Are US Treasuries becoming a financial chokepoint?
A haven asset for the financial system is becoming a source of risk
John Plender
Iran has taught the world a thing or two about the use of maritime chokepoints for geopolitical ends.
Its actions in the Strait of Hormuz also raise an interesting question as to whether there are comparable financial chokepoints — focal points of stress — that could give rise to geopolitically inspired market turmoil.
One obvious area for exploration is the relationship between global creditors and debtors and more specifically the financial imbalances between the world’s excess savers and its biggest debtor, the US.
The US has long been the world’s borrower of first and last resort.
The biggest claimants on its assets have been central bank reserve managers.
Note that the second largest, most geopolitically sensitive US government creditor after Japan is China.
With Hong Kong it holds no less than $930.5bn of Treasury securities.
There has long been a debate about how this might constitute a chokepoint.
Clearly the US could find ways of defaulting on its debt to China.
Yet the chokepoint involves joint dependency, which makes the metaphor not quite exact.
From time to time Chinese officials have made a case for using financial leverage to punish the US for selling arms to Taiwan.
Yet the Communist Party leadership is also aware that weaponising China’s dollar reserves would sink the dollar and cause US interest rates to soar, so wrecking the value of their dollar investments.
Nor is it clear how potent a weapon this might be.
As the Chinese built their Treasury market stake, US Defense Department officials reportedly argued that using Treasury securities as a coercive tool would have limited effect given the sheer size and liquidity of the Treasury market.
A new twist is that central bank reserve managers have been losing their appetite for Treasuries.
This reflects worries about debt sustainability, the weaponisation of the dollar via financial sanctions, threats to the independence of the Federal Reserve and the erosion of political checks and balances under Donald Trump.
It is striking that gold has now replaced US Treasuries as the world’s top reserve asset, according to a new European Central Bank report.
Fickle non-bank private institutions, with highly leveraged hedge funds in the lead, now absorb more Treasury issuance than central banks.
Such buyers, according to Marcello Estevão and Jonathan Fortun of the Institute of International Finance, are more responsive to interest rates, hedging costs, benchmark mandates and risk appetite.
At the same time, Treasury funding is increasingly reliant on shorter-term securities, which means constant rollover risk.
With US public debt approaching its highest ever level, this combination sounds like the very definition of a non-geopolitical financial chokepoint, with vulnerability to shocks.
It also suggests there are now systemic risks in the Treasury market.
The chokepoint metaphor is perhaps most relevant in relation to critical financial dependencies arising from overwhelming US dominance of global financial services, including payment systems, investment banking and dollar-denominated lending.
In a paper in the IMF’s F&D Magazine, Christopher Clayton, Matteo Maggiori and Jesse Schreger remind us that the US has used its geoeconomic power to impose comprehensive financial sanctions on Iran and Russia.
But they also make the important point that overuse of this power is self-defeating because it drives nations to seek alternatives.
At this point it needs to be said that geopolitical financial chokepoints may pose a less worrisome threat to the global economy than internal systemic weaknesses.
One such relates to a monetary policy framework based on inflation targeting.
In two recent books, Manoj Pradhan and Charles Goodhart have powerfully argued that sweeping demographic trends, rather than inflation targeting, have driven the past three decades of low inflation.
These include the addition of postwar baby boomers to the labour market; the rising participation of women; and the outsourcing of production to low-wage countries.
The result was downward pressure on advanced country wages and inflation.
But now this is going into reverse with an increasing share of the population reaching retirement age, the female participation rate plateauing in some countries and globalisation in retreat.
The health and care costs of an ageing population will be punitive in the absence of an AI miracle.
Pradhan and Goodhart argue that fighting stubborn inflation in economies facing debt sustainability concerns is fraught with risk, not least of financial crises.
Central banks may be unable to reconcile their inflation-targeting and financial stability objectives.
In financing much of the fiscal burden and bailing out markets they will monetise debt and end up living with much higher real interest rates and inflation. In short, a serious chokepoint.
All this applies with special force to the super-indebted US government.
If Pradhan and Goodhart are right, the US is set to be the purveyor of fewer and fewer safe assets to the world.
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