less than $6.825 billion, there is no liability toward the Treasury; if the Fed makes profits and those profits accrue to more than $6.825 billion, then a liability to the Treasury is created in the amount of the Federal Reserve System’s total accrued profits less $6.825 billion.

The 2026 version of the Financial Accounting Manual for Federal Reserve Banks (§11.96—Accrued Remittances to Treasury / Deferred Asset) states (my emphasis):

A credit balance in this [Treasury remittances] account represents the accrued remittances to be distributed to the Treasury. If a Reserve Bank’s earnings become less than the costs of operations, payment of dividends, and maintaining surplus at an amount equal to the Bank’s allocated portion of the aggregate surplus limitation, remittances to the Treasury would be suspended. A deferred asset is recorded in this account, and this debit balance represents the amount of net excess earnings the Reserve Bank will need to realize before remittances to the Treasury resume.

The Fed does not need to borrow from Treasury, either literally or effectively, to make payments on IORB or ONRRP or to pay salaries or operational expenses; as a central bank, it can create the funds to do so (to the limit of creating inflation and compromising on its mandate, to be sure).

Broadly speaking, it is true that, all else equal, fewer Fed remittances to Treasury require the Treasury to increase borrowing (or taxes). But, as noted elsewhere in this essay, not all else is equal: losses from, for example QE, could well be offset by the higher tax revenues and lower interest expenses for the Treasury that it has engendered.

But abstracting from the narrow strictures of the Fed’s specific legal foundations, it is true that, in the limit, the central bank cannot use money creation to fund its operations and framework without creating costly inflation. In this sense, if the central bank has considerable negative equity and wants to operate non-inflationary monetary policy, it would need a capital infusion, which would be provided by the Treasury (or member banks). This is recognized in the Bank of England’s relationship with HM Treasury, and explicit in its operating framework (see BoE-HMT Memorandum of Understanding, pp. 8–10). In the (more likely) case that the Treasury is the capital provider, this relationship would be similar to, but distinct from, a debtor-creditor relationship; the Treasury’s role would be more akin to that of a callable capital provider of last resort. Again, this is essentially the British setup.

In the case that the Treasury had to legally recapitalize the Fed for its losses, the net fiscal effect would still be zero, as noted in Cecchetti and Hilscher (2024), citing Buiter (2008):

Recapitalization of a central bank is in essence a trivial transaction within the government in which the fiscal authority can simply exchange government bonds for central bank equity. As we will see below, this has no impact at all on the consolidated balance sheet of the government. But if one separates the two balance sheets, it does recapitalize the central bank.

Upshot: Partial vs. general equilibrium strikes again

The partial vs. general equilibrium debate is as relevant in central banking policies as it is in any other economic question. In this setting, it manifests as a question of the central bank balance sheet in isolation vs. the central bank balance sheet as part of the consolidated government balance sheet; it is the latter that is informative about true fiscal costs. That is a matter of accounting mechanics and legal truths, but it is equally true in the economic sense: should the Fed execute a policy that costs taxpayers n dollars on its balance sheet and saves them n dollars on the Treasury’s balance sheet, the net fiscal cost is zero. Or, similarly, if the Fed executes a policy that costs taxpayers n dollars, but that the Treasury would otherwise be doing (e.g., IORB vs. Treasury payments on bills and bonds), then the Fed is adding no fiscal cost relative to the baseline. These interplays and netting effects are lost when one focuses on the partial equilibrium of the Fed’s balance sheet in isolation.

What is certainly true is that stakeholders of the Fed—informed citizens, the financial industry, and most importantly policymakers and elected officials—must understand the tradeoffs inherent in monetary policy operating frameworks. The Fed could, and should, do a better job of explaining these frameworks to the public.

The big vs. small debate

Against big

I did my undergraduate degree at the University of Virginia, by all accounts a good state school and a relatively large one. The comparisons have always been to the University of Michigan, or maybe UCLA. But one of the things I struggled with then was the idea that the school was big, that I would be lost in a sea of people. Common advice on campus was to “find the school within the school.” I found this sort of annoying—if we’re paying so much money to be here, shouldn’t it be easy to get attention and resources? But a fight over resources was exactly how it felt. My freshman year advisor was a graduate student in the Religious Studies department (I was hoping to become a chemical engineer at the time). I got some horrible guidance and ended up in a math class I wasn’t prepared for, the most-failed course in the undergraduate course register. Unsurprisingly, I had a bad time. Luckily, I had a good tutor (my now-wife). But it was really a hassle. A lot of time was spent in 300-person lecture halls, which resulted in a learning experience akin to Khan Academy. Some of the negatives of that experience were on me: I should have done my research more, and I was ultimately to blame for enrolling in the wrong courses. But it felt like I was swimming upstream.

Fast forward a few years when I landed at the Jackson School of Global Affairs at Yale and the experience was the polar opposite. With only 100-odd students in the entire school (both classes and dual-degree students) and an immense amount of resources, the resources- and faculty-per-student ratio was quite high. Finding part-time work, research opportunities, and grants was so easy it felt like the default. In two years, not once did I fail to get into a class I wanted. Paid trips to New York, DC, and abroad abounded. Conferences were funded. Even the catering was abundant. Things just felt . . . easier. Part of that is just the Ivy effect, but I felt that I could get my arms around the school in a way that even peers from other bigger schools within Yale didn’t report. From this experience, I concluded that smaller schools had some real value proposition that bigger environments couldn’t quite replicate.

In defense of big

But there’s nuance to this. It’s hard to control for the Ivy effect, and I have a sample size of two. I also saw some serious small-school limitations. Breadth is hard to replicate. My now-wife then-girlfriend at UVA ended up in the architecture school. She commented a number of times that, had we been at a tiny liberal arts school, that simply wouldn’t have been an option for her. And she’s right about that. If a large part of the value proposition of an undergraduate education is to figure out what you want to spend your life doing, then there is serious value to diversity of offerings, and if you want to see “the world,” then school should be as close to a microcosm of that world as possible. Smaller environments will, by definition, struggle to offer that.

The Jackson School managed well in this respect, but only because of a unique arrangement it had made that was somewhat idiosyncratic to Yale. At Jackson, you could enroll in course from other schools. Students had no trouble taking courses at the schools of business, law, environmental science, public health, or the College. This was a serious privilege: business school is expensive, but we were permitted to take whichever courses we wanted under the same Jackson tuition/scholarships. Professors at those other schools could cross-list their courses with Jackson. But it was also a near necessity: course offerings would be too limited at a small school like Jackson, so to get the educational experience the school aimed for, it essentially had to lean on the other schools. In this respect, characterizing Jackson as “small” is a little disingenuous: we benefitted hugely from the big university we also called home.

This model also has drawbacks. Because Jackson isn’t sufficiently large on its own, to attract talent, the school has to mostly offer joint appointments with other departments. So, someone might get a joint appointment at the Department of Economics and the Jackson School. Since tenure tracks are mostly in those “secondary” departments, there is an incentive to spend more of your time in those departments than at Jackson, since they will afford you more publication opportunities. In other words, the “small school within the big school” really needed the big school for it to exist. There are economies of scale and resources that smaller institutions cannot generally replicate, but which are necessary for producing high-caliber research and teaching.

Speaking to high schoolers

When I’m asked from time to time to speak with high school students about their futures, my advice about school size then is basically to not index on size too much. Go where you feel you’ll thrive and where you feel like you’ll be a good fit. I generally gravitate towards smaller organizations, but I found my school within a school at UVA. And if you think you’re a “big school person,” there are ways to broaden your reach within a smaller school. Among the many considerations (not least cost and job prospects), I don’t think size should be highest on anyone’s list of importance. Just go in clear-eyed about the costs and benefits of both models.

What to take and when

Like many Foreign Affairs types (yes, chemical engineering to foreign affairs), I had a pretty generalist education in undergraduate. I specialized after that, during my working time, to focus on the financial system. But even in graduate school, I found myself one semester learning about finding fixers in war zones in the morning and learning about DSGE models in the afternoon. Policy school is by construction pretty generalist, or at least as specialist as you make it. I think I had a pretty standard “policy” education. I looked back over the total six years of school and added up the courses; it came out to roughly this:

• 35% STEM + Quantitative Economics and Finance (e.g., math, computer science, statistics, securities analysis, macroeconomics, etc.)

• 30% Humanities (e.g., history, American politics, international relations, area studies)

• 20% Language Instruction

• 15% Other Stuff (mostly political science, financial history, business, and leadership)

I got the job I wanted, so I guess I can rationalize this approach as having worked, but I don’t think it’s replicable or suitable for everyone. In graduate school, I did tailor my courses pretty considerably to my field. My advice to folks starting out in school is as follows:

Take the “harder” stuff in school, with some caveats

By “harder” I don’t mean difficulty, I mean “hard” as in “hard science” or “hard skills.” This is not because I think they’re more important (actually, in the working world, I think being able to communicate effectively, both verbally and written, is probably the most important determinant of success). It’s because of the marginal value of in-classroom instruction for some fields versus others. Essentially, the question to ask yourself is, “how much easier would X subject be to learn in a formal classroom setting versus on my own by reading or taking online courses?”

I have always enjoyed learning languages, so naturally wanted to take some at Yale. An advisor talked me out of it, and his advice stuck with me (paraphrasing): “You only get 16 classes here; language pedagogy has come a long way, you’d probably get better instruction in a language here than you would at a community college or on Duolingo, but not by that much. In contrast, you can only take a finance class with Jeffrey Garten here.” He had a point: there are certain things that cannot be replicated well outside of a school, and some that we’ve made much more headway with. Consider history for example. If you take a history class at a university, you’ll find that roughly 70% of what you learn is learned through intensive readings, probably another 15% through guided lectures discussing those materials, and another 15% through your writing assignments. From this, it follows that you could probably get roughly within a 70% striking distance of the knowledge from that class by getting a good reading list and going it alone (although the quality of a university reading list is absolutely something of value). Try learning calculus on your own, though, and you’ll find it’s much more difficult. That’s not to say you should only take “quant” classes in school (I clearly didn’t!), but it is to say that you should be mindful about the marginal value-add of a university setting when selecting courses.

The caveats. Caveat one is exploration. This is why I believe liberal arts education is still of tremendous value. If you only ever took “hard skill” classes, we probably would have fewer inspired lawyers and academics (or even just human beings), and that would be very sad. Some of the most inspiring courses I’ve taken have been soft skill small-group classes where you speak with incredible people and make incredible connections; that in and of itself is a marginal value-add of a university that is very hard to replicate.

Caveat two is expertise and connections. If you are at a university with some of the best historians around, you should probably take a class from them, because that marginal value-add is much bigger.

Caveat three is “time in the saddle,” or subjects in which immersion and repetition are hugely important and school provides a straightjacket forcing you to spend that time. This is why I’d still defend taking language courses at a university. They’re often five days a week, one hour a day, plus lots of homework. That’s a bummer for your schedule, but plenty of language pedagogy research tells us that the primary determinant of success in a foreign language is simply time on task. You aren’t likely to be able to devote that amount of work in such a concentrated manner to a language outside of school, but maintenance is a lot cheaper than construction, so learning a language in school and maintaining it after is a lot easier than the other way around.

Pedagogical quality is real, but metrics lag

There is a now-tired debate in academia about whether we should firewall teaching and research. The logic for separating them goes something like this: some people are really good researchers but really bad teachers (or at minimum very disengaged teachers), and there might even be a negative correlation. Even if there’s not a correlation, if someone takes a job for the research, they’ll view teaching as a chore, and that’s unfortunate for students. Let’s self-segregate and have a separate “tenure”-type track for people who are just really good instructors. This is just an application of the specialization of labor principle: don’t force everyone to do everything, let them specialize (teaching vs research) and the result is greater than the sum of its parts. Cards on the table, I have long been pretty persuaded by this argument, but I am tempering my view a bit now.

I have seen first-hand that there are some truly extraordinary people who are both extremely good researchers and extremely good teachers. I ran into a lot of them at Yale, but they’re everywhere. I maintain that they are probably few and far between, but I do have a friend in academia who holds the “latent good” view: that if you’re so good at learning a subject as to become an excellent researcher in it, you’re probably good enough at learning stuff that you can learn to become an excellent instructor, even if you’re not one by nature. My counterpoint would be that there are still institutional incentive reasons that a very good instructor would actively try to avoid teaching (e.g., to rack up publications for tenure), but I take his point. I think there are also important distinctions between undergraduate and graduate schools: you need great researchers available to PhD students, so you can’t really firewall it at that point. That isn’t as applicable to undergraduates, who in any case probably are more sensitive to quality of instruction given their age. I therefore prefer some binning of those two disciplines at least at the undergraduate level, but I’m not partisan about it.

Setting the debate aside, though, one thing that is certainly true is that some people are really good at explaining stuff, and other people aren’t as good at explaining stuff. I don’t know if that’s an innate or a learned thing, but it’s a thing. Over the past couple of years, I have watched two different instructors teach the same topic, and I have seen wildly different levels of success. I watched one instructor spend a confusing ten minutes explaining a topic I saw another instructor explain flawlessly in two minutes with a pithy analogy.

Another observation is that being very good at doing a thing in general does not necessarily correspond to being good at teaching it. The Jackson School is famous for its Senior Fellows, people who are “professors of the practice”: not academics, but decorated practitioners. You can think of former heads of state, or retired generals or admirals or diplomats. Some of them are very successful instructors. Many of them are not.1 This probably points to some amount of support for the hypothesis that teaching is a learned skill.

The challenge for students past and present is that transparency about pedagogical skill isn’t where it should be, and varies considerably from university to university. Both at UVA and at Yale I have seen student- or school-sponsored ranking tables, in which student reviews get aggregated by class and sometimes by professor. I think this is probably the right approach, but in the case of core required classes probably doesn’t do much for you. Outside of those, I strongly endorse using these tools. Universities themselves should take them a bit more seriously in my view, but again, tenured professors have a bit of a “competitive moat,” if you will. My advice to students, though, is to take those rankings very seriously. Even if the class content looks great, if the consensus is that the instructor is terrible, avoid it at all costs.

Is it even about pedagogy?

This perhaps gets at the bigger question of why we have higher education at all. Is it to prepare people for the workforce? If so, via education or via connections? Is it to inspire people and create a thoughtful voting populace necessary for a functioning democracy? Is it not about teaching students at all, but rather about fixing a market failure in provisioning high social-value research (in this case, student fees are essentially a form of revenue that reduces, but does not completely replace, subsidies from the state)?

I’m not in the hard sciences, but I think there’s more to the last question than most Americans give it credit for. Recall that academic research (almost always intimately tied to the government, sometimes directly so) is either the birthplace of or laid the groundwork for nuclear power, nearly every vaccine ever created, the internet, and so on. This is the subject of lots of research (see, for example, research by Mariana Mazzucato, who argues that state-funded academic research and investment has been the engine of American innovation and dynamism). We shouldn’t dismiss the possibility that this is the single largest value-add of higher education institutions in the country. In fact, I’m not even sure we should call them “higher education” institutions, since that name implies that most of their value is in the education rather than the research.

My non-scientific observations of higher education in the United States is that universities are service-providers with a pretty simple revenue model and provide three services. The revenue model includes, to vary degrees, student tuition and fees, state subsidies, investment income, and philanthropic donations. Universities then provide three services, more or less all public goods, all expected to grow the economy in some way:

1. Education: Universities educate students. Most of those students go on to be in the professional labor force, but some become full-time researchers and instructors (PhDs). This is the obvious one. Essentially the social value proposition is more aggregate human capital for the economy (bigger L—human capital—in the Cobb-Douglas sense).

2. Research: Universities produce vast amounts of research with large but hard-to-quantify social value. Some of that research directly spins out into start-ups and private ventures (probably a lot more frequently than many Americans realize). Sometimes, it lays the groundwork for future private ventures many decades later (e.g., mRNA research). Sometimes, it’s only social value (e.g., it’s important to understand how ranked-choice voting impacts democratic accountability and voter preference aggregation, but there’s no marketplace for that knowledge). The social value proposition here is higher aggregate productivity for the economy (higher TFP in the Cobb-Douglas sense).

3. Social Aggregation: Universities bring together interested, bright, ambitious people from different fields in one physical location. In my view, this is probably the least appreciated role of universities and the hardest to quantify. In private markets, we’re kind of sold on why this matters (for example, this is a sizable portion of the value proposition of startup incubators like Y Combinator). The “cross-pollination” phenomenon is also what explains the network effects that drive innovation hubs like Silicon Valley. There is some sorting and matching service here, similar to why people pay (implicitly or explicitly) for professional networking or dating applications. This is the “power of soft connections” that drives so much career progression and future innovation. There is also some indirect talent-acquisition service going on here (e.g., the visiting professor who has a firm and hires some of her best students). Then there’s the post-graduation network effects and signaling efficiencies whereby a university inducts graduates into a professional network that can recruit internally, knowing that some standard has been met by all members. The social value proposition here is also a productivity-enhancing one, mostly about efficient matching and innovation (higher TFP in the Cobb-Douglas sense).

My sense is that the degree to which each service matters varies considerably based on the school and discipline. The production of a doctor or lawyer is almost certainly a human capital improvement gain: someone didn’t know stuff to produce a thing, and now they do. For a post-doc biotech researcher, though, it’s mostly the research component that matters. In policy school, I think it’s probably mostly social aggregation. Find a mid-career highly successful military officer looking to make a pivot and introduce him to leaders in AI, and you’re reasonably likely to get a new entrepreneur in defense tech (I’ve seen this one before). I think that would probably happen regardless of academic courses, although those help. My half-baked take (impression, really) is that universities the world over are pretty good at the education portion, but that American universities are unusually good at the research and social aggregation functions, and that this explains some nontrivial amount of American exceptionalism in innovation.

Higher ed has a marketing problem

Americans seem less and less enthused with higher education. According to Pew Research, seven in ten Americans think higher education is going in the wrong direction. Lots of this appears to be about cost, which, fair enough. But some of it is deeper, which is of no surprise to anyone following the news the past few years. A lot of it is about campus free speech questions.

But these questions are, once again, centered mostly around questions of education, and it seems the media attention and debate writ large mostly set aside the huge social value of university research. For those who are serially bothered by the “bad news” bias (i.e., fear sells better than hope), I have good news for you from an unlikely place: university newsletters. Here is a small smattering of headlines from Yale’s daily newsletter from the month of May:

• “Yale study finds that exercise helps slow tumor growth in mice, and may do the same for humans”

• “New Yale research uses observational data to challenge existing theories about cold dark matter — and may prompt a fundamental rethinking of this critical, unseen cosmic substance.”

• “Tetracyclines are a versatile and popular class of antibiotics, but how they actually work has been poorly understood. Researchers in the lab of Yale’s Christopher Bunick have now discovered how they attack bacteria — findings that could lead to better, safer antibiotics.”

• “In a new study, Yale researchers discovered that the virus responsible for COVID-19 doesn’t linger in the placenta of women who become infected during pregnancy — a finding that offers important insight into the condition known as long COVID.”

• “A newly approved breast cancer drug — developed by New Haven-based biotech firm Arvinas and based on the pioneering research of founder and Yale chemist Craig Crews — will soon be available as a once-daily oral therapy.”

• “A cohort of 15 Ukrainian veterans recently visited campus [Jackson School] for an intensive leadership program designed to build on their battlefield experience — and help them chart their country’s future. Though designed for the Ukrainians, lead instructor Jimmy Hatch ’24, a U.S. Navy SEAL veteran, said the program ‘ended up teaching us.’”

• “How much is the war in Iran hitting Americans’ bottom line? Martha Gimbel, director of the Yale Budget Lab, weighs in”

That’s a lot of social goods for one month of headlines! I imagine that if you compiled these types of newsletters all throughout the country, you might have a different view of the value of universities. It’s a shame they don’t do a better job marketing this.

The great GPA debate rages on

One thing you hear a lot about on Ivy League campuses is lots of angst about GPAs: angst from students about theirs being too low, and angst among faculty and outsiders about them being too high (read: grade inflation). I want to offer some annoyances about the whole concept. (The following is pretty much limited to undergraduate education, since many if not most graduate schools don’t do GPAs anyways.)

Comparing GPAs from curved and uncurved classes is apples-to-oranges. This is a constant source of tension among students, I think reasonably. Some courses are curved, and some are not. Grades, then, are measuring two distinct things: in the curved context, they measure relative performance (and relative to whom is another issue related to selection bias and institutional requirements); in the uncurved context, they measure nominal performance. Being “90% right” then means two very different things—you’re either pretty good at knowing the stuff versus . . . actually, I couldn’t tell you what that means in the context of a curve, because it depends on the curve! Which leads me to . . .

Intra-university departmental variation is a problem. Some universities have different GPA averages by department. This is bad for two reasons. First, it makes GPA as a relative-ranking yardstick less useful: a GPA of 3.5 might be really good for engineering and really bad for political science. Second, it’s distortive: students take into account which courses, or even departments, have lower expected GPAs when choosing classes. Pre-law students are famous for this: they know that they need at least a 3.7 to get seriously looked at by the best law schools, so take the highest GPA courses they can find and use the extra time to prep for the LSAT, which is 100% rational given their incentives, but obviously not optimal in the aggregate.

Inter-university variation is also a problem. One complaint that you’ll hear from non-grade-inflation school students is that, since the Ivies are well-known for their tendency to grade inflate, non-Ivy students are doubly punished: they have a degree from a less prestigious brand and they face lower expected GPAs for the same courses. That is, again, distortionary and suboptimal. Give me a student with a 3.8 from Harvard and a student with a 3.8 from Michigan and I wouldn’t really be able to tell you how to compare them.

GPA does not adjust for difficulty-of-class. Even setting aside expected GPA or curved vs. uncurved, some courses are simply known to be harder than others, in some cases because they’re thorny topics, in other cases because the professor is known to assign a ton of work. Anyone who has been in school recently knows that there are “light-lift” classes, known for minimal work requirements and easy assignments. Student A could load up on these, while Student B chooses to take the most challenging courses on offer. Even if the curves are exactly the same and there’s no intra-university departmental variation in GPAs, the two GPAs wouldn’t really be comparable: Student A spent a lot of time tossing a frisbee and Student B was burning the midnight oil to achieve the same GPA.

I don’t mean to imply that grade inflation is justifiable because there are issues with GPA, nor do I have a brilliant scheme to resolve the issues. But I do mean to say that I would not index very highly to GPAs when assessing a student or job candidate.

The challenges ahead

Universities face two massive challenges in the coming years, both of which will reshape how universities carry out their core functions: AI and a trust deficit.

There are two big AI debates about higher education. The first is about whether we even need higher education (or education at all?) in an era of AI, or AGI. This is highly speculative, obviously. The second is, stipulating that we do still need education, how should university education change to serve the needs of the future. I don’t believe I am sufficiently knowledgeable about AI to talk about it, so I won’t really.

But I do strongly endorse reading this excellent essay by Nils Gilman on AI and the university:

Persuasion

The University As We Know It Is Finished

When University of California President Clark Kerr delivered the Godkin Lectures at Harvard in 1963, published shortly thereafter as The Uses of the University, he was doing something unusual for an academi…

Read more

17 days ago · 427 likes · 7 comments · Nils Gilman

An excellent passage from the essay (my emphasis):

If the post-AI university’s pedagogic value proposition is the formation of cognitive capacity in conditions that cannot be replicated on a screen, then the function and responsibilities of faculty members must also be reconceived. It clearly no longer makes sense for professors to stand in front of a hall full (or, too often, only half full) of students delivering lectures. As a mechanism of information conveyance, AI can now provide the same at near-zero cost, tailor-made to the specific knowledge gaps of individual students. Instead, professors must reconceive of themselves as interlocutors, serving as performative models of how to calibrate uncertainty and revise frames in real time. The classroom experience should focus on helping students to understand how to constitute a goal rather than generate a text in response to a prompt provided by the professor.

And then there is the trust deficit. My own Yale University has made an honest and introspective attempt at beginning to right the ship, by publishing its 58-page Report of the Yale Committee on Trust in Higher Education. The Committee Report, the Gilman essay, and my observations here about the the roles of the university are in good conversation about the constituent roles of the university, and how we’ll have to think about parsing them.

From the Committee Report (my emphasis):

The range of topics revealed another challenge related to declining trust: widespread uncertainty about the fundamental purpose and mission of higher education. Trust is earned by doing what you say you’re going to do—and, ideally, doing it well. In recent years, however, universities have been expected to be all things to all people: selective but inclusive, affordable but luxurious, meritocratic but equitable. Rather than build public support, this diffusion of purpose has contributed to distrust. Without a clear mission and purpose, it becomes difficult to judge whether colleges and universities are living up to their fundamental commitments.

And from Gilman:

Longer term, however, we should expect the disruption caused by AI to be not just pedagogical but to the structure of the university as such. Kerr’s great insight was that the multiversity’s incoherence was not a bug but a feature—that a loosely bundled institution mirrored a loosely bundled society by providing something for everyone, from the Nobel laureate to the newbie grad student, from the NIH grant-seeker to the remedial English student. What held those disparate functions together was a social infrastructure of knowledge transmission: the laboratory, the lecture hall, the examination, the credential. Once AI can provide information delivery at near-zero cost there is no longer a compelling reason why research, teaching, and credentialing need be co-located in the same institution. What will replace the multiversity is likely to be not one thing but several: research centers that focus exclusively on the new-knowledge-production business; independent communal residence facilities that know they are in the coming-of-age business; and teaching systems that are honest about what skills they are inculcating. Even credentials from the most exclusive universities may not retain much social signaling value.

The throughline between the AI challenge and the trust deficit is that universities will need to make clear to the world—and more importantly, to themselves—what they are, and what their mission is. That will involve tackling questions of free speech, affordability, AI-tailored learning, research-production, political bias, and engagement with society writ large. It will not be an easy task, but fortunately there are some smart folks at the helm.

Concluding thoughts

In six years of school—eight of academia generally—I am leaving with fond feelings and a yearning to go back in some capacity. Perhaps what I’ve enjoyed the most about it is the essentialism of it all. I’ve avoided departmental politics mostly, so my experience, both as a researcher and a student, has been largely devoid of the administrative and bureaucratic nonsense that makes working life difficult. Simply learn the thing, publish the paper. No one cared when I worked—a paper written at 3am is the same as a paper written at noon. No one cared where I worked. There were virtually no meetings. The only thing was to understand, and to understand properly. I will forever cherish the days of professors in flip flops taking calls with senators, and teaching whatever and however they thought was best—they understood what actually mattered, and dispensed with the rest.

The challenges are real, though. From AI to concerns about equity and free speech to downright funding, universities appear increasingly in the crosshairs. But they provide a lot more than education to young people; they are engines of productivity and growth, centers for free expression and criticism, hugely important social aggregators, and perches from which to explore the greatest questions we face as a society. Don’t give up on them.

Abstract:

On March 19, 2025, a key Turkish opposition political figure was unexpectedly arrested on what were presumed to be politically motivated charges. In response, the lira depreciated sharply. Meanwhile, Türkiye has a large and active dollar stablecoin market. Using a time series dataset of trade-frequency Tether vs. lira trading, I exploit this natural exogenous geopolitical risk-off event to investigate the response function of stablecoin traders active in Türkiye to this shock. I find that the shock is associated with a large (5.33% ) abnormal depreciation of the lira. Further, I show that the shock is associated with an abnormal widening of fiat-synthetic dollar parity deviation beyond that which is characteristic of standard constrained dealer intermediation. I conclude that this exogenous geopolitical shock had large but short-lived and differential effects on fiat and synthetic dollar-lira markets, suggesting potential dollar market segmentation.

Geopolitical this, geopolitical that—Why should we care?

If you, like me, are somewhat suspicious of annoyed by the term “geopolitical” getting thrown around as an all-purpose modifier these days, you might be healthily skeptical of “geopolitical shocks” and FX arbitrage. Let me sell you on why we should care about geopolitical shocks, and why we should care about using stablecoins specifically to analyze them:

1. Safe-Haven Status: If we care about the safe-haven role of the dollar, then we should see it show up during risk-off events. But, as discussed below, that’s actually tricky for a number of reasons, since often those risk-off events contain other non-risk reasons that there might be price action (e.g., changes in dollar interest rates). So, clean risk-off events are actually pretty crucial to understanding safe-haven characteristics. Those risk-off events need not be purely geopolitical in nature, but for reasons discussed below, it is uniquely convenient if they are as close to purely geopolitical as we can get, for empirical tidiness reasons.

2. Real “pure” geopolitical shocks are actually rare: As previewed above, the issue with many “exogenous shocks” is that actually a lot of exchange rate data—in a covered-interest parity sense—is endogenized in them. As an example, if, I don’t know, the US bombs Iran or something, and you have a major IRR–USD move, you cannot pinpoint that move as a result of only geopolitical shock sentiment, since it also comprises expectations about growth in Iran (massively negative) and about oil price and inflation forwards. In other words, a geopolitical risk-off sentiment is some (probably large) part of the decomposition, but certainly not all of it and we should be worried about interaction effects. If you can identify a shock that’s pretty clean, you then have a nice empirical setup for identifying how much FX movement is driven by risk sentiment and not fundamentals.

3. Stablecoins are useful high-frequency proxies for dollar trading: It is probably somewhat shocking to many, but we actually don’t have very good globally aggregated high-frequency fiat dollar trading data, in large part because most FX trading is done over-the-counter (OTC), so there isn’t one centralized data source. If you make some identifying assumptions (discussed more in the paper), then stablecoins solve this problem for you since the vast majority of stablecoin trades are done via centralized exchanges (CEXs).

FX shock goldmine: Erdogan

So, you want to find a geopolitical shock on exchange rates. Following the first rule of macro (four economies: emerging, advanced, Argentina, and Japan), the second commandment is that if you search for bizarre FX market shocks, you should look to Erdogan’s Türkiye. Conveniently, Türkiye is also a major user of dollar stablecoins; for some related thoughts on this, see previous posts:

In this case, though, it’s better than just his mismanagement of the central bank, it’s downright political thuggery that saves the day (emphasis added here):

At 05:34:58 UTC (8:34:58 a.m. local time), the Associated Press (AP) broke a news story reporting the c. 7:30 a.m. (local) arrest of Istanbul mayor and opposition figure Ekrem Imamoglu, among a group of 100 people, on alleged corruption and terrorism charges, which the AP characterized as “a dramatic escalation in a crackdown on the opposition and dissenting voices in Turkey” (Guzel and Fraser, 2025). Following the arrest, government authorities closed roads and banned protests. Despite these clampdowns, thousands soon protested at what they called a coup attempt. Lawmakers inside parliament also protested, and eventually walked out, disrupting proceedings . . .

This particular shock has three characteristics making it an ideal candidate shock for an exogenous geopolitical event. First, it was truly unexpected. We see no suggestion of anticipation effects in the foreign exchange market or otherwise, and the media reporting itself makes clear that this event was a shock. Second, even if there were some background anticipation of such a geopolitical shock in Türkiye, the timing of this shock was certainly unanticipated, given that the event was by definition a secret dawn raid, known only to those orchestrating it ex ante. As we will see, for our purposes in such high-frequency data, even minutes make a considerable difference in the market, with newsflow being absorbed and priced in within hours. So, even if one could make the argument that some amount of geopolitical risk was anticipated, the randomized timing of the shock within a 24-hour window makes it exogenous to markets. Finally, the shock is free of the interest- and exchange-rate anticipation effects that so often plague geopolitical shocks and introduce endogeneity. While, for example, a military conflict in the Middle East may have geopolitical shock effects on the exchange rate, it almost certainly also has at least two other anticipation effects: (1) an oil shock; and (2) an expectation of a recession and associated policy rate changes (which naturally affect exchange rates via covered interest parity). In this setting, the arrest of Ekrem Imamoglu has no obvious first-order financial or economic implications whatsoever, and so represents a clean risk-off event narrowly associated with geopolitical risk alone.

As a researcher, you don’t often get luckier than a dawn raid. It has long been my dream to exploit a night op for financial knowledge purposes, so I will be retiring now.

Depreciation and the limits of arbitrage

So, what happened?

Lira-fiat currencies

First, let’s set the stablecoins aside for a minute and just look in an exploratory fashion at the fiat currencies:

Gasp! Arbitrage!

Lira-Tether

Now turning to stablecoins, the lira depreciated a ton against Tether (the dollar stablecoin of analysis in this case), which is not that shocking probably:

If you do a cumulative abnormal return (CAR) analysis, you find that the shock is pretty significant, driving a 5.33% depreciation of the lira against Tether in just two hours.

But that’s probably to be expected in direction if not in magnitude. So, the natural question is: did the fiat dollar depreciate the same way?

Lira-stablecoin vs. Lira-fiat (d.b.a. parity deviation or de-pegging)

Answer: not quite. Here’s a picture:

And we can redefine this along with the literature as “parity deviation,” where a value of 1 corresponds to perfect parity; a value of > 1 corresponds to a stablecoin premium; and a value of < 1 corresponds to a fiat premium. Here’s the picture, for the whole month of March (2025):

Gasp! Arbitrage again!

Parity deviation and balance sheet-constrained dealers

So here’s the thing about the scary picture above: we know from the literature that some of this parity deviation is to be expected as a result of balance sheet-constrained dealer firms (CEXs). In other words, it’s not all the shock, which is pretty obvious from looking at the chart: there’s persistent parity deviation between the fiat dollar and stablecoin dollar (read: $1 ≠ $1 in the lira setting) way before any shock.

This poses an empirical challenge: we cannot naïvely show that the shock resulted in this parity blowout, because some of that deviation is already accounted for by the background noise of dealer constraints. To square this circle, we adopt the canonical diff-in-diff and use another EM currency (for which I had sufficient data), the Mexican peso, to show that the shock really did drive the wedge:

So, you arrested a political rival

You might have crashed your currency! I’d like to know how this played out when the coupsters in Niger locked up poor Bazoum in a basement, but the collective nature of the CFA Franc has deprived me of this opportunity. But, look, the upshot is that doing stuff like locking up political rivals actually might in fact matter, at least in the short-term, for markets (to be honest, I was suspicious that would be borne out cleanly in the data).

There are some other questions, namely as to where the missing arbitrageurs are (I assume they’re not actually missing, but that the opportunity isn’t there because of liquidity and fees).

The upshots I think are the following:

1. The lira depreciated considerably against other reserve currencies in response to a sharp exogenous geopolitical shock, and it did so differentially against the dollar relative to other currencies.

2. The lira depreciated against the fiat dollar and synthetic dollar (proxied by Tether), but it did so differentially in a statistically and economically meaningful matter.

3. Further, the breakdown in fiat-synthetic dollar parity was driven by the exogenous geopolitical shock and in such a magnitude that could be not explained by balance sheet-constrained dealers alone.

Different strokes for different folks

I personally interpret these outcomes in total as evidence to support a market segmentation hypothesis. The idea that the folks trading Tether are different than the folks trading the fiat dollar should seem pretty credible: We know that fiat FX trading happens on dealer desks in New York, London, and Singapore; stablecoin trading against the lira pretty much happens when the good people of Istanbul wake up and check their mobile accounts. In other words, fiat FX traders of any given FX pair tend to be more institutional and international; stablecoin traders of that same given FX pair are more likely to be retail traders living in the local-currency country. There are sophistication differences, information velocity differences, rational inattention, and time-zone factors that should make these two classes of trader structurally different.

That’s the theory at least. It’s not testable with the data I have here, so while I provide a factor model for this theory in the paper, it’s hard to prove statistically. The idea in the factor model, though, is that we’ll only really see this market segmentation factor in times of stress. If you’re inexplicably trading Tether-EM currency pairs somewhere and a war starts or something, DM me.

For more detail and charts, see the full write-up.

Background: TL;DR on Senegal’s debt situation

Senegal remains one of the wealthiest countries in the Economic Community of West African States (ECOWAS), and a leader in stable governance, growth, and development in Francophone West Africa. Today, though, it faces a sovereign debt crisis that has been growing for two years. Like many Sub-Saharan African nations, Senegal has had a long history of external borrowing—that is, sovereign debt held by foreigners. Unlike many of its continental counterparts, Senegal has enjoyed broad access to international capital markets and has engaged widely in the regional West African Economic and Monetary Union (WAEMU) debt markets.

The long and short of the current situation is that the previous administration hid a considerable amount of sovereign debt from the public and, incredibly, from the IMF. The current administration called them out on this, but uncovered that the hidden debt was actually quite large (debt-to-GDP of 75% before to ~130% after). The IMF then suspended disbursements from its facility and Senegal was effectively shut out of international bond markets and pushed to source more financing from domestic and WAEMU markets in addition to borrowing from some banks at increasingly strict (including secured) terms. Meanwhile, a “maturity wall” looms, as large groups of coupon payments come due in 2026–2028. Senegal has thus far managed through the crisis by relying on domestic fiscal reforms and leaning more heavily on domestic and regional securities markets. Yet the current situation does not appear sustainable, and pressure is mounting on the government to take larger steps.

Timeline

A timeline is always nifty (2024–today):

• Sep. 26, 2024: PM Sonko2 accuses former Sall government of lying to the public after an internal audit report finds considerably larger public debt stock than was previously reported.

• Oct. 4, 2024: Moody’s downgrades Senegal’s foreign-currency ratings from B1 to Ba3 and places the ratings on a review for downgrade, citing the hidden debt episode and fiscal pressures.

• Oct. 29, 2024: Senegal confirms that the IMF has frozen its USD 1.8 billion program after revelations of accounting scandal.

• Feb. 12, 2025: Senegal’s Court of Auditors publishes its official audit report, revealing government debt significantly understated by previous administration.

• Feb. 28, 2025: S&P Ratings lowers Senegal’s foreign- and local-currency ratings from B+ to B with a negative outlook, citing the newly revealed debt burden.

• March 24–26, 2025: IMF indicates that it will not engage in negotiations for a new program until Senegal has addressed data misreporting and calls for tax and subsidy reforms in light of the audit report debt findings.

• May, 2025: Senegal borrows EUR 350 million from the African Finance Corporation via a total return swap, a type of fixed-income derivative; the borrowing is not publicly disclosed at the time.

• June, 2025: Senegal borrows EUR 300 million from First Abu Dhabi Bank via a total return swap, a type of fixed-income derivative; the borrowing was not publicly disclosed at the time.

• July 14, 2025: S&P Ratings lowers Senegal’s foreign currency credit rating for the second time in five months, from B to B-, its lowest ever S&P rating, citing the nation’s budgetary constraints and debt.

• Aug. 1, 2025: PM Sonko announces an economic recovery plan in which 90% of funding will be sourced domestically, avoiding external debt.

• Sep. 17, 2025: Government source reports to Reuters that Senegal plans to raise USD 180 million in a domestic sukuk and has plans for an international sukuk issuance in 2026.

• Oct. 3, 2025: IMF Managing Director Georgieva says that Senegalese authorities have shown an “admirable commitment to transparency” and that she welcomes Senegal’s request for a new IMF program.

• Oct. 13, 2025: Senegal releases its Medium-Term Debt Management Strategy for 2026–2028, acknowledging that the peak repayment period for Senegal in the medium-term would be between 2025–2028, and identifying the local debt market as a source of financing, particularly in the context of the suspended IMF program.

• Nov. 6, 2025: IMF team visit to Senegal concludes without a deal, with the IMF issuing a positive statement about “laying the foundation for a new IMF-supported program,” while underlining that further steps are needed on reforms to debt-management and the budget. PM Sonko later indicated that during this visit, the IMF urged Senegal to engage in a debt restructuring.

• Nov. 8, 2025: PM Sonko says that despite IMF pressure, a restructuring would be a “disgrace.”

• Nov. 11, 2025: PM Sonko says, “Senegal is a proud nation. We will not be treated like a failed state. Mobilizing tax revenue is better than accepting a debt restructuring.”

• Nov. 13, 2025: Senegalese finance ministry says it’s committed to IMF dialogue and will honor its debt obligations.

• Nov. 14, 2025: S&P Ratings lowers Senegal’s foreign currency debt to ‘CCC+’ citing “precarious” debt position, and places Senegal on a credit watch (signaling a potential future downgrade).

• March 17, 2026: S&P Ratings downgrades Senegal’s local currency debt to ‘CCC+/C’ with a negative outlook, citing heightened debt sustainability risks absent an IMF program and growing budgetary needs.

• March 23, 2026: The Financial Times breaks article that Senegal had in 2025 borrowed EUR 650 million via opaque derivatives in order to avoid default; the story was the first to publicly disclose this borrowing.

• April 15, 2026: Economy Minister Sarr says that Q1 2026 figures from the regional debt market have been supportive of Senegal’s solid macroeconomic fundamentals and should provide optimism for Senegal’s financing resources and the likelihood that Dakar would reach an agreement with the IMF.

• May 6, 2026: Senegalese WAEMU-market 3-year bonds auctions for 8.07%, compared to the 5-year yield at 7.73%, interpreted by some observers as a classic yield-curve inversion signaling concern about Dakar’s looming maturity wall.

• May 23, 2026: President Faye fires PM Sonko, for reasons that some media outlets suggested was driven by long-simmering disputes over economic policy, not least the debt crisis. The Faye-Sonko coalition had long been considered strongly unified, almost one-in-the-same, after Sonko threw his political capital behind Faye when he was unable to run for president himself.

• May 26, 2026: Senegal’s dollar bonds fall as investors digest news of the political turmoil; the nation’s 2031 dollar bond falls to trade at 53 cents on the dollar.

Senegalese Dollar Bonds (via Bloomberg):

Year-End 2025 Macro Situation

Senegal’s debt stock is very large. Among low- and middle-income countries, Senegal has the second highest debt-to-GDP ratio, only lagging war-torn Sudan. According to FDL, of the 36 episodes in which a developing country has maintained a debt-to-GDP ratio over 100% for several years, only a single one resolved without a default or debt restructuring.3 For reference, the IMF in its Low Income Country Debt Sustainability Framework (LIC DSF) considers a present value of external debt to GDP ratio of 55% as the upper limit of sustainable; by FDL estimates, Senegal’s in 2024 was 73%. Senegal’s debt stock is also largely external, with over 61% of debt held by foreigners at year-end 2024. Here’s a picture of the 2025 debt stock:

There is some good news about Senegal’s debt stock. First, its interest costs are relatively low, estimated at around 23% of revenues, compared to interest costs as high as 90% of government revenues for countries such as Egypt, Kenya, and Pakistan (although that figure has grown considerably by now). Due to a large share of concessional financing (59% of external debt is concessional or semi-concessional), Senegal has an effective interest rate of only 4.5% (although it could well rise to 5.5–6.0% in the medium term). Second, thanks to the CFA-euro peg and the large WAEMU regional market, Senegal has limited foreign exchange risk in its borrowing and benefits from reduced inflation risks. Third, while Senegal does face an acute near-term “maturity wall” in 2026–2028, the redemption schedule after 2028 begins to decline considerably, implying that there is space to refinance the “maturity wall” into the future and smooth redemptions while maintaining a sustainable repayment load.

Gambling for Resurrection: Total Return Swap Deals

After uncovering the previous administration’s hidden debt, Senegal furtively borrowed USD 1.3 billion via seven different derivative products that were not considered a formal part of the nation’s debt. Moreover, this debt is senior to existing bondholders. Dakar used a product known as total return swaps to obtain the loans.

What are total return swaps?

In short, they are what they sound like: I own the S&P; you own the DAX; I agree to pay you the S&P returns; you agree to pay me the DAX returns. In practice, it becomes a little more complicated with fixed-income products, because you need to account for two parts of value: the coupons and the market-to-market value of the bonds. In practice, you might offset them in a lump-sum cash payment (i.e., maybe the coupon I’m to receive is 3% but the value of the bond falls 3% in the same period, you might just net that and pay me $0 of cash).

Dakar’s total return swaps (TRS)

For starters, we still don’t know all the details of the transactions. But I’ll try to outline here the contours of the structures generally, based on publicly available reporting and information from someone familiar with the deals who has seen some of the term sheets. An important caveat, though: Senegal does not appear to have used a common term sheet or terminology across its different deals; they are all bespoke.

Illustrative Example: African Finance Corporation (AFC)

1. Senegal issues new 2028 6.3% EUR 500 million Eurobond and provides it as collateral and reference asset for the TRS, taking a 30% haircut, so borrowing against (swapping against) EUR 350 million.

2. Senegal and the AFC enter into the swap for a nominal amount of EUR 350 million: instead of paying its coupon rate, Dakar receives the coupon rate on its Eurobonds (in this case, 6.3%); likewise, the AFC receives (instead of pays) a floating rate of 6-month Euribor + 3.5% (if Senegal’s rating is B3 or above, but it rises if Senegal faces ratings downgrades). If 6-month Euribor has been floating around 2.5%, that leaves the floating rate somewhere around 6%. So, with no valuation adjustments, this is an attractive setup for Dakar: it’s paying something like 6% and receiving something like 6.3%, so potentially even making some money on the TRS interest payments. Note that AFC is getting seniority in this deal, even above existing bondholders (and is also betting that TRSs will be treated as domestic debt, and thus left out of any restructuring . . . they hope).

3. But it’s not just interest payments. At the first settlement date (less frequent than monthly, as it has been for some of Senegal’s other TRS deals), the parties also need to net the valuation gains (losses). Since the bonds are initially valued at par, the chances of any significant upside appreciation in bond prices is limited, but they can fall all the way to zero. So, assuming the bond prices are falling in value, that mark-to-market top-up also gets paid. Depending on the terms, Senegal may also have to provide more collateral in addition to paying the valuation change (unknown in the case of the AFC deal). (Note also that the haircut on the initially issued bond drags the weighted-average cost of the borrowing up, since Senegal is still paying the coupon on the EUR 150 million of the Eurobond that isn’t in the swap.)

This is a leveraged play on Senegal’s own sovereign debt: if the bonds do well or even appreciate, Senegal is borrowing majorly on the cheap, and maybe even making money, but if the bonds decline, Senegal is doubly penalized. Not only will it have to pay the valuation shortfall (the M2M loss), but if its ratings decline, the floating rate it pays also gets ratcheted up. It’s a highly procyclical move.

Clever financial engineering or risky gamble?

Total return swaps such as these have two advantages. First, if the sovereign bonds issued as collateral (and reference asset) hold their value, the swap structure can provide cheap financing. As we’ve seen, this setup (in the best states of the world, at least) allows Senegal to obtain cheaper financing than it could by issuing a Eurobond directly (and note that, in Senegal’s case specifically, since the CFA is pegged to the euro, there’s essentially no risk in the currency mismatch here, making the structure even more attractive). Senegalese Finance Minister Diba said that the deals costed 7%, relative to 11–12% rates on international markets (at USD 1.3 billion, this rate differential would represent up to USD 65 million in savings). For this reason, total return swaps are increasingly popular among debt-laden countries, particularly in Africa, with for example, Nigeria entering into a similar swap with the same First Abu Dhabi Bank just weeks ago. Second, since the structures are technically derivatives, not traditional loans, they can be excluded from debt statistics, thereby keeping such synthetic borrowing confidential. In the example case of the deal with AFC, the AFC even got bespoke enhanced confidentiality clauses into the deal.

Such structures can be costly. If the collateral (in this case, Senegal’s own newly issued sovereign bonds) fall in value, the borrower can be hit with expensive margin calls, requests for further collateral. Just last year, Angola experienced a USD 200 million margin call on its own sovereign debt total return swap deal with JP Morgan. Moreover, since the swap is a total return swap, not merely an interest rate swap, each payment includes two components: the netted interest rate and the valuation change. So, if the market value of Senegal’s newly issued sovereign bonds fall, then it has to pay more in the swap payment.

Total return swaps can be controversial. In Senegal’s case, not only were the structures not disclosed, but they also granted seniority to the swap counterparties over existing bondholders, essentially subordinating other investors without their knowledge. In at least one of Senegal’s deals (with First Abu Dhabi Bank), the risks are even higher than they first appear, because the bank can require immediate repayment if Senegal’s credit falls below a specified credit-rating threshold. At least some of Senegal’s swap deals appear to include other punitive terms, such as the lender’s ability to mark Senegal’s bonds to zero in the event of default. The primary point of controversy has been the lack of transparency about the swap arrangements. While originally (at the time of initiating the swaps) Senegal did not publicly disclose them, Dakar later disclosed that it had borrowed USD 1.3 billion via seven different swap transactions in 2025 after the Financial Times ran an article uncovering EUR 650 million via two swap deals.

Senegal’s Finance Minister Cheikh Diba has said that the deals resulted in up to 500 basis points of cost savings for the nation; mobilized foreign capital “in a way that strengthened [] liquidity and reassured investors”; and that the swaps were disclosed to key stakeholders, including the IMF. In Dakar’s defense, I wouldn’t probably want to publicly borrow either after the disclosure of the hidden debt; some discretion here probably made sense. Nonetheless, resorting to borrowing via complex derivatives in order to keep up with debt service costs is kind of a cry for help.

Political Shakeup: Does it change the calculus?

What to make of the Sonko dismissal?

In a nutshell, the theory is basically that Sonko had long been more militant in his opposition to restructuring (which he views as fundamentally incompatible with his view of economic sovereignty), and that Faye is more flexible on restructuring. The idea is that the departure of Sonko at Faye’s direction means that a restructuring is more likely. Mr. Sonko is the founder and head of the Pastef party (of which Mr. Faye is a member), and is viewed as more populist than Mr. Faye. That narrative seems consistent with the bond market’s reaction, which priced in a 15% haircut restructuring and a five-year maturity extension after the news of Mr. Sonko’s dismissal.

Notably, it is not only Mr. Sonko who is gone; as head of the party, he has also suspended the party’s participation in the newly created Government (i.e., is providing no ministers). (In reality, some backbencher Pastef members are in fact on the list of the new Government, but the heavyweights appear to be staying on the sidelines.) Mr. Sonko remains the head of Pastef and remains opposed to restructuring; he therefore remains a key figure.

The government shakeup matters materially because Dakar plans to reengage the IMF and hopes to reach an agreement on major points by the end of the month. Cleaning house is a way for Mr. Faye to change Dakar’s negotiating posture with the Fund.

Who is Sonko’s successor?

Ahmadou Al Aminou Mohamed Lô is the new PM, and he is a consummate technocrat, a former Secretary General of the Central Bank of West African States (BCEAO) with considerable experience in bank and financial markets regulation. He is known to be a staunch defender of the CFA Franc. He is so much a figure of the technocratic bureaucracy that the government press release announcing the replacement literally says, “a product of the technocracy, he is a specialist in macroeconomics, banking regulation, financial markets. . . .”

The choice of Mr. Lô sends a clear message: Senegal is serious about fixing its external position, and has, for now, rejected the populist path forward (read: is more open to a restructuring). Again, in the government press release, it states that Mr. Lô, “reassured the local private sector, technical and financial partners, and foreign investors” and emphasizes his experience at the BCEAO with Senegal’s Eurobond issuances and relationships with the ratings houses.

Crystal Ball?

Look, first of all, I am not a sovereign debt expert. Also this is definitely not financial advice. But it seems like the bonds have further to fall before this whole thing gets worked out.

On first principles, a country has a debt crisis when there is more debt than there is income to pay back that debt. At first, the government will try to retrench and pull off austerity, but this rarely works, because it’s growth-negative. Pulling back on services and investment just as the economy faces macro headwinds is usually counterproductive. Eventually, the country is left with two choices: default/restructure, or monetize the debt. Senegal does not have an independent central bank, so option two is off the table. That basically leaves us with successful austerity or default/restructuring. History tells us that the latter is more likely.

Of course, the bond prices could already have a restructuring priced in. Last I checked, they were trading in the mid-50s (50 cents on the dollar I mean). I don’t have a scientific debt sustainability analysis for you, but a systematic naïve approach. We know from academic research (Sovereign Haircuts: 200 Years of Creditor Losses) that, considering 200 years of data and 327 sovereign restructurings, the average haircut hovers around 45%. That probably sets a floor since, per the paper, haircuts are higher when debt stocks are high (Senegal’s is huge); and haircuts are higher for low-income sovereigns (Senegal isn’t the lowest-income in Africa by a margin, but the dataset includes high-income countries like Spain that pull the average up). Per the paper (p. 22), from 1815–2023, the average NPV haircut for restructurings in countries with a debt-to-GDP ratio above 72% is roughly 50%. Further, per the paper (p. 24), lower-middle-income countries (of which Senegal is a member) have a mean haircut of around 40% (but with wide variation, ranging up to 80%).

We could use the regression model the paper provides (p. 31), make some assumptions, and get an (imprecise) estimate of expected haircut. If you assume Senegal is the 19th percentile of global income; has a debt-to-GDP ratio of 130%; will have a default duration of six months (probably conservative?); and has a GDP contraction of 6% (probably conservative?), you get a predicted haircut of around 67%. If that’s off by +/– 10%, that gives us a range of 57–77%. Let’s be conservative and say 60%. Look, the R-squared of the model is 0.57—I wouldn’t hang my hat on this thing. But, naïvely, you might expect bond prices to bottom around 40 cents on the dollar.

We’re still early in the restructuring timetable. We’ve got a new PM, and negotiations with the IMF are set to continue on June 8. This is before any real discussion of the TRS, and seems like the first time we have a government in Dakar that is truly open to good-faith negotiations on a restructuring.

Bon courage, Dakar!

The Fed’s balance sheet used to be c. 6% of GDP; at its peak, it has reached 36%. Some folks are very worried about this; others are not. To be sure, this article isn’t an endorsement of shrinking the Fed’s balance sheet to any particular level. But this is a very helpful framing of what has become a charged (well, as charged as central banking can get, which isn’t very) topic: should the Fed shrink its balance sheet? If so, how? This is something Governor Miran talks about frequently (here’s a recent speech in which he cites this very article).

If you stipulate that you’d like to reduce reserves, without even potentially shifting to a scarce-reserves operating framework, then this paper lays out some ways to do that. Here’s a nifty table from the paper:

An aspect that this paper concentrates on—and is completely correct about—is that calibrating the size of the Fed’s balance sheet is not merely a supply question, but also a demand question. Say the authors of the paper on the repo volatility that arose from extended QT:

We cannot conclude from repo volatility alone that the Fed’s balance sheet was unable to be reduced further. If precautionary demand for reserves were lower, it would allow less constrained banks to neutralize shocks by lending into the repo market, which would lower the level of the balance sheet at which repo volatility manifested.

That’s totally right, and something that folks in the financial stability space have been talking about for some time (i.e., if we credit banks’ LCR with discount window access, they may do less precautionary “hoarding,” which would be better for everyone). Here, the authors extend that to the monetary policy framework, which is a helpful and clear connection. There are some interesting proposals, such as operating with the Effective Federal Funds Rate slightly above the Interest on Reserve Balances rate, which would also have the effect of ridding the system of an arbitrage performed by the US branches of foreign banks.

The paper is worth reading in its entirety, but the upshot is basically this line: “Modern monetary policy implementation is defined by the boundaries between scarce, ample and abundant reserves. Those boundaries can be shifted down by modifying the policy landscape, reducing demand for reserves.” Implicit (and explicit in the paper) in that “landscape” is regulatory—often deregulatory—changes. Some of the proposals, such as shifting (at least a sizable chunk of) the Treasury’s cash management from the New York Fed to commercial banks, seem unlikely to gain traction. On the whole, though, these authors have clearly laid out the channels through which shrinkage, even while avoiding a return to a wholesale scarce-reserves framework, could take place.

Seniority, Senegal & Sovereign Creditor Violence. Max Hess. Conflict & Credit.

Some personal bias here, I am a sovereign debt novice (but eager learner/fan) and just happen to have been in Senegal two weeks ago in a meeting with some Western government folks in which I heard all about Senegal’s impending sovereign debt gloom, so this struck me as particularly noteworthy. Some other personal bias, I am a big fan of Max’s work, and if you’re not subscribed to his Substack, you should be:

Conflict & Credit

Exploring economic warfare in the 21st century.

By Maximilian Hess

This article gives color to some “intrepid” reporting (agreed) from the FT about Senegal’s position, which is best described as precarious. Some context: the former administration in Senegal—Macky Sall’s—was found to have hidden considerable amounts of sovereign debt, so much so that the current “auditor government” of Bassirou Diomaye Faye has uncovered debt-to-GDP to be closer to 130% than the roughly 75% reported by Sall’s government. So, bad. But it’s actually worse, because after discovering the hidden debt, Senegal borrowed more. Worse still, the borrowed debt was, in technical terms, crazy. Senegal borrowed via Total Return Swaps (TRS), derivatives that are basically levered positions on Senegal’s own credit. Worse still, these claims are senior to existing bondholders.

Max’s piece is worth a read in full, but I’ll just add from my visit that it felt like a crisis not yet coming to a head. Government folks were certainly aware, but it didn’t feature prominently in many discussions (only one or two), and the main economic complaint seemed to be cost of living. But, like all crises, presumably this will be very slow until it’s very fast. Over to you, IMF.

Stablecoin Flows and Spillovers to FX Markets. Iñaki Aldasoro, Paula Beltrán and Federico Grinberg. BIS and IMF.

As we’ve discussed on this site, the stablecoin-offshore dollar-FX nexus is huge and, in my opinion, probably the most underappreciated angle of stablecoin proliferation. Stablecoins are not just not limited to the US—they’re mostly used and circulated outside of the US.

The authors of this paper, one from the BIS and two from the IMF, show, in a nutshell:

1. that there are deviations of funding costs in obtaining dollars offshore via stablecoins versus traditional methods (swaps), which are correlated with stablecoin flows and local FX depreciation;

2. that the global supply of stablecoin liquidity is segmented (in an arbitrage sense), which allows for the deviations;

3. that a “one percent exogenous increase in net stablecoin inflows raises parity deviations by approximately 40 basis points (bp), depreciates the local currency by 5 bp, and widens the short-term dollar 1 premium by 5-10 bp”;

4. frictions across markets are the main cause of these deviations.

As they put it:

Our findings demonstrate that stablecoin markets are already linked to traditional finance, with spillovers that affect currency stability and funding conditions. This has direct implications for policymakers concerned with monetary policy autonomy and financial stability, particularly in emerging markets where these effects are most pronounced.

Key to the story is this underlying fact: stablecoin provision is being provided by balance-sheet constrained intermediaries that act in multiple different countries. When there’s more demand for currency conversion in country B, that intermediary shifts its provision away from country A, which will create parity deviations in country A, even though nothing in country A has changed. In other words, there is limited conversion capacity, so shifts in global conversion demand exogenous to country A will result in parity deviations there. Hence what they term “cross-market spillover” effects.

It turns out that parity deviations (reminder: when local currency price in stablecoins ≠ the price in fiat dollars) are commonplace. Here’s a nice chart from the paper:

Particularly relevant for policymakers, the researchers find that stablecoin inflows are correlated both with these deviations and with local currency depreciation (a finding I have uncovered in a case study in my own forthcoming research). The authors suggest that this, “provides suggestive evidence that flows into stablecoins are not confined to the crypto ecosystem but can generate tangible pressures in traditional FX markets, potentially by increasing the net supply of the local currency in the spot market as users sell local currency to buy stablecoins.” As the authors note, endogeneity is a concern here: if you think the local currency is going to depreciate, you’d probably move into stablecoins (seemingly the case in my case study, but not necessarily true everywhere, as they show with their causal identification strategy).

To get causal ID, they need to do some fancy causal inference stuff, which they do with a special type of instrumental variable. Sparing the detailed empirics thereof, let’s stipulate that they can identify exogenous stablecoin flows, and they find that they matter a sizable amount (horizon is in days):

Here’s the big takeaway, per the authors (citations omitted, emphasis added):

A positive shock to stablecoin inflows causes an immediate, sharp increase in parity deviations of approximately 40 basis points on impact. This effect is highly persistent, decaying only gradually over the following ten days. The persistence of these deviations is consistent with impaired arbitrage of the type that characterizes segmented markets.

Stablecoin inflows also lead to a statistically significant depreciation of the local currency in the traditional spot market. The magnitude of the effect declines over time and loses statistical significance after a few days. This confirms that shocks originating in the stablecoin market spill over into traditional FX markets, exerting tangible pressure on the local currency.

Finally, the shock to stablecoin inflows causes a significant decline in 3-month CIP deviations, indicating a deterioration in synthetic funding conditions (a higher dollar premium). In contrast, the effect on 12-month CIP deviations is negligible in the short-term and statistically insignificant. This tenor-specific pattern suggests that arbitrageurs’ constraints are more binding at shorter horizons, making short-term CIP deviations more sensitive.

Argentina: What happened with the swap?

So, we have the New York Fed/Treasury FX Operations Report for October–December 2025 (hereafter Report), which I’m just now taking a look at. There’s one very interesting part, which discloses some important bits of the Argentina ESF swap drama we talked about earlier. To recap, the United States provided Argentina a $20 billion swap line through the Treasury’s ESF in September 2025. This is different from central bank (Fed) swap lines, and that’s an important distinction to remember because the operational executor of both types of swaps is the New York Fed (as trading desk for the Federal Reserve and as fiscal agent for the Treasury). Anyways, here’s the Easter egg from the Report (my emphasis):

During the weeks following the local elections, Argentine financial markets faced acute, short-term pressure on both the exchange rate and financial stability. Against this backdrop and in order to stabilize Argentine markets and preserve exchange rate stability, in October 2025, the U.S. Treasury, acting through the Exchange Stabilization Fund (ESF), purchased Argentine pesos in the spot and Blue Chip Swap markets and entered into an exchange stabilization agreement (ESA) with the Central Bank of Argentina (BCRA) for $20 billion. Pursuant to the ESA, in October 2025 the U.S. Treasury, acting through the ESF, and the BCRA executed a swap transaction whereby the BCRA exchanged pesos for $2.5 billion. In December 2025, the BCRA fully repaid the $2.5 billion swap transaction when it matured and the swap transaction was closed. As of end December 2025, no drawings were outstanding under this agreement and the ESF did not hold any pesos.

So, first of all, this is still weird. As we suspected in the earlier note on this, the intervention was at least partially driven by ideological affinity for Mr. Milei’s politics, and this report is pretty clear about that, citing the local elections Mr. Milei’s party faced. If you swapped in Malaysia for Argentina, everyone’s eyebrows would be raised.

Second, we got disclosure of the direct (and derivative) peso purchases. We don’t know how many were purchased, but we know they unwound the transactions pretty quickly. Third, we got the swap amount disclosed: $2.5 billion of $20 billion available for no more than ~3 months. The BCRA disclosed the operation and its conclusion two weeks ago. We also know that, after obtaining $2.5 billion through the Treasury swap, the BCRA, on January 7, 2026, obtained $3 billion by borrowing in the repo market against its dollar-denominated bonds, evidently to make a bondholder payment coming due on January 9.

The other bit I missed that happened in October was that the US provided Special Drawings Rights (SDRs) to Argentina so that it could make an interest payment to the IMF (if you don’t know what SDRs are, check out the primer). (Somewhat confusingly, a CRS report said that the US provided “dollar liquidity support to Argentina through transactions in international reserve assets held at the IMF,” but in fact the transaction was a sale of SDRs from the US perspective in exchange for dollars.)

From the October 2025 ESF Financial Statement (my emphasis):

The Special Drawing Rights Act of 1968 authorizes the United States to purchase, sell, and hold Special Drawing Rights (SDRs) through the Exchange Stabilization Fund "ESF". In October 2025, Treasury, through the ESF, sold SDR 641 million to Argentina in exchange for $872 million. The proceeds from the sale were invested in Nonmarketable U.S. Treasury Securities. As of October 31, 2025, U.S. SDR Holdings were SDR 127 billion. Changes in both SDR Holdings and SDR Allocations reflect changes in the foreign exchange rate.

So, my read is that (1) in October the BCRA draws ($2.5 billion) dollars from the ESF swap; and then (2) swaps back $872 million of that for SDRs to make its IMF payments; and finally (3) unwinds the swap transaction in December.

I don’t know, I can’t keep up with Argentina, but it looks like this has settled for now (?). Will we get more details on the ESF swap? Why didn’t the BCRA use it for the $3 billion it got from the repo market? What’s the rate on this thing?

Tokyo Drift?

If you were unfortunate enough to be on X (the artist formerly known as Twitter) or, even worse, LinkedIn, late last month, you’d know that folks online were talking about the New York Fed performing “rate checks” on USDJPY. (I even saw one crypto person claim, incredibly, that the Fed might “crash the dollar by 50%.”) Rate checks are basically when a central bank asks to get quotes on an exchange rate from commercial banks, sometimes allowing or instructing them to let the market know they might be mulling an intervention (i.e., to some degree jawboning the exchange rate). Now that we have the minutes from the January FOMC meeting, we do have the disclosure of this happening (my emphasis):

In the days leading up to the meeting, the dollar had depreciated markedly after reports that the Desk had made requests for indicative quotes, known as "rate checks," on the dollar–yen exchange rate. The manager noted that the Desk had requested those quotes solely on behalf of the U.S. Treasury in the Federal Reserve Bank of New York's role as the fiscal agent for the U.S.

And then, Scott Bessent said the US would “absolutely not” intervene in the yen and reiterated the time-tested strong dollar policy. Oh well, so much for the drama. Hopefully nobody reading this got caught going the wrong direction in a USDJYP trade (sorry if you did, it seemed reasonable). So, what is Treasury’s dollar policy?

Nothing much happens

Things in the rest of the world seemed quiet, according to the Report. We’ll all be glad to hear that offshore dollar funding markets are in rude health. Carry traders are at it again in EMs. One other interesting thing happened recently, though, outside of the Report at hand: there was some FIMA Repo activity: balances were up in the first week of February to $3 billion. Here’s a chart:

I am unaware of any public reporting on this or any chatter, so my guess would be that this recent draw was pretty routine—if so, good to know the pipes still work.

Readers will be familiar with the concept of central banks acting as international lender of last resort (LOLR), providing their currency to foreign monetary authorities when in need. The story of post-World War II financial history has been mostly about Federal Reserve swap lines, given the dollar’s status as the world’s international reserve currency. However, there is a second reserve currency, often underappreciated, the euro. And there is also another form of foreign currency LOLR—foreign currency-denominated repurchase agreements (repo).

We’ve talked about this nearby, but essentially a swap line is when central bank A lends its currency to central bank B and takes central bank B’s currency as collateral (e.g., the Fed lends dollars to the Bank of Japan and takes yen as collateral). A foreign currency (FX) repo is when central bank A lends its currency to central bank B and accepts some “hard” collateral (usually sovereign debt denominated in central bank A’s currency; e.g., the Fed lending dollars to the Brazilian central bank and accepting US Treasury securities as collateral).

The most well-known FX repo facility is the Fed’s FIMA Repo facility, which lends dollars to foreign monetary authorities, taking Treasury securities as collateral. It is, like the Fed’s swap lines, staffed and operated by the Federal Reserve Bank of New York, and has had some recent activity. Somewhat famously, the Swiss National Bank drew on FIMA to provide dollar liquidity to Credit Suisse.

EUREP: silent second

The European Central Bank (ECB) has its own version of FIMA Repo, called the Eurosystem’s repo facility for central banks (EUREP). I published a research paper on EUREP back in 2023, when I felt I was probably one of ten people outside the ECB who knew or cared about it. In contrast to the Fed, the ECB maintains three lines of liquidity defense: swap lines, bilateral repo lines, and EUREP. At least in 2023, the main recipients of the bilateral repo lines were Euro Area-adjacent (e.g., Albania, North Macedonia, etc.). EUREP’s collateral schedule was also narrower than that for the bilateral repos. Counterparts to EUREP are not disclosed by the ECB (though individual other counterparts might voluntarily disclose, as was the case then with the central banks of Kosovo and Montenegro1). For details on the facility, please see the aforementioned paper and the ECB’s website on its liquidity lines.

Source: ECB

Emergency liquidity for new geopolitics?

In a story covered by Central Banking, the ECB announced on Saturday (Feb. 14) that it would “enhance” EUREP. Here’s the meat of the language of that press release (with my emphasis):

The Governing Council of the European Central Bank (ECB) has decided to enhance the Eurosystem repo facility for central banks (EUREP) to make it more flexible and effective in supporting the smooth transmission of euro area monetary policy.

Under EUREP, the Eurosystem provides backstop euro liquidity to non-euro area central banks against high-quality euro-denominated collateral, with appropriate risk mitigants. The updated framework introduces standing access, in principle, for all central banks, unless excluded on the grounds of, in particular, money laundering, terrorist financing or international sanctions. The framework will enable central banks in jurisdictions outside the euro area to address risks of euro liquidity shortages swiftly. These changes aim to make the facility more flexible, broader in terms of its geographical reach and more relevant for global holders of euro securities.

Since EUREP was first introduced in 2020, the world economy has undergone profound structural shifts related to geopolitics and changes in the international financial system. These shifts have altered the dynamics of global trade and financial integration and suggest that the macroeconomic and financial environment will remain uncertain and potentially more volatile. More frequent financial disruptions and possible knock-on effects on euro area financial markets have the potential to hamper the smooth transmission of monetary policy.

Liquidity lines such as EUREP help support the smooth transmission of monetary policy in the euro area. They help mitigate potential negative spillover effects on euro area financial market conditions by addressing risks of disruptions in euro-denominated funding markets outside the euro area. In the context of greater fragmentation and uncertainty, Eurosystem liquidity facilities like EUREP will continue to ensure the timely, consistent and broad provision of backstop funding for central banks.

EUREP complements the ECB’s swap lines, which remain unchanged.

Now, it’s worth revisiting why the ECB has euro liquidity lines at all. The straightforward answer should be financial stability, which it mostly is: per the ECB, the cited motivations for maintaining central bank liquidity lines are to combat “market dysfunctions,” and to be used as monetary policy instruments. But, importantly, also because “they strengthen the role of the euro in international financial markets, thereby further enhancing the effectiveness of ECB monetary policy transmission” (my emphasis).

Look, if I were Europe, having just stared down the barrel of a potential American military invasion of European territory, I would probably be thinking that “structural shifts related to geopolitics” is a conversative way to put it. Note also the date of the press release, which overlapped with the Munich Security Conference. Indeed, this was not a coincidence. As Central Banking reported, ECB President Christine Lagarde gave a speech at the Munich Security Conference on the same day as the ECB press release, opening a roundtable titled “Chain Reaction: Navigating Geoeconomic Shifts and Dependencies.” Here are some excerpts (my emphasis, bolded):

What does this mean from the ECB’s perspective? Let me focus on one key initiative.

The ECB needs to be prepared for a more volatile environment. As industrial policy becomes more assertive, geopolitical tensions rise and supply chains are disrupted, financial market stress is likely to become more frequent.

We must avoid a situation where that stress triggers fire sales of euro-denominated securities in global funding markets, which could hamper the transmission of our monetary policy. And this means we have to give partners who want to transact in euros the confidence that euro liquidity will be available if they need it.

That is why, last week, the Governing Council decided to expand our EUREP facility – our standing facility that offers euro liquidity against high-quality collateral.

This expanded facility provides permanence: central banks outside the euro area can now rely on continuous access to liquidity in euros, not just temporary lines.

It extends scope: we move from a regional to a global perimeter. Any central bank that meets basic criteria can request access, with flexibility on usage.

And it ensures agility: access is granted by default unless there is a reason to restrict it, speeding up the provision of liquidity.

This facility also reinforces the role of the euro. The availability of a lender of last resort for central banks worldwide boosts confidence to invest, borrow and trade in euros, knowing that access will be there during market disruptions.

In a world where supply chain dependencies have become security vulnerabilities, Europe must be a source of stability – for ourselves and for our partners.

That, too, is part of European security. And that is how the ECB plays its part.

So, yeah, this is basically about geopolitics and the international role of the euro, which, fair enough—I’d be thinking the same thing. Jean Monet famously quipped that “Europe will be forged in crises, and will be the sum of the solutions adopted for those crises.” That line has aged well, and seems a fair description for major European policy initiatives. EUREP expansion may be one of them, but in service of a larger goal: expanding the international use of the euro.

Lover’s quarrel?

One might question whether the European reaction to the latest round of American policy is an overreaction, particularly given Sec. Rubio’s recent Munich speech. But again, the US implicitly (explicitly?) threatened to invade Europe to take physical territory, so it seems reasonable for Brussels to aim for more strategic autonomy on the margin. But this is also too simple a story: recall that Europe’s famous Anti-Coercion Instrument was not borne of conflict with China, but rather with America, years ago. Remember INSTEX, a (not effective) scheme to avoid sanctions? Also America, not China or Russia. This story predates the current American administration.

This is not to say that America is Europe’s main challenge—clearly far from it. And, as Sec. Rubio said, America’s “destiny is and will always be intertwined with” Europe’s. Trans-Atlanticism isn’t dead. But I mean, it isn’t in rude health either, and I don’t think we should be shocked by this showing up in the land of central banking policy-cum-diplomacy.

Will it work?

So, can Europe manage to create a compelling alternative to the dollar as an international reserve currency? Will this EUREP change do the trick? These are two distinct questions.

On the first, yes—to some degree it already has. The euro has safely been the second reserve currency for some time.

On the second, no, at least not in isolation. Pulling from an earlier piece from this site, when I was writing about the provision of swap lines by China to support renminbi internationalization:

Imagine you’re on a used car lot looking to purchase a car. As you walk past a sedan, a salesperson approaches you and says she can offer you an insurance deal on that specific car because she has a special deal with the manufacturer. Do you buy the car? I don’t know. It depends. All else equal, the provision of comparatively cheap insurance with broad coverage would, on the margin, make you more likely to buy the sedan. But not all else is equal: you’d have to want the car in the first place. Swaps lines are somewhat similar. They provide insurance against a liquidity shortage, making it easier and safer to transact in the currency and hold assets denominated in it. But again, you’d have to want to use that currency in the first place. Using the provision of insurance to enhance the desirability of the product is to put the cart in front of the horse.

Backstop liquidity provision—essentially insurance—is a necessary but far from sufficient condition to “internationalize” a currency (whatever that means to you, which seems to be in the eye of the beholder, to some degree). The lack of a generous euro liquidity safety net is not the binding constraint on the euro’s international use.

It’s the lack of more euro-denominated safe assets. Carlos Cuerpo, a Spanish minister, identified this head-on just days ago in an excellent FT Alphaville piece appropriately titled, Europe’s best bet for financial sovereignty is a true safe asset. Agreed! He’s put it better than I can, so I encourage you to read the article (FTAV is free to read). But the upshot is that the world needs safe assets; the US has manufactured them to an unparalleled degree; but there is no reason—aside from political ones—that Europe can’t expand the quantity of euro-denominated safe assets in the world.

In that case, maybe the new and improved EUREP will get some use after all.

Geopolitics matters

I think the main upshot here is less about the specifics of EUREP (although I’m so here for that) and more about the big-picture trendlines. As Bloomberg’s Joe Weisenthal and Tracy Alloway put it on a recent podcast episode (I’m paraphrasing), “we now talk about the Munich Security Conference as a macroeconomic event.” At this point, I think this realization is old(-ish) news, but that even a trans-Atlantic rift is starting to shape European central banking policy is perhaps a surprise in magnitude to some.

“We’re so back.” — geopolitics

China as overseas official development lender

China has long been an international lender, from nearly the founding of the modern People’s Republic in 1949 to today, when Chinese international lending has encompassed the globe, financing dazzling infrastructure projects in the Global South. Chinese overseas lending is, unusually, almost all official, that is, from the Chinese government or its constituent organs. At its 2016 peak, Chinese bilateral lending eclipsed that of all Western creditors combined. While China’s overseas lending crested almost a decade ago, its nominal lending footprint remains massive, and this exposure begs the question: has China’s overseas development lending been a net positive for global welfare?

Chinese lending, 1998–2019

Horn et al. 2019 (6)

Defining Chinese overseas development lending

Sovereign lending is defined as lending by a sovereign, which includes both the state itself, its constituent organs (including state-owned enterprises, SOEs), and parastatals. Usually, sovereign lending (also known as official lending) is to other sovereigns, but sometimes also to non-governmental organizations (NGOs) or even corporates. China’s overseas development lending is almost exclusively sovereign.

Chinese sovereign lending can be categorized broadly into four types:

1. Official development lending (e.g., Chinese policy banks)

2. Other official lending (e.g., sovereign wealth funds, SOEs, often in the form of commodity prepayment facilities and state-owned commercial bank loans)

3. Central bank lending (e.g., People’s Bank of China [PBOC] swap lines and deposit loans1)

4. Indirect lending via multilaterals (e.g., International Monetary Fund [IMF])

I focus here on development lending. This excludes reserve-management “lending” (i.e., China’s holdings of American Treasury bonds or European sovereign debt for purposes of managing its reserves). That is an equally interesting question, but demands a separate analytical framework and differs, both in motivation and mechanics, significantly from sovereign lending practices. I also exclude discussion here of China’s role in the IMF, also an interesting question, but far from the centerpiece of Chinese development lending (for numerous reasons).

Defining global welfare

The net welfare gain (loss) of Chinese sovereign lending hinges on the answers to the following three questions:

1. Does the lending sustainably support growth and resilience while safeguarding debtor sovereignty to a reasonable extent without creating substantial political distortions?

2. Could the debtor country have obtained the same quantity of financing on equal or better terms from another lender?

3. Do the lending practices materially prevent other lenders from being able to participate, in other words, does it systemically complement or systemically hamper the existing network of other lenders and crisis-managers?

A few caveats and clarifications are in order. First, the bar is not so high that there can be no political distortions or limitations on debtor sovereignty—that would be impractical and even at times not preferable. It would also not be comparable with outside options, all of which come with some of that baggage. Second, more is not necessarily better: simply having more financing is not sufficient to be considered a net improvement to global welfare (e.g., the lending could be used to line pockets of cronies, not supporting growth at all while indebting the citizens of the borrower country without their consent). Finally, even if the lending satisfies the other conditions, if it makes borrowing from other sources more difficult, then the bar is much higher for the Chinese lending.

The importance of benchmarking: the counterfactual lender

Doing marginally good lending is necessary but insufficient: if that marginally good Chinese lending displaces even better lending from an alternative lender, that is a net negative for global welfare. Similarly, harmful lending practices are not sufficient to make Chinese lending a net welfare negative: if they are not worse than alternative lending practices, then the marginal effect is zero. Chinese sovereign lending then must be benchmarked against an alternative.2 So, the question must be, ‘is Chinese sovereign lending less sustainable, less growth-supportive, more geopolitically weaponized, etc. than the next-best alternative?’

Does Chinese sovereign lending support growth and resilience?

Numerous academic studies have shown that Chinese lending, inter alia, supports economic growth; supports educational improvement and child health; promotes growth in remote areas; improves poverty alleviation; and helps under-resourced countries meet their infrastructure needs. In this sense, the literature is clear that in nominal terms, Chinese overseas lending has been a boon to growth and development, particularly in the Global South, where it’s most needed.

Of course, the same could be said of traditional multilateral lending, so the question is how Chinese lending supports growth and resilience relative to the next best option. In this sense, uniquely Chinese “circular lending,”3 while perhaps a creative way to avoid graft, raises questions about if more inclusive growth would be supported if the funds actually left the Chinese financial system (e.g., supporting businesses in borrower countries). Similarly, it’s difficult to disentangle Chinese official overseas lending practices from the projects they finance, since the two typically go hand in hand (see aforementioned “circular lending”). In the Chinese lending framework, the norm is “tied procurement” as a part of the package deal, which essentially means the absence of a competitive bid for the project and potentially inflated costs. As researchers at the Center for Global Development point out, “financing terms alone may understate the degree to which borrowers are incurring higher costs relative to what they would have incurred if they selected a more competitive source of debt financing.”

This is all to say that, while Chinese lending supports much-needed growth-positive projects, what is less clear is whether that same growth dividend could be obtained via cheaper and more competitive financing.

Is Chinese sovereign lending sustainable?

Loan characteristics

China’s overseas loans are known to be at considerably higher interest rates and with stricter collateral/balance sheet protection terms than similar loans from alternative lenders such as the OECD and Paris Club lenders. According to scholars at the Lowy Institute (emphasis added):

For the poorest and most vulnerable countries, payments to China make up a quarter of all debt service costs, outweighing both multilateral lenders and private creditors. No single bilateral creditor has been responsible for such a large share of developing country debt service in the past 50 years. In 54 of 120 developing countries with available data, debt service payments to China now exceed the combined payments owed to the Paris Club — a bloc that includes all major Western bilateral lenders.

China’s lending pattern in the past two decades has proven pro-cyclical, as new lending dried up just when it was needed most, with the Paris Club providing countercyclical financing to bridge the gap. It is also true that China’s overseas lending portfolio has deteriorated significantly and divergently from benchmarks. For example, the share of Chinese loan claims on borrowers in distress has skyrocketed in recent years and borrowers with Chinese debt were downgraded by five notches, compared to two notches in a benchmark emerging market index.4

The primary avenue through which Chinese overseas official lending contributes to unsustainable borrowing practices is its non-concessionary nature. Researchers at the Center for Global Development analyzed Chinese and World Bank lending in 157 countries and compared the loan terms. This comparison is particularly useful since the World Bank and Chinese official overseas lending tend to finance the same types of projects (e.g., infrastructure). They found that World Bank financing was considerably cheaper for the borrower and contained larger amounts of grant funding, with a measure of total portfolio concessionality for the World Bank of 42.2% compared to China’s 21.5%. They found that on all metrics—maturity, grace period, and interest rate—World Bank lending was far more debtor-friendly.

Scholars from the Lowy Institute provide an illustrative example in the case of Laos (emphasis added, references omitted):

Heavy borrowing from China and commercial sources delivered a remarkable reversal in the structure of Laos’ public debt. In 2004, three-quarters of debt was on highly concessional terms and only one-quarter non-concessional. By 2019, that ratio had flipped. Higher interest rates, shorter repayment periods, and the expiry of grace periods on large Chinese loans produced a dramatic rise in debt servicing costs. Including amounts ultimately deferred by China, scheduled debt service payments increased over three-fold . . ..

Laotian debt load with respect to Chinese lenders

Barney et al. 2025 (8)

Notably, though, even in the case of Laos, China did provide considerable deferral of debt payments and extended a PBOC swap line, which scholars credited with attenuating the impact of Laos’ kip crisis. There is also evidence that borrowing from China has helped debtor countries’ resilience in the face of macroeconomic shocks. For example, Zhengyang Jiang shows that major China-debtor countries tend to experience less exchange rate depreciation and equity market decline in the face of US monetary policy tightening compared to those that borrow less from China. Other research suggests that borrowing from China is associated with muted severity of capital flight during US monetary policy tightening periods, which scholars have termed the “buffering effect” of Chinese lending.

Restructuring

China’s presence in large, complex debt restructurings has made those restructurings more complex, in part because China has been unusually reluctant to grant relief and in part because of the complexity of China’s fragmented lenders. For example, in the case of Congo-Brazzaville in 2018–19, China did not provide financing assurances required to unlock IMF funding, which resulted in a protracted restructuring that required a separate China–Congo-Brazzaville restructuring. China raised similar complications in the 2021–23 Suriname restructuring, in which China refused to provide financing assurances to unlock IMF funding. Empirical research has found a positive relationship between a proxy for IMF negotiating complexity and stocks of Chinese debt. More tangibly, many Chinese loan agreements explicitly exempt the debt from Paris Club restructurings or comparable treatment. On the other hand, the existence of China as an “outside option” may strengthen the position of debtor countries in negotiations with the IMF. In short, the balance of evidence suggests that the presence of Chinese creditors in a sovereign restructuring makes the resolution of that debt crisis protracted, complicated, and costly, relative to Paris Club alternatives.

Does Chinese sovereign lending safeguard debtor sovereignty to a reasonable extent without creating substantial political distortions?

Some scholars have noted that, since the very inception of Chinese lending, it “has always had a strategic element.” It is worth noting, however, that geopolitical strategizing in official lending operations is rather the rule than the exception, and is a practice widely shared across all major creditors for the past 200 years. So here again, the question is whether or not Chinese overseas official lending has disproportionate political distortions relative to the benchmark.

Some studies suggest considerable political leverage. There are, for example, cases of China conditioning access to its PBOC swap lines to South Korea and Mongolia on geopolitical demands, the former with respect to Seoul’s decision to host an American missile defense system and the latter with respect to a visit from the Dalai Lama. However, whether or not that political leverage is more intrusive to sovereignty than, for example, IMF directives about privatizing state-owned companies, is unclear (and that is a high threshold).

One aspect of official Chinese lending, however, that would surpass even the high bar set by strict conditionality programs of the IMF is lending with sovereign collateral, subject to Chinese repossession in the case of default. Yet, these allegations are often exaggerated and misunderstood. Take the much-maligned and misunderstood Hambantota Port in Sri Lanka. There was no debt-for-equity swap, as is often mistakenly portrayed. Chinese SOEs did not “repo” the port—they negotiated a lease-back, which provided Sri Lanka hard currency cash flows and fiscal space to pay down maturing debts. And in both of the most-cited cases of borrower victimization—Malaysia and Sri Lanka—the at-issue debt programs were initiated by the borrowers, not by China. In many cases, the so-called “debt-trapping” is rather a request by a borrowing country for Chinese finance to support a project of questionable economic viability—not because of self-defeating grand strategy, but simply poor planning, limited capacity for sophisticated analysis, and poor governance.

More common than sovereign land or mineral collateral, in fact, is transactions that allow Chinese creditors to ringfence foreign currency cash flows from debtor countries (e.g., offshore bank deposits, export receipts). In fact, per the authors of a forthcoming exhaustive study of official Chinese lending practices, “contrary to popular stereotypes, physical assets back only 8% of the secured debt in our dataset; bank deposits and revenue streams account for the bulk of the collateral.”

Illustrative example of Chinese official loan collateralization: China Development Bank and Sonangol

Gelpern et al. 2025 (8)

Does Chinese sovereign lending limit or obstruct other lending?

China’s lending complicates lending from other creditors through two channels: data opacity and restructuring complexity.

Data opacity

Opacity in Chinese lending creates numerous problems for other lenders. For the private sector, ambiguity about debt loads and interest expenses makes asset valuation challenging. For the official sector, similar challenges lurk with respect to debt sustainability analyses. Creditors rely on accurate and complete data on a prospective borrower’s financial health to extend credit.

Clear, timely, accurate, and accessible data on Chinese official lending is almost impossible to come by. China does not report its international lending activities—not to the public, not to credit rating agencies, not to the OECD’s Paris Club or Creditor Reporting System or Export Credit Group, and barely even to the Bank for International Settlements. Its lending is also not covered by major commercial providers. The PBOC hardly reports any of its lending via swap lines and deposit facilities; one study including information on PBOC swap line interest rates relied on a leaked digital photograph of a paper copy of the agreement. The primary, if not only, resources on China’s overseas lending are compiled by academics, some of whom report that they expect their estimates to capture only 50–65% of total Chinese overseas loans. So opaque is China’s official lending that scholars have referred to it as “hidden debt.” One estimate suggests that, as of 2019, nearly half of China’s lending is unreported.

Chinese lending opacity

Horn et al. 2019 (25)

This hidden debt is not immaterial: accounting for it dramatically changes the debt loads and debt-servicing costs of dozens of mostly poor countries in magnitudes not previously understood.

Restructuring complexity

China’s role in restructuring has presented challenges beyond simply refusing to provide financing assurances in advance of IMF funding; restructuring challenges are exacerbated by the number of creditors involved and the complexity in bringing them all to the table. For example, in the 2018–19 Congo-Brazzaville restructuring, the IMF approached the PBOC for financing assurances, but the debt was in fact mostly owed to China Eximbank and China Development Bank, over which the PBOC in fact has very little control; not even the IMF knew which Chinese organizations were owed what or answered to whom. In fact, scholars focused on China’s role in sovereign restructurings suggest that one of the most effective avenues to improve sovereign debt restructuring vis-à-vis Beijing is for China to create a consolidated entity to handle and negotiate impaired debts.

Conclusion: Almost There

Has China’s overseas development lending been a net positive for global welfare?

On balance, in the absence of other “better” options, Chinese sovereign lending would be a net welfare positive. However, in light of more transparent and accountable borrowing avenues, including through multilaterals, other official bilateral creditors, and bond markets, Chinese lending does not provide a net gain. Moreover, Chinese lending practices have negative externalities with respect to other lenders: lending practices create asymmetric information that makes it materially more difficult for other lenders, including official multilaterals like the IMF, to provide financing.

Put differently, the answer to our question is: “in nominal terms, yes; in relative terms, no.” That conclusion need not be forward-looking. With simple changes to improve transparency through disclosure, China would accomplish much. A more centralized approach to lending programs, streamlining hiccups along the way, would reduce many of the largest frictions. The straightforward introduction of a competitive tender process for financed projects and the use of local contractors would go far in improving net benefit. The issues that limit the effectiveness of China’s development lending are not so much debt trapping or geostrategic reach, but rather relatively prosaic issues of bureaucratic complexity, lack of identifiable responsibility, cronyism, and opacity. These are solvable issues that Beijing will hopefully address. The world would be better for it.

What is a public policy person, you might ask? Well, if you want to measure it by advanced degree, it’s the MPP/MPA folks from the Harvard Kennedy School and Hopkins SAIS1 and the Wilson School who roam the halls of Capitol Hill, the DoD, the New York Fed, and the Foreign Service. Among the MPP/MPA-holding folks (including SAIS) out there are people like former FRBNY President and Treasury Secretary Timothy Geithner; former general and CIA Director David Petraeus; current Icelandic Prime Minister Kristrún Frostadóttir (from my school!); and current Dallas Fed President Lorie Logan, among many others. If you want to measure it by role or disposition, I would qualify it as a technocrat. There are technocrats-cum-politicians (e.g., Mark Carney), but they are technocrats first, almost always. Technocrats mostly exist in governments, but also in the non-profit sector and, to varying degrees, in the private sector.

It looks different to different people. For me, it means about 70% of my time and energy is spent on economics/finance/statistics, about 20% on political science and international relations, and about 10% on other stuff (e.g., ethics, foreign language, history). But my policy school class includes special forces operators, refugee resettlement experts, finance ministry civil servants, energy engineers, and even an astrophysicist. All to say, by profession, it’s all over the place, but this leads me to how I think about the pipeline of public policy. It is this pipeline that makes all the public policy folks connected.

Policy sausage-making

One way to think about the creation of public policy2 is that there are three distinct but deeply related stages of production: (1) information gathering and knowledge-generation; (2) knowledge synthesis and (yes, normative) analysis; (3) advocacy and execution. The first stage involves deep dives into topics relevant to policy and the production of sophisticated research—think randomized control trials on a cash-transfer program. The second stage involves review of that research, implementation scoping, operationalization, and analysis—think reviewing all the studies on the cash-transfer programs, designing a real-life program, outlining options to implement such a program, and briefing policymakers on the pros and cons of the intervention. The third stage involves essentially legislation, rulemaking, or decision-making—think reading the memos on the cash transfer programs, getting briefed on the approaches on the table, raising it to a Parliamentary/Congressional committee, and ultimately voting on it. There are different groups at each stage.

The first is academic and quasi-academic researchers, often economists in my slice of the policy world, but also sociologists, demographers, political scientists, and experts of all stripes (including in the hard sciences!). These people usually have PhDs and move fluidly between government, academia, and the non-profit/think tank worlds. They produce new knowledge, and disseminate it out into the world, but usually with a particular audience. Sometimes that audience is implicit, sometimes very explicit (e.g., the Congressional Research Service). In the Fed, this usually means the research departments of the reserve banks, or of the Board. In broad strokes, they write and present academic papers with most of their time; they also provide expert opinions, and sometimes cautiously advocate normatively. They love regressions. Bad writing habit: academic prose that’s 10x too long.

The second is the public policy people. These people only episodically write or contribute to academic papers (it varies by person, but usually none). But they read a lot of them. They digest papers and reports, type up 2–3 page memos with key points, brief principles, and attend meetings. They are the technocrats. In general, when they advocate it’s based on cost-benefit analyses, not ideological convictions; you’ll see them working for members of different parties. They are problem-solvers, somewhat akin to McKinsey consultants, but inside a government (incidentally, many do go into government consulting or to McKinsey, literally). They don’t love regressions, but respect them, and know how to read an output table. Bad writing habit: inscrutable acronyms and jargon.

The third group is politicians. In broad strokes, these people do not contribute to academic papers, and only very rarely read them. They read the public policy people’s memos. They are effective advocates, and among those with graduate degrees, they are unusually likely to have law degrees. They are more likely to be party-loyal and, by definition, partisan. They are astute operators of reality and the landscape of political, budgetary, and administrative constraints. I once had a colleague who had been both an advisor in the civil service (read: public policy people) and later a parliament member (read: politician) tell me, “when you’re in the civil service, you get to advocate for the best policy based on outcome; when you’re in the political arena, you have to be the fun-killer, telling those civil service people that X or Y union or lobby group will kill the proposal.” They aren’t terribly familiar with regressions in general, but they’re very adept at explaining the narrative of the stylized facts in a digestible manner. Bad writing habit: poetry that’s light on substance.

A question of framing

The three groups think about different questions, with different framing.

The politician asks: What rights should an individual have to own a gun? What is the trade-off we should make between public safety and individual freedoms? How do constituents (individual, corporate, nonprofit) think and feel about this issue and what is most salient to them about it?

The public policy person asks: I’ve been tasked with reducing gun violence in area X—what does the academic literature say about driving causes, how high conviction am I on those causes, and what interventions can I implement at the highest efficacy and lowest cost, subject to the prevailing political, cultural, legal, administrative, and budgetary constraints?

The knowledge-creator asks: Controlling for as many exogenous variables as possible, can I identify a causal link between numbers of guns per capita and gun violence? Is a randomized control trial plausible here? If not, what do we know about similar causal channels in other historical episodes of comparable issues?

Wheelhouses for days

Related to the above, and unsurprisingly, the size of wheelhouses varies. Spend enough time around truly academic conferences, and you’ll hear a lot of qualification and even downright avoidance of questions that are “outside my wheelhouse.” I have a lot of appreciation for this. Ask a labor economist about health care, and they’re likely to (very honestly!) say, “I have some informed speculation, but I’m not an expert in this area, you should speak with X.” These people spend their lives becoming experts on a topic, stay in their lane, and understandably wish others would too. Sometimes that expertise is too narrow or esoteric to be useful, but it’s true expertise.

Among the policy folk, there are more opinions, but still a fair bit of qualification. They are the types that at dinner parties strike you as widely read. They are comfortable on a range of topics, and are willing to discuss them, though are often appropriately hesitant to draw generalizations and do like to toss around, “I’m over my skis on this, but…”. (This is why they make such good Foreign Service Officers.3) They have a tendency to talk too much about The Economist.

Politicians have opinions on everything, which, I assume, is exhausting. But, to be fair to them, it is literally their job. Imagine asking your elected official about their opinions on child care, and them saying, studiously: “This is a deeply complex topic and one that’s clearly cross-cutting among OECD countries, so not particularly idiosyncratic to the United States. I’m not well-read on this literature, so I’m over my skis here, but my very surface-level read is that we’ve got a supply-side issue to the extent it’s a market failure. I don’t know much about successful interventions, but I’m sure someone has done some work on it, I can get back to you.” Yuck, very uninspiring! In practice, this is why well-functioning governments of elected politicians have a deep bench of policy talent,4 and the politicians themselves have the very difficult task of public-facing synthesis and persuasion.

In many governments, you’ll have all three in the legislative branch (e.g., in the US, we have the Congressional Research Service, policy staffers, and elected officials all in the legislative). Usually, the executive branch is very policy people-heavy, save for the top levels where there are political appointments (hence “career staff” vs “political appointment”). If, for example, you go to a US embassy abroad, almost everyone there, often with the exception of the ambassador themselves, is professional staff (i.e., technocrats).

Picking your poison

I don’t like to generalize very much, and this essay has done that. Discount as appropriate—these are caricatured archetypes. Obviously in the real world it varies. I have policy friends and colleagues who flirt hard with the line of being an academic, and obviously some policy folks flirt pretty hard with politics. Some have done it all (again, see Mark Carney). I hope this is a helpful way to think about it, though, and useful for those considering a master’s degree and what types of work they might want to do.

Dutch Treat: The Netherlands’ Exorbitant Privilege in the Eighteenth Century. Stein Berre and Asani Sarkar. Federal Reserve Bank of New York.

Exorbitant privilege is a polarizing concept these days. For those not in the field, it’s basically the idea that the country that provides the world’s reserve currency can finance itself more cheaply than it otherwise would, and that it has an unnaturally high debt capacity due to the large demand for its debt. It pretty much refers to the dollar (the actual quote is from Valéry Giscard d’Estaing, then the French minister of finance, in the 1960s in reference to the dollar’s growing role). But the US isn’t the only country that’s held the exorbitant privilege! The UK did before, but before that, so did the Netherlands in the 17th and 18th centuries.

I love financial history, in part because it’s just interesting, but in part because it reveals the structural consistency over time—not all that much changes. From the note:

The role of the Dutch guilder as the global reserve currency allowed the Netherlands to have the lowest prevailing rate of interest in Europe, as foreign investors were more willing to exchange their surpluses for financial assets in the Netherlands. One consequence was that foreign investors left large deposits with the leading merchant banks of Amsterdam. Since these deposits paid no interest, they provided these firms with a source of low-cost funding.

This was basically foreign institutional investors placing deposits with the New York Fed prior to interest on reserve balances! Plus ça change.

2034: A Novel of the Next World War. Elliot Ackerman and Admiral James Stavridis, USN. Penguin Random House.

I don’t typically include fiction here, but this novel is likely of interest to Discursive readers. Its description from publisher site is below:

On March 12, 2034, US Navy Commodore Sarah Hunt is on the bridge of her flagship, the guided missile destroyer USS John Paul Jones, conducting a routine freedom of navigation patrol in the South China Sea when her ship detects an unflagged trawler in clear distress, smoke billowing from its bridge. On that same day, US Marine aviator Major Chris “Wedge” Mitchell is flying an F35E Lightning over the Strait of Hormuz, testing a new stealth technology as he flirts with Iranian airspace. By the end of that day, Wedge will be an Iranian prisoner, and Sarah Hunt’s destroyer will lie at the bottom of the sea, sunk by the Chinese Navy. Iran and China have clearly coordinated their moves, which involve the use of powerful new forms of cyber weaponry that render US ships and planes defenseless. In a single day, America’s faith in its military’s strategic pre-eminence is in tatters. A new, terrifying era is at hand.

So begins a disturbingly plausible work of speculative fiction, co-authored by an award-winning novelist and decorated Marine veteran and the former commander of NATO, a legendary admiral who has spent much of his career strategically outmaneuvering America’s most tenacious adversaries. Written with a powerful blend of geopolitical sophistication and human empathy, 2034 takes us inside the minds of a global cast of characters–Americans, Chinese, Iranians, Russians, Indians–as a series of arrogant miscalculations on all sides leads the world into an intensifying international storm. In the end, China and the United States will have paid a staggering cost, one that forever alters the global balance of power.

Everything in 2034 is an imaginative extrapolation from present-day facts on the ground combined with the authors’ years working at the highest and most classified levels of national security. Sometimes it takes a brilliant work of fiction to illuminate the most dire of warnings: 2034 is all too close at hand, and this cautionary tale presents the reader a dark yet possible future that we must do all we can to avoid.

On the scale of tragedy to comedy, this is 100% in the former bucket. 2034 is indeed chilling, not only for its ‘disturbingly plausible’ war scenarios in particular, but for its reminder of the dangers of excesses of human ego and, in the aggregate, of national spirit. If the book sounds far-fetched, an interview with one of the authors (Adm. Stavridis) is worth listening to, as he mentions that Pearl Harbor and the assassination of Archduke Ferdinand also seemed unimaginable at the time. That, he says, is why we have fiction: to avoid the mistake of failures of imagination. If you want some IR-flavored tragedy in your life (or just to think about how scary modern weapons are, or a conflict in the South China Sea or Taiwan might be), this is a must-read. (Incidentally, co-author Elliot Ackerman is currently a senior fellow at the Yale Jackson School of Global Affairs, my current outpost, though I didn’t know that when I was gifted this novel—small world indeed!)

International Lending in War and Peace. Sebastian Horn, Carmen Reinhart, and Christoph Trebesch. Riksbank draft paper.

Debt is a surprisingly opaque thing. Private global lending is huge, and also widely known (at least today), but even it suffers from patchy data. Much more opaque then is public lending, i.e., lending from sovereigns and multilaterals. Horn, Reinhart, and Trebesch put together the first consolidated dataset of official capital flows—mostly lending but also aid/grants—from 1790–2020. They offer six primary takeaways:

1. Official lending is actually huge, often eclipsing private capital flows globally.

2. The main driver of official capital flows is war.

3. In peacetime, the main driver is financial crises (which happen a lot, actually).

4. Geopolitical hegemons tend to be the largest official creditors during their respective peaks.

5. Official capital flows are counter-cyclical: they expand the most when private capital flows dry out.

6. In war or peace, geopolitics and realpolitik are at play, with nations lending to wartime allies and/or major economic partners.

Theirs is a deeply timely study, highlighting two issues we talk about a lot on this site: the rise of China in the global financial system and central bank swap lines. Here’s a great excerpt (my emphasis):

Our paper helps to better understand the profound changes in the current international financial system. It is not widely appreciated that we are seeing a comeback of state control in international financial flows. China’s rise as an international creditor has been underestimated due to a lack of transparency. We document how China has become one of the most important official creditors worldwide, as almost all of its foreign lending is extended by the government and its state-owned banks (see also Horn et al., 2021). Unknown to the broader public, China has also granted billions in rescue lending to developing countries (Horn et al., 2024). China’s extensive use of state finance is emblematic for other new global creditor powers, such as Russia, India, Brazil or the Arab oil states, who are all prone to use state institutions when allocating capital abroad and who have now all become active official lenders to varying degrees. These new creditors are also increasingly prone to create new multilateral lending institutions, including the Beijing-based Asia Infrastructure Investment Bank or the BRICS Development Bank. “South-South” (official) lending is likely to continue to rise – with considerable state involvement. We are also witnessing a resurgence of official financing via central banks. Central bank “swap lines” have grown in volume and relevance, most evident during the crisis of 2008 and the Covid-19 pandemic. We show that this development is reminiscent of the flourishing cross-border central bank lending during the gold standard era.

Their work is particularly useful for its long aperture, avoiding the recency bias we so often succumb to (my emphasis):

The main advantage of studying capital flows across 200 years is that it allows us to look beyond the current, post-1970 era of open capital accounts, US (dollar) dominance, and relative peace. Our data show that in periods of geopolitical turmoil and great power rivalry, private capital flows can come to an almost complete halt, while state-led finance becomes the dominant form of cross-border capital allocation. This long-run view informs our understanding of what may lie ahead for the global financial system . . . .

It’s hard to overstate the comparative size of official capital flows per this data. The authors report that in major upheavals (e.g., WWI, WWII), official capital flows reached 10% of US GDP. And these data actually understate the “real” official flows, since these data only include official bilateral data, thus excluding sovereign wealth fund investments, which in recent decades have been massive.

Another equally interesting finding is their application of the workhorse gravity model (gravity models never get old!). They find, empirically, that trade exposure, geographic proximity, military alliance, and status of being a former colony are highly predictive of sovereign lender-borrower links, all else equal. This is perhaps not directionally surprising, but very cool to see validated empirically. For example, they find that military allies receive a 100% higher bilateral official flow volume than non-allies (although the predictive strength of military alliances has declined over time).

I could sum up more, but a picture says a thousand words, so here are some awesome figures from the paper:

The hidden axis: the left-right spectrum has a non-ideology problem. G. Elliot Morris. Strength in Numbers.

One of my pet interests is political science, in which I would not call myself an expert, but an interested traveler. This excellent essay deserves particular attention. For those who need reminding: the United States does not run ranked-choice multi-member districts with proportional representation. The United States is decided not a parliamentary democracy. The rules of the game in large part dictate the possible universe of outcomes, and in a single-member district first-past-the-post system, we’ll get two parties, more or less. That is not politics; that’s math/game theory. But Americans aren’t so different from other people, so this particular system is reductive to political ideologies. G. Elliott Morris goes to the data to find out what those (considerably more diverse!) political ideologies are. This matters for relatively obvious reasons. In short, per Morris:

What if, instead of making all these assumptions [re survey question design], we simply asked voters straight-up what they wanted their party to advocate for — in their own words? This would certainly get us closer to the result we are trying to draw inferences about.

To this end, in our November Strength In Numbers/Verasight poll I asked over 2,000 Americans to describe, in their own words, their ideal political party. This article analyzes those answers and presents several conclusions for general readers, party reformers, and partisans looking for actual data to guide future electoral strategy.

(For those who have survey methodology questions, please email Morris, I don’t want to talk about two-stage clustering with probability proportional to size and LLMs here. Pls. But yes, N = 2,000 is enough.)

There are some very important takeaways that were not immediately obvious to me, particularly in our hyper-partisan world (where we also often suffer from selection bias in online media). Here are the main three:

1. Many Americans—a plurality (38%)—are not ideological at all but are simply focused on quality-of-life issues.

   

   This is kind of surprising! Note that the non-ideological group isn’t “moderate” or “centrist” on the left-right scale (that’s the purple group); they just don’t really espouse partisan views on much at all. In Morris’ words:

   The vast majority of respondents in this group also don’t use clearly political language at all . . . In that sense, this group is best described as focused on material wellbeing, and not intensely interested in politics — or potentially even aware of the ideological lines of American politics.

2. American voters are mostly revealed-preference left-leaning (but only slightly) on both economic and social policy.

   This one I found perhaps less surprising than some. Per Pew Research, Americans are basically 49% Democrat or Democrat-leaning and 43% Republican or Republican-leaning. This surprises many Americans, but it’s been true for awhile. (It’s probably surprising because of the institutional rules in America, of which the Senate and electoral college historically overweight rural areas and thus make America look moderately more right-leaning than it is in a population-weighted sense.) However, we shouldn’t overstate the magnitude: the revealed preferences are left, but barely. Most Americans are clustered very near the center, ever so slightly to the left:

   

   This space clustered around the center is also the home of many independents. Another interesting finding is that if you bin the “non-ideology” group by their revealed policy preferences, they are pretty much that paragon of the average American—pretty centrist, a little to the left (but more on social policy than economic policy):

   

3. But really, most Americans don’t think very ideologically when they describe an “ideal political party.”

   Note the bimodal distribution(s) here, interesting. Probably because roughly four of ten Americans don’t care that much and just want to buy a house.

   

   Those who were grouped into the “left- or right-leaning” camp were in the 6–7 range of ideological intensity, whereas the non-ideology folks were around 2 (the direction of which is no surprise, the magnitude of which did surprise at least me).

To folks who have at least observed American political science from the sidelines, this these findings are perhaps not entirely shocking, but for most of us, this research is probably a healthy corrective for how we think about the American voter.

Morris’s prediction: both parties should battle to win the non-ideology camp by toning down the ideology. As someone who has long been an ideology-skeptic (of all varieties, not just political), that sounds good to me!

For those interested in this literature, I’d also check out research by Lee Drutman, who got his PhD from UC Berkley studying political science. He’s been beating this drum for some time (and, to boot, is associated with both left- and right-leaning orgs, New America and the Federalist Society). If you don’t know what ranked-choice voting or multi-member districts are and are curious, check out FairVote’s explainer (which has a pro-reform bias, to be very clear, but is eminently digestible and has good external links). This is a sadly under-studied area, but it’s super interesting if you like game-theory-lite stuff (or elections).

DLT Eurodollars as fiscal relief valve?

Stablecoin issuers are already one of the largest buyers of Treasury bills, larger even than the entire nation of Japan, per Ahmed and Aldasoro (2025):

Let’s imagine that our scenario from Part II happens: foreign retail investors measurably net expand demand for Treasury bills via stablecoin/tokenized MMF demand. Some thoughts/reactions:

Short-End Rates

This scenario seems straightforwardly to drag short-term rates down, albeit of course bounded by monetary policy. But the upshot is more demand for bills resulting in lower rates. A stylized finding from Ahmed and Aldasoro (2025) is that a two-standard deviation inflow into stablecoins lowers the three-month Treasury bill yield by 2–2.5 basis points over the course of ten days. As we’ve seen, State Street puts the pressure anywhere between 3 and nearly 9 basis points of T bill yield reduction in the longer term.

Of course, all prices are a balance between supply and demand—at some point, Treasury could increase supply enough to meet the demand, and we might end up back at our initial equilibrium, just with more T-bill stock. But all else equal, more demand and higher prices (lower yields).

Long-End Rates

If you don’t expect Eurodollar stablecoins to be inflationary (more on that below), then you might not expect long-end rates to rise in an expectations-theory-of-the-term-structure kind of way. You might however, think, “oh boy, that’s a lot of debt and its weighted average maturity is decreasing, and the people who are buying it are unsophisticated retail investors in Jamaica; this doesn’t feel great!” and read Reinhart and Rogoff and say, “I’d like a few more basis points of compensation.” That would be rational. In other words, taken with short-term rates, a steepening of the curve.

More mechanically, if the Treasury shifts issuance to the front end, they’d also be reducing supply at the long end. This could in turn have the effect of driving down long yields too.

Pressures will likely pull in different directions, and it’s a tricky general equilibrium question.

Debt Issuance

This is something we discussed in Part II: would potentially lower short-end rates tempt Treasury to issue more at the front end of the curve? My expectation is that Treasury would be tempted to. And they’d be somewhat justified in doing so, if the increased demand at the front end brings short rates down; in fact, one might argue that they’d have an obligation to shift issuance to achieve the lowest cost to the taxpayer, subject to the predictability limitation. One effect here, as State Street points out, is that this makes the overall economy less robust to cyclical fluctuations (i.e., more rollover risk to funding).

Of course, we don’t really have data for this, directly, yet. However, recent academic work from Barthélemy, Gardin, and Nguyen (collectively at the Banque de France and ECB) examining the interaction between stablecoins and commercial paper is at least suggestive. In their study, the authors find that “an increase in the demand for stablecoin tokens caused additional commercial paper (CP) issuance, when tokens were backed by CP.” This shouldn’t be any huge surprise, and the authors then make the natural speculation: “This novel connection may extend to other short-term funding markets, notably Treasury Bills, with effects shaped by issuer supply elasticity.” Right.

Inflation

But that sort of looks and smells like monetizing the fiscal debt? Or at least monetizing more of it at the margin than is usual. Which begs the question: Would it be inflationary? This is a tricky question. In a world in which stablecoins exist only in an autarkic setting of the US, the expectation would be that they migrate money stock out of M1 and into M3, which might not by itself be particularly inflationary, assuming no new net money stock expansion. However, as we’ve seen, once you bring foreign currency into the mix, you’re net adding stock to the US money supply via the stablecoins. (This is all setting aside the interesting question of whether dollar stablecoins will themselves become a proper part of the US money supply in the future.) Per TBAC:

Of course, any inflationary pressure from Eurodollar stablecoins would be to some degree offset by expected dollar appreciation pressures, but the extent would depend greatly on numerous variables, of which a forecast I won’t attempt here. All to say (again): unclear, pressures will likely pull in different directions, and it’s a tricky general equilibrium question.1 But it doesn’t scream inflation, in and of itself, more so than how we’d think about normal bill issuance.

Financial Stability

There is a lot to be said about stablecoins and financial stability writ large (e.g., see here, here, and here). I’m not quite sure how to think about the effects of Eurodollar stablecoins specifically.

Start with the onshore spillbacks. On the one hand, one might think of less sophisticated foreign retail investors as being pretty “sticky” and less likely to run on stablecoins than sophisticated US fund managers; in this sense, they might be a shock absorber for US volatility. On the other hand, if and when they do run, research suggests that stablecoin Treasury buying and selling is asymmetric (more intense impacts when selling than when buying), and this can become a fire sale relatively quickly. And experience shows that electronic foreign retail depositors are the flightiest depositors of all; there’s a good chance stablecoin “deposit” flows would be more, not less, volatile in a state of the world where a large share of USD stablecoin circulation is in the Eurodollar market. That could spell more volatility in the front end of the curve, just as the Treasury sits on more rollover risk.

The effects on financial stability abroad seem less benign. One way to think about offshore retail stablecoin proliferation is that the average citizen can run out of their local currency a lot faster, which might be a shock amplifier. One could imagine a US-origin crisis in which, counterintuitively, purchases of stablecoins offshore help hold US short rates down as spreads widen, while amplifying bank runs and currency depreciation abroad (heard that story before?).

Monetary Policy Transmission

Here again, separating the aspects related to Eurodollar stablecoin issuance specifically (as opposed to stablecoin issuance writ large) is difficult, but the upshot relevant for monetary policy in any case is mainly the expanded base of stablecoins. For one, a shift into more money instruments being composed of stablecoins should reassert the now well-established dominance of the repo markets as prime monetary policy transmission markets. But it might materially impact the channels through which monetary policy functions. As Aldasoro and Ahmed put it:

Suppose the stablecoin sector grows 10-fold to $2 trillion by 2028 (as suggested by the Treasury Borrowing Advisory Committee) and the variance of 5-day flows increases proportionally. Then, a 2-standard deviation flow would amount to roughly $11 billion, with an estimated impact of -6.28 to -7.85 bps on T-bill yields. These estimates suggest that a growing stablecoin sector may eventually suppress short-term yields to an extent that meaningfully influences the transmission of Fed monetary policy to market-based yields. (p. 20; notes omitted)

And it would also work in reverse: with a large stablecoin sector, monetary policy would influence the size of the asset class in ways that research suggests would be different to money market funds (at least for now, given that the main use case remains related to crypto, and given that stablecoins don’t—nominally at least—pay yield).

Fed Balance Sheet Changes

As stablecoins grow as a money-market instrument, the Fed’s balance sheet will likely change too, albeit variably depending on the extent to which the Fed supports this new money market. This is another category for which it’s difficult to segregate Eurodollar stablecoin demand from demand overall, but we’ve established that the former accounts for much of the latter, so we’ll proceed here regardless. For a comprehensive overview on the Fed’s balance sheet in response to stablecoins, see David Beckworth over at Macroeconomic Policy Nexus. I’ve lifted here a great paragraph from David that I think sums this up nicely:

If stablecoins mean greater demand for Fed liabilities, then what kind of balance sheet expansion might this entail? In my view, there are two ways for understanding this process. One view—rooted in the “safe asset shortage” narrative—sees the Fed’s balance sheet expanding to meet an excess demand for safe and liquid assets, with quantitative easing (QE) functioning as a kind of public intermediation service that supplies the safety that private markets cannot. The other view—anchored in concerns about fiscal dominance—sees the Fed’s balance sheet growing in response to an excess supply of safe assets, as mounting public debt pressures the central bank to absorb and manage an expanding stock of treasuries. Stablecoins may intersect both of these dynamics: they could amplify global demand for dollar safety even as they deepen the channels through which the Fed intermediates the government’s swelling debt.

And an awesome table he’s put together for us:

Essentially, the QE story is that there is more demand for USD safe assets than there is supply (e.g., the Global Savings Glut) and the consolidated government (government + central bank) expand the supply of safe assets to meet that demand. This time, the Fed could expand its balance sheet (QE) via support for expanded stablecoin circulation rather than through conventional QE tools. It might do this by providing access—even if in limited “skinny master account” forms—to its financing facilities for stablecoins, and we could live in a world where the Fed’s liabilities include an ON RRP-style facility for stablecoin issuers.

The fiscal dominance story is that the Fed essentially finances fiscal deficits by supporting stablecoins, harking back to the WWII period we discussed in Part I of this essay series. In this universe, the outcome is the same—balance sheet expansion—but it’s the tail wagging the dog.

Of course, it can always be both! Here’s Beckworth again:

Stablecoins, in other words, may cause the Fed’s balance sheet to expand both to accommodate global demand for safe dollar assets and to simultaneously facilitate the absorption of ever-growing treasury issuance . . . Stablecoins, then, may become the bridge between the safe-asset-shortage and fiscal-dominance worlds: private instruments that generate public demand for Fed liabilities, even as they tether the central bank more closely to the Treasury’s balance sheet. The endgame may be a Fed balance sheet that is both structurally larger and more politically entangled—a central bank at the center of a digital safe-asset empire, but one increasingly constrained by the fiscal foundations that sustain it.

That first sentence pretty well encapsulates the thesis of this essay series: stablecoins represent two sides of the fiscal-monetary coin (pun very much intended).

Of course, regardless of fiscal dominance or stablecoin-QE, the composition of the Fed’s balance sheet might change as stablecoins replace other forms of money, as Beckworth lays out in another piece. For one, stablecoin displacement of cash2 could, all else equal, reduce the Fed’s seigniorage income, although a recent proposal for non-interest-bearing “skinny accounts” might limit the disruption. Similarly, there’s the chance that stablecoins eat away at (onshore) bank deposits (I think this is unlikely), in which case, in a world of skinny master accounts, Fed liabilities shift at the margin from banking system reserves to this new form of Fed liability, the skinny master account.

Where this all ends up is pretty speculative at this point, but these are possible worlds worth thinking through.

Dollarization

The scenario we’ve arrived at by way of Part II—expanding new dollar claims from Eurodollar stablecoins—seems unambiguously supportive of the dollar’s role abroad. The bridge between retail investors holding stablecoin Eurodollar liquidity in their crypto accounts or truly expanding offshore dollar usage will depend on other factors, like singleness of money, fungibility with demand deposits, and willingness of businesses offshore to accept them as means of payment. But the path to further incremental entrenchment of the dollar offshore seems clear, if not guaranteed. We’ve talked about this on this site.

KYC/AML/CFT/OFAC

The alphabet soup: sanctions and money laundering. We have talked about this here before, so I won’t spill too much ink on it now, but suffice it to say, I don’t have as pessimistic a view as some on the sanctions/money laundering/terrorism financing risks. Yes, to be sure, Tether & co. have a notorious past—there’s no doubt dollar stablecoins have been used by cross-border crime syndicates, thugs, autocrats, and drug-dealers. But that’s largely a failure of enforcement and compliance, not an inherent flaw of the technology, and the GENIUS Act should bring issuers that want to go legit into the regulatory fold by requiring compliance with the Bank Secrecy Act (see 12 U.S.C. §5903(A)). In fact, the programmability of smart tokens could, if leveraged properly, make them more secure than ledger-based money claims. Further, pseudonymity ≠ anonymity. As Darrell Duffie, Odunayo Olowookere, and Andreas Veneris point out in a recent IMF note, zero-knowledge proofs will allow KYC compliance while preserving users’ identities, showing that the choice between privacy and security is a false dichotomy.

Finally, recall that the US already has a virtually unregulated Wild West of offshore dollar use almost certainly supporting transnational crime groups: cash. Stablecoins aren’t a silver bullet—far from it—but they are leaps and bounds more traceable and enforceable than cash.

All told, while there’s much to worry about, I think we have reason to be cautiously optimistic here. And, as I like to say about policy choices in general, the benchmark matters: the alternative here is dollar cash or Bitcoin, depending on the use case, both of which are far dirtier and less regulated.

Abroad

Going hand-in-hand with dollarization is capital outflows from local currency into dollars, which would put depreciation pressure on local currencies and, all else equal, be inflationary abroad. In the classic Mundell-Fleming framework, these foreign jurisdictions (of which developing economies will be disproportionately affected) will be forced to hike rates or impose capital controls to limit FX slippage.

There will also be temptations to produce local competitors, either in the private (stablecoins) or public (central bank digital currency, CBDC) space. The Eurozone, for example, has taken the latter approach, as have numerous other jurisdictions. China even reacted to the GENIUS Act by publicly supporting a launch of its own renminbi stablecoin with the express goal of circulating offshore. (Although it seems this was quietly walked back.)

And then there’s the question of wealth effects. If the average family living in, e.g., Malaysia, now has a higher share of their financial assets denominated in dollars instead of ringgit, this naturally alters the wealth effects of foreign exchange rate changes. Rashad Ahmed has described this eloquently:

If households adopt significant amount[s] of dollar stablecoins, they have long dollar exposure on their balance sheet now, and they’re going to be exposed to currency mismatch on their balance sheet, and that’s going to be impacted by US monetary policy. If the Fed raises rates, you have dollar appreciation. That’s going to affect the value or the net worth of the household . . . Now, normally this would leave an amplified contractionary effect on the emerging market because they tend to hold a lot of dollar-denominated liabilities, but now they have quite a bit of dollar-denominated assets in the household sector. The value of that household balance sheet is going to go up, and that will hedge a little bit of the short dollar position of the public sector and the private sector.

Put another way, emerging markets tend to borrow—often via the official and private sectors—in dollars, with the household sector more muted, leaving the consolidated nation’s balance sheet short dollars. If households and companies acquire dollar stablecoins, though, this might actually have a balancing effect, where dollar appreciation has both wealth-creating and wealth-destroying effects simultaneously offshore. Food for thought.

Plus ça change

A view of American financial history shows that fiscal authorities have made clever use of channels through which to monetize fiscal debt if and when regular issuance becomes insufficient. In most cases, it takes a war, depression, or extreme disaster to push monetization to the edge. We’re very unlikely to see that kind of outright monetization with stablecoins, barring a crisis. However, we have shown thus far that:

• most stablecoin ownership (stock) and transaction volume (flow) are offshore;

• demand for stablecoins offshore continues to rise;

• foreign retail investors are essentially the “final frontier” of untapped T-bill demand

This supposition—that the fiscal authority will be tempted to take advantage of this newfound ability to shift larger volumes of issuance to the front end of the curve as a result of burgeoning offshore stablecoin demand—does not rest narrowly on stablecoins. Tokenized MMFs or short-term bond ETFs would have similar effects.

So, what if you do?

New monetary-fiscal arrangements are neither “good” nor “bad” in reductive terms. A model in which stablecoins tap foreign retail demand for Treasury bills to some sounds like a weak form of fiscal dominance, while to others it sounds like the US provisioning a global public good. I lean toward the latter side of this debate, but of course both can be true at once. Such an arrangement would provide a global public good in constant demand: safe assets, which to foreign retail investors can serve as a better store of wealth and inflation shelter than local currencies. This particular manifestation of safe asset might also make remittances cheaper and simpler. In this sense, a stablecoin Eurodollar market would be a public good.

On the other hand, such an arrangement could result in more volatility in the front-end of the yield curve, pose financial stability risks, and increase foreign exchange volatility, while potentially having inflationary and/or distortionary effects in the US and exacerbating capital flow volatility abroad.

Stablecoin growth has the potential, like other monetary-fiscal arrangements in the past, to alter the structure of markets and to shift the way the government funds itself. There’s no guarantee that will happen, but we would be remiss to be guilty of a failure of imagination.

This series has benefitted from generous comments from Rashad Ahmed and Richard Berner, and from fruitful discussion and research-sharing with Elliot Hentov and Steve Englander. All mistakes and views are my own, but I want to thank these brilliant people for sharing their time.

There are reasons to be skeptical. As Stefan Jacewitz of the Kansas City Fed argues, people have to buy stablecoins with something, which is usually bank deposits, but could be money market funds, in which case the effects on net new Treasury demand would be attenuated. However, this analysis and many others mostly focus on the domestic system.

Here’s my pitch: stablecoin circulation in the United States (onshore) will mostly (though not exclusively) reshuffle existing demand, but stablecoin circulation outside the United States (offshore) will create genuinely new demand. Further, that’s where most of the growth will be, so the offshore segment should not be overlooked.

How do stablecoins impact T bill demand?

State Street puts this very well (bolding original; italics my emphasis):

There are four primary channels through which stablecoin demand can manifest itself:

1. Displacement of bank deposits: Primarily involves asset substitution, resulting in minimal net-new demand as bank reserves and associated short-term assets on the bank side are simply transferred to stablecoin reserves without any system-wide increase in demand for T-bills.

2. Substitution of Money Market Funds (MMFs): Like bank deposits, this represents an asset swap wherein stablecoins are substituted for MMFs, limiting additional net Treasury demand. We view this as a low-probability scenario as stablecoins cannot pay interest, whereas MMFs do.

3. Foreign deposits converted into stablecoins: This channel represents a genuine net-new Treasury demand, as global investors shift funds from foreign assets into stablecoins backed by Treasuries. Liquidity preferences rather than yield-seeking behavior appear to be the primary driver of this shift, given that stablecoins do not pay interest.

4. Cash and banknotes replaced by stablecoins: Direct conversion of physical currency into stablecoins could generate new, incremental T-bill demand as issuers seek stable collateral backing. We see this as a low-probability scenario in most economies.

Of these channels, only foreign deposit conversion and cash/banknote replacement produce substantial new demand, while displacement from bank deposits and MMFs largely reflects asset reallocation rather than net-new demand.

Agreed! Mostly. One bone to pick: I disagree on the first bit: no system-wide increase in demand for T-bills as a result of bank deposit migration to stablecoins. The reality is that banks own precious few T-bills (only roughly 8% assets in Treasury securities writ large), where stablecoins own a lot of them. As such, a migration from bank deposits to stablecoins likely would result in a material increase in demand for T-bills (this is essentially like migrating to a narrow-bank model).

Here’s a nice figure they have:

Let’s dive into those two net-new-demand-creating categories.

Cash and foreign deposit migration: how do they create new T bill demand?

There are three ways foreign demand reaches stablecoins: (1) from non-dollar holdings (e.g., I spend my lira and buy USDT); (2) from dollar cash abroad; and (3) from Eurodollar deposits (dollar deposits held offshore—outside the United States).

The first is straightforwardly new T bill demand, as State Street highlights, so I won’t cover it separately here: it is a non-dollar claim becoming a dollar claim backed in large part by T bills, so is mechanically net new T bill demand. This is probably the single largest driver of stablecoin growth—good news for our thesis. But how it creates new T bill demand is clear.

Insofar as net new T bill demand is concerned, though, one might quibble about the latter two: they are both cases of one dollar claim migrating to another, so could we be running into the same mere-reshuffling issue again? No; we have reason to think these migrations too will create net new T bill demand:

Cash

Cash isn’t directly backed with T bills. Directly. Cash—currency—is a liability of the Federal Reserve, and sits on the liability side of the Federal Reserve System’s consolidated balance sheet. On the asset side, the Fed holds lots of things, but mostly Treasury securities and MBS. The Fed could back all its liabilities with short-duration assets and do perfect maturity matching, but it currently doesn’t (intentionally). In any case, the composition of the Fed’s balance sheet is variable, and while the weighted average maturity of the portfolio is declining, it’s certainly not a $1 cash = $1 T-bill money market fund. In fact, according to the Fed’s Sep. 25, 2025 H.4.1 release, T bills account for roughly 3% of the System’s consolidated assets, while cash represents 36% of its consolidated liabilities.2 This is compared to roughly 65% T bill composition behind Tether’s USDT, per its reserves report. So, in a crude oversimplification, if someone migrates $100 of offshore cash holdings into $100 of newly minted USDT, we’d expect roughly $62 of T-bill purchases from this transaction in the system as a whole. That overstates the effect,3 but the direction is clear.

Eurodollar bank deposits

Eurodollar bank deposits are a large market, but they are bank deposits, so mostly backed by loans, not Treasury securities, and certainly not short-term Treasury securities. So, migration out of a Eurodollar bank deposit and into a stablecoin would represent a net increase in T-bill demand. Same as for domestic bank deposit-to-stablecoin migration, as discussed earlier, but likely to a great extent.

The assets of Eurodollar banks are tricky to parse, and there’s no great consolidated location for reporting (in contrast to the onshore dollar banking system). But we can take an illustrative example. The Bank of the Philippine Islands is a bank (in the Philippine islands, shocker) that offers dollar-denominated savings accounts. If you take a look at their balance sheet, government securities writ large comprise roughly 17% of their assets, and remember that’s all government securities, not specifically T-bills, or even dollar-denominated assets; presumably they mostly hold peso-denominated Filipino sovereign debt. Now, again, similar to the Fed’s balance sheet, the bank probably does more exact liability matching, and it’s hard to tell exactly “what they buy” with $1 of dollar liabilities. Suffice it to say, though, even American banks hold well under 23% of assets (probably under 10%)4 in T-bills, so it’s safe to say that Eurodollar banks hold even less. If we assume—very conservatively—that our Filipino bank holds 20% of its total government securities in US T-bills, that’s 3.4% of total assets. But we don’t need exact figures to know that the weighted-average Eurodollar bank T-bill asset composition is far less than USDT’s 65%.

This is no surprise: $1 of a bank deposit is mostly backed by bank asset stuff (e.g., loans, mostly, some MBS); $1 of a money market fund (cough cough, stablecoins) is mostly backed with short-term government securities. We know this. It should be no surprise that the same is true offshore.

Total effect

Yes, it is true that not all offshore dollar stablecoin circulation will reflect net new dollar claims, since some fraction of it will be migrated from offshore dollar cash holdings and offshore dollar bank account holdings. But, given the asset composition backing those claims, we’ve concluded that:

cash → stablecoins = increased T-bill demand

Eurodollar bank deposits → stablecoins = increased T-bill demand

One of two things is happening when dollar stablecoins circulate offshore! Either (1) they are net new dollar claims, in which case, definitely new T-bill demand; or (2) they are migrated dollar claims from cash and Eurodollar bank deposits, in which case, still net new T-bill demand (albeit less on the margin).

Fine, but why would foreigners want dollar stablecoins?

And this question implicitly has an addendum: “, when you could get dollar cash or bank deposits.” That’s the rub, though—those options both have serious drawbacks.

Start with cash. Getting cash offshore is not always easy; there is a limited supply of it (literally, and also because of capital controls); you can lose it/it can get stolen; you can’t earn any interest on it;5 you can’t make cross-border (or even cross-country) payments with it; and it has a limited physical lifespan as it naturally wears down.

In the case of Eurodollar bank deposits, they simply aren’t available to many people, especially in emerging/frontier markets; they often come with heavy paperwork that many people can’t/won’t deal with; they’re not very accessible to people in rural underdeveloped areas, where smartphone apps are the easiest way to access financial services; they often come with fees; and they don’t enjoy FDIC deposit insurance and are not backed one-to-one with other money claims, so there is genuine risk in holding them relative to cash or money fund-style instruments.

And then there’s the general question, addendum aside, of why a foreigner would want to hold dollars at all, in any form. But that’s well-trodden ground: for the same reason that they might want to hold gold or some other perceived safe asset—safety and inflation shelter, plus maybe the benefit of cross-border payments/remittances, depending on the payment rails. And here, stablecoins have some advantages: they can easily be obtained via smartphone, payments are fast and efficient, and they offer a nearly instant off-ramp from the volatility and inflation of local currencies. Eye-popping stylized fact: 43% of sub-Saharan African transaction volume is in stablecoins. The proof is in the pudding.

How big really is offshore stablecoin growth?

Well, okay, I’ve privately heard a stablecoin representative once say, more or less, “our path to huge growth at this point is overseas.” So, the direction of travel is clear. But it’s already big.

Unfortunately, though, getting exact figures is tough, since stablecoin ownership is pseudonymous by construction and stablecoin companies jealously guard user data. That said, some laudable attempts have been made, notably by Marco Reuter at the IMF. In his paper, Reuter deploys a large language model to exploit natural language and cultural references in stablecoin wallets, as well as transaction data mapped onto time zones, in order categorize them by region of the globe. Using these data, he’s able to map stablecoin flows geographically in a manner that is considerably more robust than the existing commercial databases, which don’t account for virtual private network (VPN) use, which masks the country of origin.6 His finds are telling: 80% of stablecoin wallets are outside of North America, and 72% of transaction volume7 occurs outside of North America. Now, an immediate response to this is, “well, sure, but they’re all wallets with $20 in them doing tiny transactions frequently, that doesn’t mean the share of actual holdings offshore is large.” And that’s fair! It is true that the median transaction size in North America is large, and the mean North American transaction is even larger. But not by a ton. From Reuter:

And it’s also true that these are flow volumes, not stock, so $1 moved across borders 1,000 times becomes a sizable transaction volume, even when the stock amount is tiny. If that were true, though, we should see much lower median transaction sizes, which we don’t see (Africa is virtually the same as North America). As such, it’s reasonable to infer stocks from flows here, as a ballpark estimate, and say with relatively high confidence that 70–80% of dollar-denominated stablecoins are circulating offshore, consistent with (1) eight of ten wallets residing outside of North America; (2) roughly similar transaction sizes inside and outside North America; and (3) 80% of stablecoin transactions occurring outside the United States.

Finger in the wind

Time for some back-of-the-envelope figures. If the stablecoin market reaches $2 trillion in 2028 as TBAC suggests it might, that’s $1.6 trillion of dollar claims outside the US at 80% foreign composition. Of that $1.6 trillion, if we take Tether as a benchmark, we could expect roughly 65% of that to be backed by T-bills, roughly $1.04 trillion. Incidentally, this figure—$1.04 trillion—while for 2028, happens to be almost exactly the 2030 figure Brookings comes up with using conservative estimates of 3% p.a. offshore dollar demand growth and a low 6% stablecoin penetration rate. (Their middle-of-the-road figure is $1.9 trillion.) We’ll talk more about this in the next essay but, suffice it to say, this figure is relatively moderate, if not conservative.

If T-bill supply stays in the roughly 20% of GDP range as it has in recent years, and we take the CBO’s current growth forecasts at face value, then the ballpark 2028 T-bill supply is around $7.6 trillion. If we think that supply would be met at equilibrium with existing buyers,8 then that’s an extra $1.04 trillion on the sidelines (roughly 14% of supply), which should put downward pressure on yields, edge out other market participants, or some combination of both.

Recall that this completely sets aside onshore stablecoins—this is only an estimate of offshore stablecoin circulation, for which we can have higher confidence about net new T-bill demand.

Why should we care about stablecoins specifically, though?

At this point, the crypto-skeptics might be saying, “sure, but this is just a bad money market fund. Bad because it doesn’t pay interest, and a money market fund because it’s . . . a money market fund.” I am deeply sympathetic to this view. Especially in a world of tokenized (actual) money market funds (e.g., BlackRock’s BUIDL or Franklin Templeton’s Benji), it’s unclear how or why stablecoins would exist and grow, offshore or onshore, aside from their original use case as a crypto off-ramp.

For our purposes here, though, the distinction between a tokenized MMF and a stablecoin9 doesn’t much matter; what matters is that they are tokenized, backed in large part with T-bills, and available to foreign retail investors.

Conceptually (and reductively), you might think about it this way:

Stablecoins (and/or tokenized MMF shares) open up the upper-right quadrant of the second box; that’s basically the innovation here.

Conclusions

In Parts I and II, we have concluded:

• Historically, monetary-fiscal arrangements change over time, often leveraging money demand for debt finance;

• While purely onshore stablecoins might represent a reshuffling of Treasury demand, offshore stablecoins (Eurodollar stablecoins) represent real net new demand for Treasury securities, but we don’t know yet how much;

• Subject to the above, we have a sense that it’s significant, and it is definitely growing;

• Ergo, there exists some new T-bill demand and a means to satisfy it via stablecoins, all while shifting the weighted-average maturity of US sovereign debt shorter.

In Part III, we’ll discuss what it might look like if this occurs.

This series has benefitted from generous comments from Rashad Ahmed and Richard Berner, and from fruitful discussion and research-sharing with Elliot Hentov and Steve Englander. All mistakes and views are my own, but I want to thank these brilliant people for sharing their time.

A lot has changed since we last talked about stablecoins here! Namely, the GENIUS Act has passed, bringing stablecoins fully into the regulatory fold, and thereby providing the imprimatur of regulation needed to bring financial products into the mainstream. There’s a lot one could say about stablecoins, but I want to think here about how they might act as another innovation in financial infrastructure that increases the capacity of the market to digest ever-expanding amounts of debt.

A survey of American financial history shows that the government has made use of the monetary system (monetary authority as well as market structure) to help monetize fiscal debt in ways that support high issuance volumes, usually in times of war, but sometimes not. Today, stablecoins offer a potential new monetary-fiscal arrangement, one in which latent demand for American sovereign debt is tapped in foreign retail investors (foreign institutional investors have long been tapped to help fund American deficits). While the outcome is far from certain, if stablecoins do open a path to new demand for American debt, it will have far-reaching implications for soft power, the international monetary system, America’s fiscal deficit, and monetary policy.

On monetary-fiscal entanglement in American history

“The line between money and the public debt has never been entirely clear or distinct.” — Menand and Younger (2023, 237)

To understand the future of monetary-fiscal entanglements, we need first to understand their past. I’m using the term “entanglement” (or “arrangement”) intentionally—as opposed to something like “monetary financing” or “fiscal dominance”—because, as we’ll see, the role of money markets and their infrastructure in the US has not always been characterized by fiscal dominance or the like, but it’s always been intimately tied to the issuance of fiscal debt (safe assets).1 The source for a readable history here is Menand and Younger 2023, which lays out four ‘fiscal-monetary configurations,’ summarized below:

The National Banking System: 1863–1916

Prior to the National Banking System, the US nominally separated fiscal funding from money markets,2 but this broke down when the financing requirements of the Civil War pushed the United States (and the Confederate States, incidentally) to monetize debt issuance. In 1862, Congress passed the Legal Tender Act, which allowed the Treasury to mint paper money (which was green, hence “greenbacks”) to fund the war effort, but this resulted (predictably) in inflation. As a result, they changed tact: in 1864, Congress passed the National Banking Act, which essentially forced state banks to obtain federal charters. These banks would issue “national bank notes” receivable for payments to the US government, but they had to be backed by Treasury securities: The Treasury deputized the national banking system to buy and indirectly monetize (via issuing notes against them) the wartime fiscal debt. Maturity transformation in support of a war effort, more or less.

A national bank note; Museum of American Finance

The Federal Reserve System: 1916–1951

By 1913, the Federal Reserve System had been created and the primary money instrument of banks had shifted from notes (the paper form of deposits, if you will) to deposit accounts on which checks could be written (“checking” accounts). The new Federal Reserve banks could buy Treasuries directly. A few months after the Federal Reserve System was founded in 1913, though, war broke out on the Continent, and massive financing needs struck again. While the Treasury at first rallied the American populace by marketing war bonds as a patriotic duty, the voluntary fundraising proved insufficient. So, the Treasury deputized the Federal Reserve to help fund the war by use of credit controls and bridge financing for war bonds. By World War II, the Fed intervened to support war finance more strongly, and in spring 1942 agreed to control all borrowing costs of the US government, capping short-term rates at 0.375% and long-term rates at 2.5%. At this point, the majority of war debt was financed by expanding the money supply, in part via direct Fed purchases, and in part via commercial bank deposit expansion funding purchases of government bills.

The Primary Dealer System: 1951–2008

1951 marked the famous Fed-Treasury Accord, wherein the Fed gained its political independence, in part because of the crowding out of bank lending, and in part because of the need to control inflation that arose at the end of the war and the outbreak of hostilities in Korea. The Accord meant the Fed would stop its yield curve control, and the Treasury would focus on smooth, predictable, and affordable debt issuance. A less-remembered episode in the 1950s was soon to follow, though, when Treasury market disruption struck in the spring of 1953, triggering the SOMA manager to alert the FOMC that there was, “virtually no market for government securities at the present time” (FOMC meeting minutes). The Fed intervened at first with restraint (via repo) and then more intensely with outright purchases. This episode exposed to the Fed that Treasury securities dealers couldn’t stand on their own yet, and thus the Fed decided to support the market by financing the trading inventories of nonbank dealer firms via repo.3 The legality of this practice was internally questioned, but ultimately the Fed’s legal counsel determined it was permissible on the basis that the repos were supportive of market functioning, not aimed at helping particular firms. The Fed’s implicit funding backstop engendered the growth of a commercial market for repo to dealer firms. To become a dealer able to participate in direct Fed operations (a primary dealer), dealer firms needed to participate in (i.e., underwrite) Treasury auctions. In essence, the Fed was indirectly supporting the digestion of fiscal debt via backstopping and subsidizing the dealer firms that sold the debt.

The Shadow Dealing System: 2008–2022

By 2008, the conversion of many non-bank dealers into bank holding companies or their subsidiaries introduced new prudential regulations which limited intermediation activity in formerly non-bank dealers (e.g., market risk capital rules and leverage ratios). Other regulations later added to the cost of capital for intermediation activity, which crept away from the traditional banking sector and into the “shadow dealing” sector (mostly principal trading firms and high frequency traders, often hedge funds). These funds began to accumulate long positions in Treasuries and short positions in their derivatives, thus looking like a synthetic version of older dealer balance sheets. However, this approach involved leverage, making the system more brittle, which ultimately showed in the 2014 “flash rally” and the 2020 Treasury market panic. Like before, the Fed needed to support this crucial market and, after first intervening with repo expansion, ultimately took to large-scale asset purchases, this time for financial stability and market functioning reasons, rather than monetary policy.

Upshot

Over time, we’ve seen that the US government, like other governments throughout the world (check out Sweden!), taps all demand available to absorb its debt, with money claims having an obvious appeal (because short-term rates tend to be lower than long-term rates). Whether via the creation of new paper bills, national bank notes, or central bank purchases or interventions, the monetary plumbing has always been intimately tied with the production of safe assets, itself a byproduct of fiscal debt. Contrary to popular belief (e.g., gold bugs), this system has been remarkably resilient and has adapted to the changing landscape of the financial system over time, while naturally finding the cheapest and most efficient ways to finance government deficits and supporting dynamic credit creation. (The elasticity of the currency is a feature, not a bug!)

Do stablecoins represent the next chapter in monetary-fiscal arrangements? Maybe, but unlikely to mirror the scale and importance of previous innovations. For there to be a new monetary-fiscal arrangement, the government would need to find new demand for its debt. The qualifier new is doing heavy lifting there. From here, we’ll need to figure out whether or not stablecoins can actually unlock latent net new Treasury bill demand. That’s where we’ll go in Part II.

This series has benefitted from generous comments from Rashad Ahmed and Richard Berner, and from fruitful discussion and research-sharing with Elliot Hentov and Steve Englander. All mistakes and views are my own, but I want to thank these brilliant people for sharing their time.

Fiscal Dominance: A Primer. Stephen Cecchetti and Kermit Schoenholtz. Money and Banking.

Fiscal dominance is hot again (turns out it’s a very cyclical thing in the thousands of years of human existence). Cecchetti and Schoenholtz are the right minds to bring to bear on this topic. First of all, starting a piece with a juxtaposition of quotes from Thomas Sargent and Neil Wallace on the one hand, and a Truth Social post from Donald J. Trump on the other is (1) funny, and (2) brutal. 10/10 on a great opening.

But this is a sober piece. Embedded in those quotes is that the US is at serious risk of fiscal dominance occurring. Perhaps one of the best contributions of this note is to define, clearly, what fiscal dominance is and how it’s different from monetary dominance. Here’s their definition: “when fiscal policy pressures or compels a central bank to forsake its price stability objective in favor of helping to finance the public debt.” There’s some nuance here in my view: interventions in public sovereign debt markets might justifiably be for market functioning purposes, not backdoor fiscal support. But the line is blurry.

Importantly they tie in sovereign debt, which Americans often don’t think about (my emphasis):

… the central bank faces a tradeoff between satisfying fiscal needs and keeping prices stable. For example, to ease their financing burden, fiscal policymakers may pressure the central bank to lower the policy rate below the level consistent with its inflation target. Fiscal policymakers would benefit in the short run both from the lower cost of new debt issuance and from a surprise inflation that lowers the real value of outstanding debt – analogous to a partial default. Eventually, however, lower interest rates drive inflation expectations, and then inflation, markedly higher, leading to a loss of central bank credibility.

For those who enjoy financial history, there are lots of great Easter eggs, but as the authors point out, you don’t need to dust off history books to see fiscal dominance: Venezuela, Argentina, and Türkiye have had episodes very recently. And they make the point that the US is pretty exposed today, from a standpoint of debt service sensitivity to interest rates: “a sustained one-percentage-point rise in the average yield now adds over one percent of GDP to the annual cost of federal finance: that is more than double what an equal yield increase added in the mid-1980s.” This is not hypothetical with the sitting US president pressuring the Federal Reserve to lower interest rates explicitly to lower the country’s debt servicing costs.

Tariffs, Stablecoins, and the Demand for Dollars. Anantha Divakaruni and Peter Zimmerman. Federal Reserve Bank of Cleveland.

More on stablecoins. This is a recent paper (from August) that uses dollar stablecoin trading as a proxy for dollar trading writ large and analyses how those trading patterns respond to tariff announcements. For those who aren’t FX market plumbers, the core challenge is that most FX trading is over-the-counter (OTC), meaning it’s done bilaterally or trilaterally through dealers, instead of on exchanges. This makes getting disaggregated high-frequency data on FX trading difficult—trust me, I’ve tried.

One way to square this circle is to use market-based trading (enter: stablecoins) as a proxy for broader dollar trading. Now, there are some challenges here, because people trade dollar stablecoins for reasons other than those for which they might trade plain-vanilla FX, but it turns out it’s not a bad proxy (they do some robustness checks for those interested). Specifically, they use limit order book imbalances, which in English means the relative share of orders placed by buyers versus sellers. And they can do geographic identification by proxy of currency used (e.g., folks buying USDC in Turkish lira probably are Turkish—fair enough).

Their findings suggest that in response to “liberation day" tariff announcements, there was increased demand for buying dollars (via stablecoins):

But they can do one better! They then look at differences in announced tariff rates across countries to quantify by how much the tariff rate affected dollar buying (again, as proxied by dollar stablecoin trading). To do so, they run a fixed effects regression model and obtain the following results (my emphasis): “In all five models, we find that a larger increase in the tariff rate on a country is associated with significantly higher buying pressure of dollar-pegged stablecoins with respect to that country’s currency.”

These findings may seem esoteric, but they’re actually pretty important insofar as they relate to the reserve-status-of-the-dollar debate. During the GFC, which, as astute foreign observers oft point out, was caused by the US, the dollar appreciated and there was increased demand for buying and holding dollars, very counterintuitively. This is because of the safe haven status of the dollar, as expressed in the dollar smile theory. These recent stablecoin proxy results show that, even in the face of tariffs from the United States, foreigners tend to buy more dollars in response.

TINA: There Is No Alternative (yet).

Financial Channel Implications of a Weaker Dollar for Emerging Market Economies. Mikael Juselius, Philip Wooldridge, and Dora Xia. BIS.

Speaking of the dollar abroad, the BIS has a nice piece out on dollar depreciation in EMs. Here’s a thought for EMs: trade uncertainty and tariffs = bad, depreciating dollar = good, so it’s all fine? Maybe.

But exactly how depreciating dollar = good is not completely simple, and not universally true. A few channels, the authors say:

• The balance sheet channel: If your balance sheet has local currency assets and (unhedged) dollar liabilities, dollar depreciation mechanically strengthens your balance sheet by reducing liabilities.

• The financial channel of the exchange rate: For global banks, the improved strength of those borrower balance sheets (see above point) means you can expand credit; this channel is supportive for goods trade, among other things.

• The other balance sheet channel: So, the above could be inverted: if an EM company/bank has local currency liabilities, but dollar assets, then actually dollar depreciation would result mechanically in losses. We haven’t historically fretted about this, because traditionally EMs have been more likely debtors and the US has been a creditor, but that is increasingly not the case:

Of late, EMs have increasingly taken on creditor positions, particularly vis-à-vis the United States. This means more dollar-denominated assets on their balance sheets, which means losses on dollar depreciation. To be sure, that’s not to say all or most EMs are net creditors to the US or the rest of the world, but on the margin, they have more long-dollar positions than they used to in aggregate, which attenuates the tailwinds of dollar depreciation.

Of course, if these positions are hedged, then they are less exposed (a 100% hedged dollar position is synthetically a non-dollar position). If you want to see a case study of this, look to Taiwan, the authors say, where large unhedged long dollar positions on the balance sheets of life insurance firms expressed themselves in losses, which materialized in equity prices for those firms. And this matters increasingly because while not all EMs are net creditors, many are, and more are becoming so:

This all implies that the financial channel of the exchange rate might ultimately start working in the other direction: losses on balance sheets resulting in credit supply contraction, not expansion.

Can China’s Long-Term Growth Rate Exceed 2–3 Percent? Michael Pettis. Carnegie Endowment. (🕐)

I read Michael Pettis’ 2023 prediction/analysis on China’s growth, and thought it was worth re-upping.

Some background context for the non-China-watchers: the number one keyword when reading about China’s macroeconomic outlook is imbalance. This refers to the idea that China’s economy is unusually reliant on investment for growth relative to consumption (and, to a much lesser degree, net exports). For reference, for many advanced economies, investment’s share of GDP hovers around 15–20%; in many developing countries it’s as high as 30–35%; in China (in 2023) it was ~43%. As returns to investment start to decline (diminishing marginal returns are everywhere!), every new unit of investment yields less growth. (If this doesn’t make sense, read this footnote.1) This is straightforwardly a challenge, one that policymakers in China themselves recognize.

Pettis argues that this eventual rebalancing isn’t a policy option, but that it must happen/will eventually be forced because of China’s rapidly growing debt stock, which he argues is the other side of the investment coin. There are, then, two ways to get around this problem: (1) do less investment, or (2) increase the rate of return on investment. Pettis thinks the latter is highly unlikely. So, how can China rebalance?

Pettis says, essentially: with considerable difficulty. He draws out five plausible scenarios for China to get its investment share of GDP to ~30% in ten years:

1. Surge in Consumption: To get this done in ten years, consumption needs to grow by 6–7% a year while investment grows 0–1% a year.

2. Current Consumption Rates Hold Steady: Then GDP growth needs to slow considerably. To get it done in ten years, investment needs to contract at negative 1–2% a year, and GDP hovers around 1.5% growth per year.

3. Sharp Decline in Consumption Growth: GDP growth remains flat and investment would need to decline in the area of 3% a year (although net exports would surge, which would help).

4. Sharp GDP Contraction: So unlikely he doesn’t even model it.

5. Rebalance Over an Extended Period: If China takes 15 or 20 years to achieve the rebalancing with consumption growth at 3–4% a year, then GDP growth drops to 2% and 2.5%, respectively.

He summarizes the potential outcomes in a tidy table for us:

Here’s a key bit of his bearish takeaway:

Unless Beijing can somehow manage to set off a surge in consumption growth, which is possible but highly unlikely, it will be very difficult for a rebalancing China to grow at rates much higher than 2 percent . . . China can slow down the adjustment pace to one that is more politically acceptable, but this involves two costs. The first is that a longer period in which debt continues to rise faster than the country’s debt-servicing capacity increases the risk of a disruptive financial adjustment. The second is that, like with Japan, slower growth stretches out over a much longer time period. It is worth noting that in the early 1990s, Japan’s share of global GDP was close to 18 percent. Within twenty years, it was less than 8 percent.

Well, on that bright note, that’s a wrap.

Golden Parachute: Financial Sanctions and Russia’s Gold Reserves. Daniel McDowell. Istituto Affari Internazionali.

This piece focuses in on the Russia’s gold strategy, and expands on work McDowell has done in his book Bucking the Buck. Here he focuses on gold’s value as a sanctions hedge—a uniquely geopolitical consideration. A nice top-line (my emphasis):

Moscow’s rekindled love for gold is a direct result of the accumulation of US financial sanctions programmes targeting the Russian economy between 2014 and 2021 . . . Russia’s gold holdings were no panacea for the Kremlin in the face of these severe sanctions, but unlike CBR’s dollar and euro holdings, its bullion remained under Moscow’s control. I argue that gold reserves helped Russia in two distinct ways during the early days of the conflict. First, evidence suggests that Russia sold some of its bullion early in the conflict as a means of acquiring foreign exchange– something feasible, despite sanctions, because the physical nature of gold makes it possible to hide its origins. Second, as the ruble’s value crashed in March 2022, the Russian government implemented policies to encourage citizens worried about their savings to buy gold. Many Russians heeded this advice. In this way, Russian gold reserves operated as a de facto anchor for the ruble. This may have made severe capital outflow restrictions, which blocked off investments into foreign currency assets, more palatable to Russian savers.

I learned for the fist time about Russia’s sales of some of its gold holdings—likely at a serious discount—in non-traditional markets (some suspect Dubai) and China to support the ruble and its invasion of Ukraine. Also novel to me was the state support for ruble-for-gold sales domestically to blunt the wealth effects of capital controls on Russian savers.

He makes an important point about physical gold, preempting the critique that it’s non-yield-bearing and illiquid. While I’m putting this in my words, my read of his comments is that gold has a payoff structure somewhat like buying far out-of-the-money put options: totally useless in most states of the world—and costly—but immensely valuable in the far left tail. In other words: an insurance policy you pay non-trivial premia for, but for which the coverage makes it make sense, especially to highly risk averse organizations, like sovereigns.

This is awesome paper, worth reading in full; you’ll be rewarded with fun nuggets like this: “Russia used a paramilitary organisation known as Wagner Group to craft ties with regimes in several destabilised, conflict-prone African countries. By providing security services to embattled military leaders, Wagner accepted payment in gold which was then transported by air to Russia” (my emphasis; citations omitted). 10/10.

ICYMI, we’ve discussed this topic, in the context of rising gold prices, around here:

Influence by omission: The IMF’s lending capacity and central bank design. Ana Carolina Garriga and Michael A. Gavin. SSRN.

Lender of last resort (LOLR) meets IMF cross-over episode? All in. Here’s a nice top line (my emphasis):

In this article, we show that declining prospects for international assistance in times of crisis and continued efforts to boost the capabilities of domestic central banks are subtly connected. Unlike existing research which shows how the IMF influences countries by commission, such as through its lending practices, recommendations, and especially loan conditionalities, we argue that the relative size of the IMF’s lending capacity influences states by omission. Our argument in brief is that the inability of the IMF’s lending capacity to match the growth of financial globalization is noticed by the IMF’s potential borrowers and that states respond by strengthening the capabilities of their central banks to combat crises, especially to act as more capable lenders of last resort.

The authors carefully trace the evolution of the IMF’s lending capacity, showing it to decline in size relative to aggregate external liabilities over time. E.g.:

Then, through compilation and analysis of an extensive dataset on LOLR authorities and illustrative case studies like the Bank of Thailand, the authors provide evidence that central banks have filled the gap themselves, preemptively boostrapping their way out of the IMF lending void. They employ standard OLS regression with fixed effects to assess the impact of lower IMF borrowing capacity (relative to external debt stock) on country (okay, monetary authority, sorry) LOLR capacity, with significant results. Finally, they do an event study of the COVID-19 crisis and response, further supporting their hypothesis.

Sovereign Debt Restructuring with China at the Table: Forward Progress but Lost Decade Risk Remains. Gregory Makoff, Théo Maret, Logan Wright. Harvard Kennedy School.

I am a seasonal dilettante in the sovereign debt universe, but these three gentlemen are decidedly experts. This piece does an excellent job highlighting and synthesizing China’s changing role in the sovereign debt landscape over time. For one, it is a useful corrective for Western readers to appreciate the magnitude of Chinese sovereign lending in recent decades: “China’s lending to developing countries has rivaled that provided by the G7 since 2000, and it has had a significant concentration in many of the poorest—former HIPC [highly indebted poor countries]—countries” (my emphasis).

They trace the numerous motivations, geopolitical and otherwise, that drove China to engage so aggressively in this lending, and summarize recent challenges in Congo-Brazzaville, Suriname, and Zambia, and the infrastructural changes made by major Paris Club members and the IMF in response to those challenges.

Perhaps the most interesting addition of the piece is to examine why China struggles so hard to grant debt relief to highly indebted countries, which the authors explain is largely related to China’s internal domestic political landscape and incentive structure, which they sum up pithily as “loss avoidance and institutional complexity.” The authors make a compelling point that China’s administrative foot-dragging on permanent debt relief may risk repeating a lesson we’ve already learned:

China’s position on sovereign debt restructuring, and its significant sway as a large lender, risks a repeat of the lost decade of the 1980s, when international banks insisted on “extend and pretend” restructurings to avoid taking losses. In that period, U.S. banks were so exposed to what was then called Less Developed Country (LDC) debt that they couldn’t afford to take losses. To protect them the U.S. Treasury, the Federal Reserve, and the IMF developed economic plans that assumed sufficient growth to pay off the existing debt. The growth never materializing, this led to serial debt restructuring, which didn’t end until the 1990s, when the countries carried out Brady restructurings with significant debt relief. The Brady plans were a success. After these restructuring nearly all the Brady countries thrived, using the opportunity to reform and improve financial governance to avoid ever going into debt default again. (citations omitted)

They finish with a pragmatic policy recommendation inspired by China’s own handling of its 1990s banking system bad loan problem: that China create a single unified specialized asset management vehicle to manage its bad sovereign debt assets from its disparate creditors.

The Emergence of Tokenized Investment Funds and Their Use Cases. Pablo Azar, Francesca Carapella, JP Perez-Sangimino, Nathan Swem, and Alexandros P. Vardoulakis. Federal Reserve Bank of New York.

One way to think about tokenization is that it’s sort of back to the future with financial assets: the original form of tokenized claim was cash bills and tradable bills of exchange. Now we have tokenized digital assets. Stablecoins have been the first, but they have confounded many of us, since they don’t have (legal) yield. Tokenizing 2a-7 money market funds, though, now that makes some sense. It’s happening! And as the authors point out, it’s not necessarily the payment rails that are revolutionary, but rather the 24/7 trading window. Being able to post and move collateral 24/7 instantaneously is an interesting proposition.

Financial Bubbles Happen Less Often Than You Think. William Goetzmann. Wall Street Journal.

Bill Goetzmann is one of the most accomplished financial historians around, and just so happens to teach at the Yale School of Management. This is an excellent piece about the psychology of crowds, and a refreshing reminder about loss aversion bias. A nice line from the article that sums up the idea:

Since 1887, there have been just four cases where the Dow Jones Industrial Average has dropped by more than 10% in a single day—and two of those were during the big crash of 1929 . . . one of the biggest mistakes an investor can make is to rely on a handful of colorful historical episodes and ignore the long intervals in between: the sequence of quiet gains that stock markets have made over the decades and centuries they have existed.

If that didn’t hook you, perhaps the following will: he discusses the great Mississippi Company bubble of 1719–1720 in what was then French Louisiana. Incredible story, highly recommend.

Argentina Gets a Bailout, Brazil Gets the Stick. What Unites Them. Karthik Sankaran. Barron’s.

Karthik Sankaran is one of my favorite macroeconomic commentators and he has a Substack, The Home-Groan Globalist, which you should check out:

I think of this piece as the analytical pairing to my mostly descriptive recent note on the background of the Argentina aid package, here:

Karthik makes the point that Argentina is the yin to Brazil’s yang in America’s treatment of South American economies, both subject to what is little more than geoeconomic statecraft. He makes another interesting analogy: to ECB treatment of Eurozone countries during the Eurozone Crisis.

Dollar’s Share of Reserves Held Steady in Second Quarter When Adjusted for FX Moves. Glen Kwende, Erin Nephew, and Carlos Sánchez-Muñoz. IMF.

For those in the field, this has been a huge topic of conversation, and to some degree, controversy. The IMF maintains COFER data, which provides aggregated data on the currency composition of reserves (it literally stands for Currency Composition of Foreign Exchange Reserves). If you looked at the data this past year, it looked like the dollar share of reserves had been falling, and that wouldn’t be a crazy conclusion, given the chaos surrounding “Liberation Day,” attacks on Fed independence, massive fiscal overhang, and any number of erratic policy changes in the US. But the trouble is that, as the authors note (emphasis mine):

These shares are reported in US dollars . . . So, when exchange rates shift—even if no central bank buys or sells anything—reported shares change . . . [the depreciation of the dollar] means that even if central banks made no changes to their portfolios, the value of their non-dollar holdings—when expressed in dollars—increased, resulting in a corresponding decrease in the share of dollar holdings.

It’s so important it became the IMF’s chart of the week!

Interpreting Turbulent Episodes in International Finance. Hélène Rey and Vania Stavrakeva. Asian Monetary Policy Forum conference paper.

That capital inflows should move exchange rates and asset prices in the recipient country is seemingly obvious, but it’s one of these tricky things that’s deceptively “obvious” insofar as causal inference is notoriously difficult (because of all the endogeneity) and, as a result, so is quantification of the effect. In this paper, Rey and Stavrakeva take an instrumental variable approach (more 2SLS regressions, yay!), exploiting accounting identities about asset ownership and exchange rates, and identify a causal link.

Some of they highlights:

• Equity finance is larger than debt finance in cross-border investment since 2023.

• Usually, the local exchange rate appreciates on capital inflows, but there are some major and important outliers: USD (and some USD-pegged currencies), JPY, HKD, and CHF.

• Foreign holdings do tend to be supportive of asset prices.

• Cross-border capital markets are bigger and deeper now than in recent history.

But here’s the big one (emphasis mine):

Based on our novel daily decomposition we provide an interpretation of the striking disconnect between the USD and the standard global financial cycle that we have observed since the announcement of Trump’s tariffs. More specifically, the response to the Trump tariff announcement on April 2, 2025, marked a notable shift in global investment behavior, as the U.S. dollar depreciated sharply and foreign investors disproportionately reduced their holdings in U.S. equities and long-term government debt in favour of non-U.S. markets. This stands in stark contrast to prior crises like Covid-19 and the global financial crisis (GFC), where foreign investors typically sought safety in U.S. assets, increasing their demand for U.S. long-term government debt and decreasing demand for foreign equities in relative terms. The tariff shock represents a rare instance where global investors fled U.S. assets more than those of other countries, challenging the traditional “flight-to-safety” pattern.

We also get some very cool pictures here mapping out cross-border investments:

What are swap lines?

Literally, what are they?

Swap lines are arrangements—usually (but not always!) between central banks—to exchange one currency for another at some initiation date and then swap them back at a pre-agreed exchange rate in the future. One way to think of them is that they are repurchase agreements (repos) collateralized by foreign currency.1

I wrote a standalone primer on central bank swaps lines, which I’d encourage readers to check out. Additionally, some more comprehensive coverage can be found at the Fed and the Yale Program on Financial Stability.

Why do we have them?

Nine times out of ten, swap lines are extended because of funding pressures, i.e., spikes in borrowing costs in offshore currency markets. In practice, this means that it gets really difficult/expensive for European or Asian banks to borrow dollars, so to calm those dollar funding stresses, their monetary authorities obtain a swap line with the Fed. This is the answer you’re most likely to get from a central banker, and they’ll tell you about the cross-currency basis swap spreads (the cost of borrowing dollars abroad) rising sharply. This is true not just of the US, but to a lesser degree also for the ECB and their euro swap lines.

In reality, there can be other reasons at play too, although they’re much less common. For example, you might draw on a swap line to obtain large amounts of foreign currency so you can lend to a specific bank that’s on the brink of failure and has lots of foreign currency-denominated liabilities (and/or assets), as Iceland and Switzerland have done. In the context of emerging market economies, you might extend swap lines to help support another country’s currency, as the UAE has done for Türkiye, or as China has done for Argentina; or to try to internationalize your currency (or for other geopolitical means), as China has done.

What’s this ESF/Treasury stuff then?

Are Treasury swaps a thing?

Yep. Earlier I said that swaps are usually but not always between central banks. That is true, because historically fiscal authorities have also done swap arrangements. In fact, in the 1930s, US dollar swaps were extended by the Treasury through the Exchange Stabilization Fund (ESF), not the Fed (although this changed in coming decades). The ESF is a pot of Treasury money2 composed of foreign exchange (technically, foreign exchange, gold, and SDRs) that is held in a segregated account at the New York Fed (segregated from the Treasury General Account, that is). In more recent history, the Treasury has used the ESF to provide swap lines other countries, namely in the 1982 and 1994 Mexican crises. Historically, the use of the ESF, whether via swap or spot transactions, was mostly to do with the exchange rate of the dollar and/or other currencies (and prior to 1971, to gold). But the Treasury has also used it extensively in credit operations to support various countries. (Fun fact: the first use of an ESF credit loan—a few were offered but not used before then—was to Mexico in 1938 for $10 million.)

Intervening to affect the level of the exchange rate—or to aid other countries’ fiscal positions—is a fiscal policy decision in the US, and ergo a Treasury consideration, in contrast to standing or broad-based dollar swap lines extended by the Fed, which are for monetary policy and financial stability purposes. That said, it bears noting that the New York Fed is the fiscal agent of the Treasury (i.e., the Treasury’s bank) so any transactions done out of the ESF are staffed and executed by members of the New York Fed’s Open Market Trading Desk.

Does this make the swaps different?

Definitely. For one, as mentioned above, they are inherently political tools when housed in the Treasury. This also has ramifications for the their use; while Fed swap lines are authorized under Section 14 of the Federal Reserve Act (authorizing open market operations) and approved by the Fed’s Board of Governors, Treasury swap lines from the ESF are authorized by executive authority (via the Secretary of the Treasury with approval from the President). Authorizing legislation for the ESF is the Gold Reserve Act of 1934 (as amended) and Section 7 of the Bretton Woods Agreements Act of 1945 (as amended).

The other obvious difference here is that the Treasury is not the monetary authority and therefore cannot create reserves (and the pot of money is the ESF, a segregated account, not the Treasury General Account in any case). This means the lending is inherently limited. For reference, Mexico’s NAFA swap line with the Treasury is $9 billion; the total size of the ESF3 is $219 billion (of which about $16 billion is harder-to-liquidate assets and SPV investments); and the largest amounts outstanding drawn under a Fed swap line from a single counterparty was over $300 billion (from the ECB during COVID).

There are also reporting requirements on longer duration loans,4 but the 1995 precedent (as well as earlier 1982) with Mexico shows this isn’t a crazy hurdle. I won’t spend too much time on it here, but it’s worth noting that there were some legal controversies in 1995 regarding the term of ESF swaps. This prompted a memorandum from the Attorney General’s office to the Treasury Department on the use of the ESF for long-term (up to five years) swaps confirming the Treasury’s interpretation of the relevant statutes. Of interest is the use of the language “unique and exigent circumstances” which somewhat mirrors the language of the Fed’s Section 13(3) authorities (“unusual and exigent circumstances”). All to say, while there was initially some thought to restricting ESF loans to shorter durations,5 that view was put to bed in the summary memorandum, if not before then in 1982. It is well codified today that the Treasury can lend for long durations via ESF swaps.

In short, the main differences vis-à-vis Fed swaps: (1) governance; (2) purpose; (3) scope/scale.

What’s going on with the US and Argentina right now?

I’ll let Sec. Bessent himself tell you:

The [US Treasury] stands ready to purchase Argentina’s USD bonds and will do so as conditions warrant. We are also prepared to deliver significant stand-by credit via the Exchange Stabilization Fund, and we have been in active discussions with President Milei’s team to do so.

The Treasury is currently in negotiations with Argentine officials for a $20 billion swap line with the Central Bank. We are working in close coordination with the Argentine government to prevent excessive volatility.

In addition, the United States stands ready to purchase secondary or primary government debt and we are working with the Argentine government to end the tax holiday for commodity producers converting foreign exchange.

So, there are really three things going on here: (1) a swap line; (2) potential bond-buying; (3) ending a tax holiday for commodity producers. The purposes of (1) and (2) are the same as in the past: to support the peso and Argentine government debt (which kind of go hand-in-hand). The tax holiday issue is new to me, but also seems to be targeting pressure on the exchange rate.

What prompted the support?

In short, a run on the peso (for the 1,000,000,000,000,000th time)—nothing new under the sun here. To hear Bloomberg put it: “Javier Milei has lost the confidence of investors and he knows it” (!). To hear Mr. Milei put it, “the market is in panic mode.” In just three days last week, the Banco Central de la República Argentina (BCRA) intervened with over $1.1 billion (at a time when markets estimated reserves stood at <$20 billion).

The current situation is pretty standard of this sort of EM currency crisis: markets think the peso is overvalued and want the BCRA to let it float, and fear that they won’t be able to defend the peg. Mr. Milei and the BCRA would like to tame the volatility. This is well-trodden ground for emerging markets, and often ends in tears, without overwhelming intervention force. Context here is important, too: Argentina has had episodic balance of payments crises with such frequency that it has become the punchline in many traders’ jokes. In other words, the shadow of crises past looms large over Buenos Aires.

What might the swap line to Argentina look like?

Good question; not really sure. ESF swaps are done on an ad hoc basis. What we know thus far is that it was announced at $20 billion, and we know that swap lines from the Treasury in the past have come from the ESF.

For some historic context, the peak amount announced for Mexico for its 1995 swap was $20 billion,6 which was roughly 5.3% of Mexican GDP at that time. Today’s announcement of $20 billion would put the swap at roughly 3.2% of Argentine GDP, so well within historical bounds.

Notably, Argentine reporting suggests that a condition of the $20 billion swap will be to use $5 billion to extinguish the swap with China (see more on China below).

What about the bond-buying scheme?

Direct purchases of sovereign debt to support Argentina would be a strong direct intervention, and to my knowledge the ESF has mostly used stand-by credit or guarantees, rather than direct bond purchases. Those do have similar effects, though. For example, in the 1995 intervention, the US government included in its aid package an agreement to guarantee Mexican sovereign debt, which would have the same result of lowering yields (via the risk premium channel rather than the demand/supply channel). Notably, Mexico did pay a premium for that insurance, and there were preconditions.

Where does the IMF come in?

The IMF is the ultimate sovereign lender of last resort, to which Argentina is a frequent patron. (As of April, loans to Argentina, which represents <0.6% of global GDP, represented 34% of the IMF’s loan book.) Currently, Argentina benefits from numerous arrangements with the IMF:

Most recently, Argentina obtained—with strong US backing—a $20 billion EFF package. Now, notably, the IMF and US Treasury are not competitors here, rather collaborators (at least ideally). The statutory language related to ESF use is pretty clear that it should be used, “consistent with the obligations of the Government in the International Monetary Fund on orderly exchange arrangements and a stable system of exchange rates” (31 U.S.C. § 5302(b); my emphasis).

It was overshadowed by the Bessent/Trump announcement, but Milei also met today with Kristalina Georgieva.

How are markets reacting?

Well. It’s pretty soon (and light on details) to tell, but immediate signs are positive, which is no surprise. Reuters provides a nice smattering of economists’ notes, which I would characterize roughly as, ‘this is a material show of strength and lops off the left tail in the short run, but we’ll have to see how structural weaknesses are handled in the medium and long term.’

Is there politics at play?

Well, yes. I mean, there are geopolitics at play insofar as any Treasury swap line (some might argue any swap line) extension is an inherently geopolitical decision to some degree (in fact, Sec. Bessent explicitly said the package was symbol of the “geopolitical strategic importance of the relationship between the United States and Argentina”). There are also some more partisan politics at play;7 Argentina’s president, Javier Milei, is facing midterm elections next month after having suffered a brutal defeat in provincial elections a couple of weeks ago. Mr. Milei is an outspoken ideological ally of President Trump.8 Again, there is precedent here: the US pushed against IMF board concerns to approve a $20 billion IMF package in April (when the potential of a US credit line was first mentioned by Mr. Bessent).

Why is China relevant?

China’s current central bank swap line with Argentina is $18 billion, and its swap line at one point represented nearly 95% of Argentine reserves. In the past, it’s been used to support the peso by “putting money in the window” of the BCRA. I have written about this somewhat extensively, here and here. China’s recent (past ten years) history with Argentina has been significant, viewed as savior-like or with alarm, depending on whom you ask. I surmise from private conversations that Argentina turned to China in the past for wont of more forthright American support, and we’ve talked on this site about how China’s swap lines have been used as a geopolitical tool as much as a financial fire extinguisher. China has even used its swap line as a bridge loan to an IMF package for Argentina.

Taken together, the IMF and China have provided a huge chunk of the BCRA’s reserves in recent years. In fact, as Brad Setser points out, if you strip out reserves from the IMF and the People’s Bank of China, Argentina’s reserves position has looked worse throughout 2025, not better.

Which perhaps begs the question: agnostic to who’s in the White House, is this latest announcement good diplomacy on the side of the US? Probably. I have urged before that the US should be more active in its financial diplomacy, and in particular with this type of situation. That being said, it’s hard to be agnostic to who’s in the White House, and it’s unclear to me how much of this is about aiding Argentina or aiding a fellow right-wing populist politician in Latin America. Time might tell in the end.

Was this helpful? Further questions? Drop me a line at vincient.arnold@yale.edu.

That said, I’m trying something new (maybe just once, we’ll see!) while I work on a two-part essay series (yay), because (1) I like when other people do it; (2) I hope you might like when I do it; (3) I see things I think my readers might enjoy, but about which I cannot justify devoting significant writing and this offers a compromise. I’m going to drop a few links here I’ve found interesting, and maybe say something brief about them. (As a housekeeping issue, I’ll mention that while I’ll always try to include some free/non-gated stuff, there may be pay-walled or journal-walled content. Sorry.) If you love it, lmk; if you hate it, lmk.

Democracy does not cause growth. Guillermo Vuletin, Julia Ruiz Pozuelo, and Amy Slipowitz. Brookings.

This is a succinct piece by scholars of a longer academic study, which nicely summarizes their main argument. That argument is more or less a methodology/econometrics critique, but the upshot is material to development and political economy folks alike. A common causal inference (“does X cause Y”) tool is two-stage least squares (2SLS) regression, d.b.a instrumental variable regression (IV).1 A common approach in the literature was to instrument democratization with waves of democracy—i.e., your country gets democracy because your neighbor got democracy and it spreads contagiously, which is nice because you can say that democratic waves have nothing to do with economic outcomes and then conclude, after running an IV regression, that democracy causes economic growth. These authors critique this argument by saying, essentially, “that’s a bad instrument, you’re probably getting waves of democracy precisely because the economy has hit rock bottom.” And it looks like they’re right: once you control for the economic-origins-of-democracy endogeneity, the growth-causing features of democracy disappear. This sits somewhat uncomfortably with the “institutions matter” camp, although there’s plenty of evidence in their favor too (also using IV!). I’m not sure I’m sold on their conclusion yet (as someone partial to institutions-matter), but credit where credit’s due: the weak instrument critique here is clever.

What would happen if Congress repealed the Fed’s authority to pay interest on reserves? William English and Donald Kohn. Brookings.

This topic has been in the headlines of late and has garnered a rather unusual amount of partisan salience. Good thing, then, that the experts have weighed in with an explainer. Even among Fed-watchers, monetary policy implementation regimes are relatively esoteric, so this is a welcome post.

A couple of points I’ll highlight, in defense of interest-on-reserve-balances (IORB):

• When the Fed didn’t pay interest on bank reserves but forced banks to hold them, it was an implicit tax. This is something the “Fed needs oversight and democratic legitimacy” people should be opposed to, and it was distortionary.

• It is by now the norm among advanced economy central banks (for a reason).

• Ample (and/or abundant) reserves systems are practically relatively straightforward to run. Scarce reserve regimes are harder to run, and monetary policy slippage (losing rate control) is more likely to occur, as well as funding shortages, when you’re in a scarce reserves regime.

The main argument we’re hearing against IORB is that it’s a fiscal cost. Which I find interesting! An interest of mine/this site is that the line between the fiscal and the monetary is blurrier than we give it credit for. But these arguments miss the mark with superficial accounting and belie an understanding of the mechanics, regardless of where you stand on the size of the Fed’s balance sheet debate. It’s a tractable and timely piece.

What the West Gets Wrong About China. Rana Mitter and Elsbeth Johnson. HBR.

This is somewhat trodden territory for China-watcher types, but it’s a nice readable essay from which the non-China watchers among us will benefit. The authors—an historian and management professor—attempt to do some myth-busting about China, in three purported myths: (1) economics and democracy are two sides of the same coin; (2) authoritarian political systems can’t be legitimate; and (3) the Chinese live, work, and invest like Westerners. I don’t wholly agree with the authors in all they say here, which is probably no surprise, and I’m not even convinced most people believe myth number 3. Nonetheless, it’s a well-written answer to the “how did China not become like us” question.

The Rate of Return on Everything, 1870–2015. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, Alan M. Taylor. NBER.

Something of an instant classic, this is one of my favorite academic papers, if for no other reason than their rockstar title. What a headline. There’s a lot to cover here, which, as I’ve previewed, I won’t do. But this is very much worth at least a student-read (abstract, intro, conclusion, charts). For your convenience, I’ll just paste here the abstract because it’s so cool:

What is the aggregate real rate of return in the economy? Is it higher than the growth rate of the economy and, if so, by how much? Is there a tendency for returns to fall in the long-run? Which particular assets have the highest long-run returns? We answer these questions on the basis of a new and comprehensive dataset for all major asset classes, including housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, and our new evidence reveals many new findings and puzzles.

Also just . . . data on real estate returns from Norway in 1871? Awesome. There are lots of upshots, but the thing I noticed starkly was that housing not only historically has the highest returns, it also has the highest risk-adjusted returns (Sharpe Ratios = excess return/sigma):

Another cool thing about this paper is that it’s both finance and economics, and necessarily has something to say about the macroeconomy, in this case about inequality. If r > g, in other words, returns to financial assets (wealth) are higher than the returns of the economy writ large, you’d expect inequality to expand, and their dataset has something to say about this too:

TL;DR: aside from wars, r >> g. Anyways, the paper is worth a skim at least. Reactions to it could vary from “become a real estate mogul” to “become a communist” so, ya know, idk, pick your poison, but either way, it’s a very cool paper.

***

Fin. Happy reading.

But to shake confidence in America’s dollar liquidity safety net would be to work at cross purposes with the administration’s other goals, like reducing foreign demand for Treasury assets and limiting the trade deficit. The mechanism is that swap lines can serve as a substitute for reserve accumulation, which, all else equal, would result in more purchases of Treasury and Agency debt, sometimes with surpluses created intentionally for that purpose: war chest-building, if you will. To resolve trade imbalances, you have to think about financial flows too.

Please check out the full article over at Barron’s, with a gift link for Discursive Etc. readers, courtesy of the good folks at Barron’s. (It will look like you’re still paywalled at first, but you’re not—just click the carrot dropdown to minimize the ad banner.)

Last week, the Yale Program on Financial Stability (YPFS) published Volume 7, Issue 1 of the Journal of Financial Crises. This one is close to my heart, as it comprises our series of case studies—and survey thereof—on what we’ve termed ad hoc emergency lending. The keystone piece is Ad Hoc Emergency Lending in the 21st Century, with Steven Kelly, Greg Feldberg, and Andrew Metrick (see bios here).

As many readers will know, the work of YPFS involves essentially three steps: (1) identify common tools used to respond to financial crises; (2) review selected case studies in which those tools were used; and (3) analyze best practices and caution areas for future policymakers in using those tools. The tools and case study universe come from a seminal paper by Andrew Metrick and Paul Schmelzing, which catalogues all financial crisis interventions since 1257 AD. For more on this and the way YPFS thinks about financial crises and interventions, see my earlier note on diagnosing financial crises.

You can see the various different case studies organized by intervention tool (e.g., account guarantees, capital injections, swap lines, etc.) on the New Bagehot platform, here, where we’ve compiled hundreds of case studies and thousands of pages of documentation on financial crisis interventions, from capital injections in Napoleonic France to COVID-era currency swap lines in Mongolia.

The Lender of Last Resort, targeted

Emergency lending is one of the most potent and most commonly used tools to respond to financial crises. It is often the tip of the spear—the tourniquet of financial crisis triage: emergency lending may not do the ultimate resolution and rebuilding, but it’s often the first intervention. It stops the bleeding, buying time for complex surgery or transfusions. YPFS has previously examined what we call broad-based emergency liquidity, as well as market-based emergency liquidity (here and here). We defined the former as lending that is available to any eligible institutions (think the Fed’s discount window, or other Lombard facilities), and the latter as lending that is meant to support particular markets (think lending to support the commercial paper market).

But this excludes one of the most important, controversial, and difficult types of lending: bespoke lending for specific firms. These are the Bear Stearns of the world, the Lehman Brothers, the Credit Suisse. It is exactly this—what we term ad hoc emergency lending (AHEL)—that we’ve just analyzed and published last week.

AHEL of a ride: upshots from the review

This project took two years, hundreds of pages, thousands of hours, countless interviews, and an incredible team to complete. I was honored to be a part of it, and to work with my incredible co-authors, from whom I’ve learned so much. I would encourage all interested parties to read our survey of AHEL cases in the 21st century; it’s not long, and we hope it’s quite tractable. Here’s the paper’s abstract:

This paper surveys 22 case studies of 21st century instances when financial crisis-fighters implemented ad hoc emergency liquidity (AHEL) interventions, interventions designed to provide liquidity to a troubled institution that the authorities believe is systemically important. While emergency liquidity support is often introduced with the real or communicated intention of preventing illiquidity from leading to insolvency, the liquidity crisis should instead be viewed as the manifestation of the market’s assessing the firm as nonviable as a going concern. For that reason, authorities should provide AHEL assistance only to institutions that they have deemed viable or that they have committed to make viable through additional interventions, most commonly through a government capital injection or merger with a stronger institution. Despite AHEL assistance, which the authorities in several cases sized to meet all potential funding outflows from the troubled firms, in no cases did liquidity provision alone prove a “cure” to the run on the institution. Crisis-fighters also should not use the terms of an AHEL intervention to manage moral hazard. Moral hazard can be addressed in the more structural policy responses that will need to follow AHEL assistance. AHEL programs should focus on providing sufficient liquidity to get the institution through its acute crisis phase.

I’ll highlight here some features I found particularly interesting.

AHEL interventions are very common. Even limiting ourselves to the 21st century, and even after landmark legislation in the US significantly curtailed AHEL interventions post-Global Financial Crisis, AHEL interventions were often central to the biggest financial crises and the biggest institutions (e.g., Bear Stearns, Credit Suisse, Northern Rock, all that chaos in Cyprus, and yes, even Lehman1, just to name a few).

Actually, it is about solvency. This is one of the key contributions to the literature in my view. While, yes, it is possible that a bank run occurs because of pure liquidity challenges, we find that almost never happens in the ad hoc setting. The run is symptomatic of fundamental solvency concerns. As my co-author Steven Kelly noted in his summary of the paper: “death to the myth of the ‘illiquid but solvent’ bank that needs a rescue.”

Moral hazard is better addressed elsewhere. We are not suggesting that authorities shouldn’t be concerned about moral hazard; they should. But we find that AHEL interventions are used as bridges to more permanent solutions, and punitive terms for the AHEL often end up, counterintuitively, making those other solutions more difficult and/or expensive. For example, in a few cases, authorities tried charging punitively high interest rates to punish the bank, and then realized those interest payments were eroding the bank’s capital, which they were replacing.

Creative thinking about balance sheet protection. Lenders, mostly central banks, are often required by law or internal regulation to lend against collateral, like tradable securities and loans that the central bank can easily value (there is usually a published list of acceptable collateral for standing broad-based lending facilities). Yet it is precisely the lack of eligible collateral that creates the need for an AHEL intervention in the first place: if the bank had sufficient everyday collateral eligible for a Lombard facility, it wouldn’t need an AHEL. As a result, lenders had to get creative, using fiscal guarantees, recourse, forthcoming interventions (like capital injections), and loss-sharing arrangements to limit their risks.

Political economy and the fiscal realities of monetary lending. Of particular relevance to a common theme of this site is the political economy of AHEL interventions. My priors on this were that nearly every lender would be a central bank. I was wrong. In many cases non-central bank lenders were involved, and in four of 22, they were the primary lender. Moreover, fiscal guarantees of central bank lending were very common, occurring roughly a third of the time. This has interesting implications for political economy and central bank independence. I have written about this in the European setting in a Yale blog.

A casual observation is that one can draw a sort of bell-shaped curve, where the y-axis represents something like “autonomous central bank lending as share of total lending,” and the x-axis represents size of lending relative to the economy or banking system. At the very left end, where lending is very small, there can be no central bank involvement at all—this is where we see banking “self-help” interventions or industry loans. In the middle, we see nearly 100% autonomous central bank lending—this is the vast majority of cases in practice. In the far right, the lending gets too large for a central bank to conduct independently, owing to legal or political constraints, and it ends up being a largely fiscal operation, with the central bank taking low or very little counterparty risk itself. This is the subject of ongoing personal research.

Associated pieces

There’s a lot more to be said about AHEL, but it’s all said in the paper, so I’ll leave it here for now. I will highlight the list of cases, some of which authored by yours truly, in case of further interest, all of which can be accessed here:

Source: Ad Hoc Emergency Lending in the 21st Century

You can follow me on Twitter (X) @ArnoldVincient, or connect with me on LinkedIn.

This work is independent from and not endorsed by the Yale Program on Financial Stability or Yale University; all views are my own.