Introduction: Political Incentives and the Inevitability of Debt
Praise to Satoshi Nakamoto, whose existence and the law of compound interest are independent of individual identity.
Even governments have only two ways to pay for expenses: using savings (taxes) or issuing debt. For governments, savings are equivalent to taxes. It's well known that taxes are unpopular with the public, but spending money is much more appealing. Therefore, when distributing welfare to the people, politicians tend to issue debt. Politicians always tend to borrow from the future because when the bills are due, they may no longer be in office.
If all governments are "hard-coded" to issue debt rather than raise taxes to distribute welfare due to incentives for officials, then the next key question is: how do buyers of U.S. Treasury bonds finance these purchases? Do they use their own savings/equity, or do they finance them through borrowing?
Answering these questions, especially in the context of "Pax Americana," is crucial for predicting future dollar money creation. If marginal buyers of U.S. Treasury bonds finance their purchases, we can observe who is providing them with the loans. Once we know the identities of these debt financiers, we can determine whether they are creating money out of thin air to lend or using their own equity to lend.
If, after answering all the questions, we find that the financing parties of government bonds create money in the process of lending, then we can draw the following conclusion:
Government-issued debt will increase the money supply.
If this assertion holds true, then we can estimate the upper limit of credit that the financing party can issue (assuming there is an upper limit).
These questions are important because my argument is that if government borrowing continues to grow as predicted by large banks (TBTF Banks), the U.S. Treasury, and the Congressional Budget Office, then the Federal Reserve's balance sheet will also grow accordingly.
If the Federal Reserve's balance sheet grows, it will be a boon to dollar liquidity, which will ultimately drive up the prices of Bitcoin and other cryptocurrencies.
Next, we will answer the questions one by one and evaluate this logic puzzle.
Q&A Session
Will US President Trump finance the deficit through tax cuts?
No. He and the Republicans recently extended the 2017 tax cuts.
Is the U.S. Treasury borrowing money to cover the federal deficit, and will it continue to do so in the future?
Yes.
Below are estimates from major bankers and U.S. government agencies. As you can see, they project a deficit of approximately $2 trillion, financed by $2 trillion in borrowing.
Given that the answer to the first two questions is "yes", then:
Annual federal deficit = Annual issuance of Treasury bonds
Next, we will analyze step by step the main buyers of government bonds and how they finance their purchases.
"Waste" that swallows up debt
1. Foreign central banks
If "peace under American rule" is willing to steal funds from Russia (a nuclear power and the world's largest commodity exporter), then no foreign holder of US Treasury bonds can be assured of safety. Foreign central bank reserve managers, aware of the risk of expropriation, prefer to buy gold rather than US Treasury bonds. Therefore, since Russia's invasion of Ukraine in February 2022, gold prices have truly surged.
2. The U.S. private sector
According to data from the U.S. Bureau of Labor Statistics, the personal savings rate was 4.6% in 2024. In the same year, the U.S. federal deficit accounted for 6% of GDP. Given that the deficit is larger than the savings rate, the private sector is unlikely to become a marginal buyer of government bonds.
3. Commercial banks
Are commercial banks in the four major currency centers buying large amounts of US Treasury bonds? The answer is no.
In fiscal year 2025, these four major monetary centers purchased approximately $300 billion worth of U.S. Treasury bonds. In the same fiscal year, the Treasury issued $1.992 trillion in U.S. Treasury bonds. While these buyers are undoubtedly significant purchasers of U.S. Treasury bonds, they are not the final, marginal buyers.
4. Relative Value (RV) Hedge Funds
RV funds are marginal buyers of Treasury bonds, a fact acknowledged in a recent Federal Reserve document.
Our findings suggest that Cayman Islands hedge funds are increasingly becoming marginal foreign buyers of U.S. Treasury bonds and bonds.
As shown in Figure 5, from January 2022 to December 2024—a period during which the Federal Reserve reduced its balance sheet by allowing maturing Treasury bonds to flow out of its portfolios—Cayman Islands hedge funds made net purchases of $1.2 trillion in Treasury bonds. Assuming these purchases consisted entirely of Treasury bonds and bonds, they absorbed 37% of the net issuance of Treasury bonds and bonds, almost equivalent to the total purchases by all other foreign investors combined.
RV Fund's trading model:
- Buy spot treasury bonds
- Sell the corresponding Treasury bond futures contracts
Thanks to Joseph Wang for providing the chart. SOFR trading volume is a proxy for the size of RV funds' participation in the Treasury market. As you can see, the increase in debt burden corresponds to the increase in SOFR trading volume. This indicates that RV funds are marginal buyers of Treasury bonds.
RV funds engage in this type of trading to profit from the tiny spread between the two instruments. Because this spread is extremely small (measured in basis points; 1 basis point = 0.01%), the only way to make money is by financing the purchase of government bonds.
This leads us to the most important part of this article: understanding the Fed's next move.
How does the RV Fund finance its purchase of government bonds?
Repurchase market, implicit quantitative easing and dollar creation
RV Fund finances its Treasury purchases through repurchase agreements (repo). In a seamless transaction, RV Fund borrows overnight cash using the purchased Treasury securities as collateral, and then uses this borrowed cash to settle the Treasury bonds. If cash is plentiful, the repo rate will trade at or below the upper limit of the Federal Reserve's federal funds rate. Why?
How the Federal Reserve manipulates short-term interest rates
The Federal Reserve has two policy rates: the upper limit and the lower limit of the federal funds rate; currently, they are 4.00% and 3.75%, respectively. To enforce the real short-term interest rate (SOFR, the secured overnight funding rate) within this range, the Fed uses the following tools (listed in ascending order of interest rate):
- Overnight Reverse Repurchase Agreement (RRP): Money market funds (MMFs) and commercial banks deposit cash here overnight to earn interest paid by the Federal Reserve. Reward Rate: The lower bound of the federal funds rate.
- Interest on Excess Reserves (IORB): Commercial banks earn interest on excess reserves held by them at the Federal Reserve. Incentive Rate: Between upper and lower limits.
- Standing Repurchase Facility (SRF): When cash is tight, it allows commercial banks and other financial institutions to pledge eligible securities (mainly U.S. Treasury bonds) and receive cash from the Federal Reserve. In essence, the Fed prints money and exchanges it for pledged securities. Reward Rate: The upper limit of the federal funds rate.
The relationship among the three:
Federal Funds Rate Lower Bound = RRP < IORB < SRF = Federal Funds Rate Upper Bound
The SOFR (Secured Overnight Funding Rate) is the Federal Reserve's target rate, representing the composite rate of various repurchase agreements. If the SOFR rate exceeds the federal funds rate ceiling, it indicates a systemic cash crunch, which could trigger significant problems. A cash crunch would cause the SOFR to spike, and the highly leveraged fiat-based financial system would cease to function.
This is because if buyers and sellers of marginal liquidity 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 Treasury bonds because they cannot obtain cheap leverage, making it impossible for the US government to finance at an affordable cost.
Exit of marginal cash providers
What caused SOFR trading prices to be above the upper limit? We need to examine the marginal cash providers in the repo market: money market funds (MMFs) and commercial banks.
- Money Market Fund (MMF) Exit: The goal of MMFs is to earn short-term interest with minimal credit risk. Previously, MMFs would withdraw funds from RRPs and invest them in the repo market because RRP < SOFR. However, now, due to the highly attractive yields on short-term Treasury bills (T-bills), MMFs are withdrawing funds from RRPs and lending them to the US government. With RRP balances nearing zero, MMFs have essentially exited the cash supply of the repo market.
- Commercial banks' constraints: Banks are willing to provide reserves to the repo market because IORB < SOFR. However, a bank's ability to provide cash depends on the adequacy of its reserves. Since the Federal Reserve began quantitative tightening (QT) in early 2022, bank reserves have decreased by trillions of dollars. Once balance sheet capacity shrinks, banks are forced to charge higher interest rates to provide cash.
Starting in 2022, both the MMF and banks, the two marginal cash providers, will have less cash to supply the repurchase market. At some point, neither will be willing or able to provide cash at a rate below or equal to the federal funds rate ceiling.
At the same time, the demand for cash is rising. This is because former President Biden and current President Trump continue their extravagant spending, demanding the issuance of more Treasury bonds. RV funds, the marginal buyers of Treasury bonds, must finance these purchases in the repurchase market.
If they cannot obtain daily funding at rates below or slightly below the federal funds rate ceiling, they will stop buying U.S. Treasury bonds, and the U.S. government will be unable to finance itself at affordable rates.
The activation of SRF and Stealth QE
Because a similar situation occurred in 2019, the Federal Reserve 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 (the upper limit of the federal funds rate). Therefore, RV funds can be confident that no matter how tight cash becomes, they will always be able to obtain funding in the worst-case scenario—the upper limit of the federal funds rate.
If the SRF balance is above zero, we know that the Federal Reserve is using the money it prints to cash in the checks made by politicians.
Treasury bond issuance = Increase in the supply of US dollars
The chart above (top panel) shows the difference between the SOFR (Federal Funds Rate cap) and the SRF (Small Free Trade Area) rates. When this difference is close to zero or positive, cash is tight. During these periods, the SRF (bottom panel, in billions of dollars) is used non-negotiably. Using the SRF allows borrowers to avoid paying higher, less manipulated SOFR rates.
Stealth QE: The Federal Reserve has two methods to ensure sufficient cash in the system: the first is to create bank reserves by purchasing bank securities, i.e., quantitative easing (QE). The second is to freely lend to the repurchase market through the SRF (Special Funding Request).
QE is now considered a "swear word," widely associated with money printing and inflation. To avoid accusations of triggering inflation, the Federal Reserve will strive to claim that its policy is not QE. This means that the SRF (Special Funding Flow) will become the primary channel for printed money to flow into the global financial system, rather than creating more bank reserves through QE.
This can only buy some time. But ultimately, the exponential expansion of government debt issuance will force the SRF to be used repeatedly. Remember, Treasury Secretary Buffalo Bill Bessent not only needs to issue $2 trillion annually to finance the government, but also trillions more to roll over maturing debt.
Implicit quantitative easing is imminent. While I don't know the exact timing, if current money market conditions persist and government debt piles up, the SRF (Special Fund of Last Resort) balance, acting as the lender of last resort, will have to grow. As the SRF balance increases, the global supply of fiat currency, the US dollar, will also expand. This phenomenon will reignite the Bitcoin bull market.
Current Market Stagnation and Opportunities
We must control capital before implicit quantitative easing begins. Market volatility is expected to continue, especially until the US government shutdown ends.
Currently, the Treasury is borrowing money through debt auctions (negative for dollar liquidity), but has not yet spent this money (positive for dollar liquidity). The Treasury's General Account (TGA) balance is about $150 billion higher than the $850 billion target, and this additional liquidity will only be released into the market after the government reopens. This liquidity siphon effect is one of the reasons for the current weakness in the crypto market.
With the four-year anniversary of Bitcoin's all-time high in 2021 fast approaching, many will mistakenly identify this period of market weakness and fatigue as a top and sell off their holdings. Of course, this assumes they weren't wiped out in the altcoin crash a few weeks ago.
But this is a mistake. The logic behind the dollar money market doesn't lie. This corner of the market is shrouded in obscure jargon, but once you translate those terms into "printing money" or "destroying currency," it becomes easy to understand how to grasp the trends.
