Introduction: The Inevitability of Debt and Political Incentives
The crypto world often lauds Satoshi Nakamoto, the creator of Bitcoin, for the existence of the laws of time and compound interest independent of individual identity. But even governments only have two ways to pay for their expenses: use savings (taxes) or issue debt. For governments, savings equates to taxes. As is well known, taxes are unpopular, but spending is very popular. Therefore, politicians are more inclined to issue debt when handing out benefits to people. Politicians always tend to borrow from the future, because they may not be in office when the bills come due.
If all governments are “hard-coded” to prefer issuing debt over raising taxes to deliver benefits, due to official incentive mechanisms, then the next key question is: how do buyers of US Treasuries finance these purchases? Are they using their own savings/equity, or are they financing them through borrowing? Answering these questions, especially in the context of “Pax Americana,” is critical for us to predict future dollar creation. If the marginal buyer of US Treasuries is completing purchases by financing, then we can observe who is providing the loans to them. Once we know the identity of these debt financiers, we can determine whether they are creating money out of thin air to provide the loans, or using their own equity to provide the loans. If, after answering all the questions, we find that the Treasury financiers are creating money in the lending process, then we can draw the following conclusion: debt issued by the government will increase the money supply. If this argument holds, then we can estimate the maximum amount of credit that financiers can issue (assuming there is a maximum). These questions are important because my argument is: if government borrowing continues to grow as predicted by the large banks (TBTF Banks), the US Treasury, and the Congressional Budget Office, then the Federal Reserve's balance sheet will also grow. If the Federal Reserve's balance sheet grows, that is beneficial for dollar liquidity, which will ultimately push up the prices of Bitcoin and other cryptocurrencies.
Will US President Trump Finance Deficits Through Tax Cuts?
No. He and the Republicans recently extended the 2017 tax cuts. Is the US Treasury borrowing to make up for the federal deficit, and will it continue to do so in the future? Yes. Here are estimates from major bankers and US government institutions. As you can see, they estimate the size of the deficit at about $2 trillion, and it is being financed through $2 trillion of borrowing. In light of the fact that the answer to the previous two questions is “yes,” then:
Annual Federal Deficit = Annual Government Bond Issuance
Who Buys the Debt?
- Foreign Central Banks: If “Pax Americana” is willing to steal the funds of Russia (a nuclear power and the world’s largest commodity exporter), no foreign holder of US Treasuries can be assured of safety. Foreign central bank reserve managers are aware of the risk of expropriation, and they prefer to buy gold rather than US Treasuries. Therefore, gold prices began to really surge after the Russian invasion of Ukraine in February 2022.
- US Private Sector: According to data from the US Bureau of Labor Statistics, the personal savings rate for 2024 was 4.6%. In the same year, the US federal deficit was 6% of GDP. Given that the size of the deficit is greater than the savings rate, it is impossible for the private sector to be the marginal buyer of Treasuries.
- Commercial Banks: Are the four major money center commercial banks buying large quantities of US Treasuries? The answer is no. In fiscal year 2025, these four money center banks purchased about $300 billion worth of US Treasuries. In the same fiscal year, the Treasury issued $1.992 trillion worth of US Treasuries. While this segment of buyers is undoubtedly an important buyer of US Treasuries, they are not the final marginal buyer.
- Relative Value (RV) Hedge Funds: RV funds are the marginal buyer of Treasuries, a point acknowledged in a recent Federal Reserve document. Our findings suggest that Cayman Islands hedge funds are increasingly becoming the marginal foreign buyer of US Treasuries and bonds. As shown in Figure 5, from January 2022 to December 2024 -- a period when the Fed reduced its balance sheet by allowing maturing US Treasuries to roll off its investment portfolio -- Cayman Islands hedge funds net purchased $1.2 trillion of Treasuries. Assuming that these purchases were composed entirely of Treasuries and bonds, they absorbed 37% of the net issuance of Treasuries and bonds, almost equivalent to the total purchases of all other foreign investors.
How Do RV Funds Finance Treasury Purchases?
RV funds finance their Treasury purchases through repurchase agreements (repo). In a seamless transaction, RV funds use the purchased Treasury securities as collateral, borrow cash overnight, and then use that borrowed cash to complete the settlement of the Treasury. If cash is plentiful, the repo rate will trade at a level below or just equal to the upper bound of the Federal Reserve's federal funds rate.
How the Fed Manipulates Short-Term Interest Rates
The Federal Reserve has two policy rates: the upper bound (Upper Fed Funds) and the lower bound (Lower Fed Funds) of the federal funds rate; they are currently 4.00% and 3.75%, respectively. To force the actual short-term interest rate (SOFR, i.e. secured overnight financing rate) to stay within this range, the Federal Reserve uses the following tools (ordered by interest rate from lowest to highest):
- Overnight Reverse Repurchase Facility (RRP): Money market funds (MMF) and commercial banks deposit cash here overnight, earning interest paid by the Federal Reserve. Equivalent interest rate: lower bound of the federal funds rate.
- Interest on Reserve Balances (IORB): Commercial banks earn interest on excess reserves deposited with the Federal Reserve. Equivalent interest rate: between the lower and upper bounds.
- Standing Repurchase Facility (SRF): When cash is tight, allows commercial banks and other financial institutions to pledge eligible securities (mainly US Treasuries) and obtain cash provided by the Federal Reserve. In effect, the Federal Reserve prints money in exchange for pledged securities. Equivalent interest rate: upper bound of the federal funds rate.
SOFR (Secured Overnight Financing Rate) is the Federal Reserve's target interest rate, representing the aggregate rate of a variety of repo transactions. If SOFR trades at a price higher than the upper bound of the federal funds rate, it indicates that cash is tight in the system, which will trigger a major problem. Once cash is tight, SOFR will soar, and the highly leveraged fiat financial system will cease to function. This is because if marginal liquidity buyers and sellers cannot roll over their liabilities near the predictable federal funds rate, they will suffer huge losses and stop providing liquidity to the system. No one will buy US Treasuries because they cannot obtain cheap leverage, causing the US government to be unable to finance itself at an affordable cost.
SRF Activation and Stealth Quantitative Easing (QE)
Due to a similar situation occurring in 2019, the Fed established the SRF (Standing Repurchase Facility). As long as acceptable collateral is provided, the Fed can provide an unlimited amount of cash at the SRF rate (i.e. the upper bound of the federal funds rate). Therefore, RV funds can be confident that no matter how tight cash is, they can always obtain funding in the worst-case scenario -- the upper bound of the federal funds rate. If the SRF balance is higher than zero, we know that the Federal Reserve is cashing checks issued by politicians with printed money. Government bond issuance = dollar supply increase
The chart above (top panel) shows the difference between (SOFR – upper bound of the federal funds rate). When this difference is close to zero or positive, cash is tight. In these periods, the SRF (bottom panel, in billions of dollars) is used non-trivially. Using the SRF allows borrowers to avoid paying higher, less manipulated SOFR rates.
Stealth Quantitative Easing (Stealth QE):
The Federal Reserve has two ways to ensure that there is enough cash in the system: the first is to create bank reserves by purchasing bank securities, i.e. quantitative easing (QE). The second is to lend freely to the repo market through the SRF. QE is now a “dirty word,” and the public generally associates it with money printing and inflation. To avoid being accused of causing inflation, the Federal Reserve will strive to proclaim that its policy is not QE. This means that the SRF will become the main channel for money printing to flow into the global financial system, rather than creating more bank reserves through QE. This only buys some time. But eventually, the exponential expansion of government bond issuance will force the SRF to be reused. Remember that Treasury Secretary Buffalo Bill Bessent not only needs to issue $2 trillion per year to fund the government, but also needs to issue trillions of dollars to roll over maturing debt. Stealth quantitative easing is about to begin. Although I don’t know the specific timing, if current money market conditions continue and mountains of government bonds accumulate, the SRF balance as the lender of last resort must grow. As the SRF balance grows, the number of global fiat dollars also expands. This phenomenon will reignite the Bitcoin bull market.
Current Market Stagnation and Opportunities
Before stealth QE begins, we must control capital. The market is expected to continue to fluctuate, especially before the US government shutdown ends. Currently, the Treasury is borrowing money by issuing debt auctions (dollar negative for liquidity), but it has not yet spent this money (dollar positive for liquidity). The balance of the Treasury General Account (TGA) is about $150 billion higher than the target of $850 billion, and this extra liquidity will only be released into the market after the government reopens. This liquidity-siphoning effect is one of the reasons for the current weakness in the crypto market. Given that the four-year cycle anniversary of Bitcoin's all-time high in 2021 is approaching, many will mistakenly regard this period of market weakness and burnout as a top, and sell their holdings. Of course, assuming that they were not “cleansed” in the altcoin crash a few weeks ago. But this is a mistake. The operating logic of the dollar money market does not lie. This corner of the market is shrouded in obscure terms, but once you translate these terms into “money printing” or “destroying money,” it becomes easy to know how to grasp the trend.
EN
