Bob McCauley is a non-resident senior fellow at Boston University’s Global Development Policy Center and associate of the faculty of history at the University of Oxford.
What’s wrong with the international monetary and financial system? Stephen Miran, whom Donald Trump has nominated to head the US Council of Economic Advisers, thinks he has the answer.
In essence, he thinks we live in a neo-Triffin world:
1. Central banks buy dollars to hold down their currencies and to run surpluses on trade in goods and services.
2. Central banks hold their dollars in US Treasury securities.
3. The US dollar is overvalued and the US runs current account deficits.
4. US manufacturing shrinks and US workers have fewer good jobs.
5. Eventually US external deficits undermine US safety and the dollar as reserve currency.
What is to be done? To improve the US position, Miran suggests that the US could cajole or coerce foreign government creditors to accept 50- or 100-year Treasury bonds, extending the duration of US government debt in the process. Alphaville’s Robin Wigglesworth characterises this suggestion as Godfatherly: “Nice global financial system you got there, be a shame if something happened to it.”
A related out-of-the-box proposal reaches further, but requires a quick feasibility check. To address the “root cause” of the problem, Miran proposes to impose a “user fee” on official holdings of Treasury securities. If official dollar purchases pollute the international financial system — harming American manufacturing workers — why not impose a (Pigovian!) tax on the effluent?
Miran hopes that central banks would sell the dollar and weaken it. But if they don’t, then they would receive lower interest rates on their Treasury holdings. Heads I win, tails you lose. As Miran puts it:
Reserve holders impose a burden on the American export sector, and withholding a portion of interest payments can help recoup some of that cost. Some bondholders may accuse the United States of defaulting on its debt, but the reality is that most governments tax interest income, and the U.S. already taxes domestic holders of UST securities on their interest payments. While this policy works through currencies as a means of affecting economic conditions, it is actually a policy targeting reserve accumulation and not a formal currency policy. Legally, it is easier to structure such a policy as a user fee rather than a tax, to avoid running afoul of tax treaties. Such policy is not a capital control, since aiming it exclusively at the foreign official sector targets reserve accumulation rather than private investment.
It must be said that neither the diagnosis nor the treatment has much merit.
Dollar reserve accumulation bears no clear relationship with US current account deficits. What is more, Robert Triffin in 1960 could point to the impending crossover point when foreign-held dollars would surpass US gold holdings and could set off a run. The neo-Triffin dilemma analogy limps without a clear crossover point of unsustainable US net international debt and equity liabilities — currently a cool $24tn, or 80 per cent of US GDP.
Would the proposed treatment succeed and lead foreign central banks to sell dollars or to receive less interest? Or would officials just find other places to invest their dollars? Probably the latter.
Foreign officials could easily evade the user fee on official Treasury holdings by switching from Treasuries to US agencies. In mid-June 2023, foreign officials held $657bn of agency debt (mostly mortgage-backed securities issued by Fannie Mae and Freddie Mac) and $3.5tn of Treasuries. Back in 2008, China held as many dollars in US agencies as in Treasuries and has recently switched some Treasuries into agencies. The user fee might have to be extended to official holdings of agencies.
Even that would probably not work. Like the Interest Equalization Tax of 1963 — prompted by Triffin’s warnings that the gold/dollar link was at risk — the user fee would most likely simply lead activity in the dollar to move offshore.
After all, the prohibitive tax on most “Yankee” bonds issued by overseas borrowers in the the US swiftly moved dollar borrowing to what became London’s Eurobond market. As Morgan Guaranty chair Henry Alexander is said to have presciently lamented to colleagues on the day the IET was announced:
This is a day you will remember forever. It will change the face of American banking and force all the business off to London.
A tax on bonds held in the US would surely move official reserve managers to simply shift dollars offshore. Recall that US sanctions from 2014 led the Bank of Russia to keep its dollars offshore rather than sell them.
Countries could shift their Treasury holdings to offshore custodians in Brussels, Luxembourg and London. There, the US Treasury may lose the trail and not be able to identify official holders. As it happens, the Chinese are thought to have relied more heavily on offshore custodians recently.
They could also add to the $1tn-plus already invested in offshore bond issues and banks. Central banks can and do hold lots of dollar bonds issued by the likes of KfW, the German government-guaranteed export bank that dates to the Marshall Plan, and those of a host of other solid borrowers.
If the pricing of AAA- and AA-rated sovereigns, provinces, agencies and supranationals became more favourable because of the user fee on Treasuries, these top borrowers would issue more dollar debt if only to swap into other currencies. In addition, dollar repo transactions with top-rated banks offshore are a pretty good substitute for holding US Treasury bills subject to a user fee.
Of course, none of these alternatives to US Treasuries held in custody at the New York Fed would benefit from the Fed’s standing offer to provide immediate dollar funding in amounts up to $60bn per counterparty. The Swiss National Bank found this central bank repo facility usefully fast and stigma-free when it was funding Credit Suisse almost two years ago.
However, were US Treasuries subject to a substantial user fee, experience would quickly underscore that the US Treasury enjoys no monopoly in supplying dollar investments to central banks.