Article by Bao Yilong, Wall Street View
The U.S. Department of the Treasury continues to expand its issuance of Treasury securities, making its role increasingly resemble that of a de facto monetary issuer, and gradually encroaching on the Federal Reserve’s domain through quasi-monetary policy operations.
On September 2, Bloomberg macro strategist Simon White noted that this trend will structurally increase inflationary pressures, undermine the Federal Reserve’s policy independence, and expose market stability and real returns on equities and bonds to greater risk.
Currently, Treasury bills account for 22.7% of the outstanding U.S. debt balance, exceeding the Treasury’s informal upper limit of 20%. Excluding holdings by the Federal Reserve, this proportion rises to 24.1%.
White believes that as the fiscal deficit continues to expand, this ratio is expected to rise further, and policy rates will then no longer be merely the central variable of monetary policy, but also a key anchor determining fiscal stability.
This structural shift means that if the Federal Reserve attempts to control inflation through interest rate hikes, it will face greater political and fiscal resistance, as rate increases directly raise the government’s borrowing costs, effectively tightening fiscal policy and exerting countervailing pressure on monetary policy.
White bluntly stated that, against the backdrop of continuously expanding Treasury issuance, finding an interest rate level that simultaneously meets inflation targets, maintains financial stability, and prevents government borrowing costs from spiraling out of control may be an impossible task.
From Financing Tool to "Shadow Currency": The Evolution of Treasury Bills' Role
Treasury bills have traditionally been a standard tool for short-term financing by the U.S. government, but White noted that the Treasury is intentionally using Treasury bills to replace long-term bonds in order to meet the increased financing demand resulting from a growing fiscal deficit.
From the perspective of the Treasury itself, this strategy has clear financial logic:
- Short-term debt financing costs are typically lower than long-term debt, and treasury bills attract a broad pool of investors who prefer low-duration assets;
- Compared to long-term bonds, Treasury bills have a smaller effect on diverting funds from bank deposits, helping to maintain market liquidity and real economic spending;
- In addition, this approach has, to some extent, avoided the political sensitivity of openly implementing financial repression, even though the Treasury’s expansion of its treasury repurchase program has been seen as a substantial step in that direction.
But to White, Treasury bills are no longer just ordinary short-term financing instruments. According to Perry Mehrling’s hierarchy of money theory, the top of the financial system consists of Federal Reserve reserves, followed by bank deposits, repurchase agreements, and money market fund shares—so-called “shadow money.”
Treasury bills, due to their extremely short maturities and minimal valuation uncertainty, are typically granted a zero discount in the repurchase market and can be repeatedly reused through collateral rehypothecation mechanisms without losing value.
White noted that this makes Treasury bills increasingly function like money itself—a liquid instrument usable for final settlement.
The re-staking mechanism amplifies effects, quietly expanding monetary supply.
White emphasized the critical role of the rehypothecation mechanism in this process.
In the repurchase market, dealers can obtain collateral from their own treasury holdings or borrow it through reverse repurchase agreements and then re-pledge it to other counterparties.
According to a 2021 academic study cited by Bloomberg, U.S. Treasury collateral was rehypothecated an average of three to five times between 2015 and 2021; in other periods, this figure was estimated to be even higher by various sources. In other words, dealers effectively continue to amplify the amount of usable collateral available in the market.
White points out that for long-term government bonds, each round of re-collateralization gradually erodes the actual value of the collateral; however, Treasury bills, with a zero discount rate, can be repeatedly pledged without suffering value loss. This characteristic enables Treasury bills to replicate themselves within the financial system, generating a monetary-like expansion of liquidity.
Historically, an increase in the share of treasury bills relative to total outstanding debt has often preceded the emergence of structural inflation.
White believes there is a reasonable transmission mechanism: increased liquidity raises asset prices, strengthens the wealth effect, artificially lowers the cost of capital, and ultimately transmits to the real economy, pushing up overall price levels.
The Federal Reserve is caught in a dilemma, with its policy independence facing a fundamental challenge.
White believes that the increased issuance of Treasury securities imposes a fundamental constraint on the Federal Reserve's policy space.
As more public debt becomes directly linked to short-term interest rates, each Fed rate hike immediately increases government interest expenses, effectively acting as an automatic fiscal tightening. This mechanism creates objective political pressure, making it harder for the Fed to act decisively when inflation rises.
White directly stated that as the share of Treasury securities continues to rise, "the Federal Reserve may no longer be able to set policy optimally to achieve its inflation target."
Meanwhile, an increase in Treasury supply could also trigger fragility in the short-term funding market. If the additional supply pushes Treasury yields higher, money market funds may shift funds from the repurchase market to Treasuries, thereby reducing liquidity supply in the repurchase market.
White specifically noted that, given the current low combined level of Fed reserves and reverse repurchase agreements relative to GDP, this shift in funds poses a particularly concerning risk of tightening in the short-term funding market.
At the level of financing structure, the treasury itself will face increased vulnerability. Issuing treasury bills implies more frequent and larger auctions, and any rise in inflation expectations will immediately be reflected in borrowing costs. Even if the treasury intends to reduce long-term bond issuance, if the term premium rises sharply, long-term financing costs may ultimately increase rather than decrease.
White’s conclusion is rather pessimistic: as the share of treasury bills grows, the policy rate will simultaneously bear the dual responsibilities of monetary policy and fiscal stability. Finding an equilibrium interest rate level that satisfies inflation targets, financial stability, and fiscal sustainability may well be an unsolvable problem.