When it comes to the abundance of US dollar liquidity, the first thing we think of is often the Federal Reserve, interest rate cuts and balance sheet expansion. But in fact, in addition to the control of the Federal Reserve, the Treasury Department also plays an important role in the control of liquidity. At this moment, its status is more important than ever before, because the US public debt has once again hit a new high. The scale of debt is larger than the total economic volume, and the growth rate of interest is even faster than the growth rate of GDP. The scale, time and term of the issuance of treasury bonds are all decided by the Ministry of Finance alone, and the Federal Reserve can only stare blankly. The Ministry of Finance, which controls the supply of bonds, has become the most powerful department in the country. The Ministry of Finance has issued treasury bonds without any bottom line, creating a false prosperity driven by debt (or maintaining the illusion of a soft landing). The final result can only be to force the central bank to start the printing press again to clean up the country's huge debt.
Before talking about the Treasury's TGA account, we also need to popularize some prerequisite concepts, including the Ministry of Finance's functions, deficits, and treasury bond issuance.
Understanding the Ministry of Finance
The power structure of the United States is a typical separation of powers, with legislative power held by the Senate and the House of Representatives, executive power held by the president, and judicial power exercised by the federal courts. These three systems operate independently and check and balance each other. The Treasury Department is just one of the many executive departments of the federal government, and all decisions are directly responsible to the current White House leadership. Therefore, in terms of policy independence, there is a world of difference between the Treasury Department and the Federal Reserve (only in name). Although the Federal Reserve was created by Congress and the members of the Board of Governors are nominated by the President of the United States, there is no clear affiliation. Therefore, the Federal Reserve is neither a typical government department nor a completely private institution. Perhaps it should be called an independent public institution with mixed characteristics of the private and public sectors.
The Federal Reserve is mainly responsible for monetary policy, bank supervision and foreign exchange management, while the Treasury Department is mainly responsible for the government's fiscal policy, taxation and public debt management. In short, all the work of the Treasury Department revolves around ensuring that the US government has sufficient funds, which involves both revenue and expenditure. The US fiscal revenue mainly comes from taxes, including personal income tax and social insurance taxes, while the bulk of expenditures are on public services, defense spending, debt interest, etc.
Economic prosperity driven by normalized deficits
When government spending exceeds revenue, a fiscal deficit will occur, and increased spending and tax cuts are usually seen as loose fiscal policies. In the traditional impression, Trump is a president who is "particularly good at spending money", and Biden's ability to squander finances during his tenure is even worse. In the past four years, the Biden administration has successively promulgated the "Infrastructure Investment and Employment Act", the "Reducing Inflation Act" and huge subsidies for chip manufacturing and new energy, resulting in further widening the fiscal deficit. Since the 21st century, the average size of the US government deficit has been around 1 trillion US dollars, and in the past two years, this figure has generally been close to 2 trillion.
It is true that deficits drive economic growth. GDP not only reflects a country's total output, but also represents total expenditure. Therefore, GDP growth can be linked to "personal and corporate spending (including exports and investment) + government spending." Taxes weaken the spending power of the private sector, but increase the spending power of the government. If government spending is greater than taxes, then a deficit and net spending are incurred. The series of economic activities triggered by the government's spending on goods and employee wages ultimately lead to an increase in total economic output (such as GDP) that is usually greater than the amount of initial expenditure. If the government spends money to build a stadium in a certain place, it will attract private sector investment, and supporting facilities such as housing and restaurants will spring up like mushrooms after rain, adding jobs and boosting the economy. This kind of spending is usually targeted at specific targets, more direct and immediate than that of enterprises and individuals, and is not limited by profit motives. It is very effective especially in economic downturns. This is called the "multiplier effect" of government spending.
From Roosevelt's New Deal, which advocated massive public spending and government intervention, to Johnson's soaring fiscal deficits during the Great Society and the Vietnam War, to Reaganomics' tax cuts and increased defense spending. The fiscal deficit is actually a consensus of the same origin. Its principle is to stimulate the economy through government spending in exchange for significant GDP growth and ensuring support during the term.
Treasury bond issuance: a tool for the Ministry of Finance to control liquidity
The question is, where does the money for the increased deficit come from? The answer is to issue government bonds. If there is no budget surplus, this is the only way. The tax department also supports government bonds and deficits because they can inject liquidity, drive up stock prices, increase wages, and increase capital gains taxes and personal income taxes. In this way, deficits and taxes form an almost perfect two-way interaction, and the only cost is debt that is not paid back in a hurry. As for inflation? This is not an issue that Yellen cares about.
In theory, the government recovers liquidity through taxation and then releases liquidity through spending. This internal cycle of taking from the people and using it for the people is normal. However, relying on issuing treasury bonds to borrow money is equivalent to eating food in the next year and drinking poison to quench thirst. Generally, a country's debt-to-GDP ratio of more than 100% is a danger signal, which means that the country may face the risk of debt default. The European debt crisis, the Greek debt crisis, and the Latin American debt crisis are all lessons from the past. Congress obviously cannot condone the government's unlimited reliance on issuing treasury bonds for financing. In 1917, the U.S. Congress introduced the debt ceiling system until 2023. After 103 debt ceiling adjustments in 105 years, the Biden administration temporarily lifted the debt ceiling until January 1, 2025, because this is the time when he leaves office as president, and he must ensure that there is money to spend during his term to support his Biden economics.
Strangely, in the process of debt expansion over the past few years, we have not seen a liquidity crisis in US debt, and it is still a risk-free asset described in textbooks. This is because US dollar debt itself is quite special. It relies on the hegemony of the US dollar and has always had no shortage of buyers in the past. Take Saudi Arabia, an oil exporter, for example. Since oil needs to be priced in US dollars, no matter which country imports oil, Saudi Arabia will receive a large amount of US dollars. There is no income from simply holding so many US dollars. Therefore, in addition to retaining a part as foreign exchange reserves, the remaining US dollars are usually used to purchase US Treasury bonds through sovereign funds and other forms. These US dollars flowing to the world actually flow back to the US economic system (mainly the financial system). This circular chain of US dollar reflux is an important reliance of the US dollar to harvest the world through the hegemony of the US dollar. The Treasury bonds that should have been taken over by the Americans themselves can find many buyers abroad. Fundamentally, the premise for the United States to maintain a normalized deficit and avoid a debt crisis is that the US dollar maintains an absolute dominant position in the international arena and that the United States' comprehensive national strength is sufficient to cover up the dilemma of national credit overdraft.
Today, this situation seems to be gradually being pried open. Since the interest rate hike in March 22, the bear market background of US bonds has lasted for 2 years. Low prices mean high yields, which means that the Treasury must offer higher interest rates to attract buyers. In other words, US bonds are starting to sell poorly. The high interest rate environment is only the surface reason. In this round of bond bear market, the specific factors affecting the yield of US bonds are actually the imbalance between supply and demand, especially the over-issuance of the supply side. By comparing the following two figures, it can be seen that the Ministry of Finance has been expanding its debt significantly since 2020. When the Federal Reserve implements unlimited QE, this approach is not a big problem, because no matter how much new debt is issued, the Federal Reserve will cover it by printing money, and the currency depreciation caused by the increase in the issuance of US dollars will be borne by the world. However, since 22, the Federal Reserve has begun to raise interest rates (newly issued treasury bonds have higher interest rates) and has begun to shrink its balance sheet (not only does it not cover the bottom, but it also sells treasury bonds). On the other hand, the Ministry of Finance has not reduced its bond issuance from 23 to now (forced by various subsidy policies of Biden's economics). New and old treasury bonds have poured into the market together, exacerbating the supply pressure in the bond market. It is worth noting that during this period, Yellen turned to issuing short-term bonds (blue column). As we mentioned in the first article on US dollar liquidity, while reducing overnight reverse repo positions, money market funds will turn to buying short-term bonds, which can be regarded as barely offsetting the pressure of short-term bond issuance during this period. The overnight reverse repo account is like a blood transfusion bag to extend the life of the lingering bond issuance. Now that the account has fallen below 300 billion and hit the bottom, it can be imagined that the Treasury's subsequent bond issuance will be more difficult. The Federal Reserve plans to cut interest rates and end the balance sheet reduction in September, ostensibly due to considerations of the weak labor market, but in fact it is also to ensure that US bonds can be issued smoothly.
The Ministry of Finance leads liquidity
The Treasury General Account (TGA) is the main operating account opened by the U.S. Treasury at the Federal Reserve. This account is used to manage the cash flow of the U.S. federal government and handle daily revenue and expenditure. The federal government's tax and tariff revenues, as well as the funds obtained from issuing treasury bonds, are deposited in the TGA account. Payments such as social security, medical insurance and interest are also made through this account. Like the overnight reverse repo account, if too much money is accumulated in these accounts, it becomes dead money (or, the money deposited in them has a money multiplier of 0x, while the multiplier deposited in any other financial intermediary is at least non-zero, depending on the reserve ratio). Therefore, the TGA account, as the second minus in the dollar liquidity formula (Federal Reserve asset size-RRP-TGA), directly affects market liquidity. With other conditions unchanged, a decrease in the account balance means that the Treasury is spending money to stimulate the economy and inject liquidity (mainly flowing to bank reserves with the largest money multiplier, which may increase broader lending or investment, which will be discussed in the next article).
However, when examining overall liquidity, it cannot be ignored that the balance of the Treasury's TGA account is also a figure with obvious periodicity, mainly due to the impact of some key tax receipt times on the TGA account. April, June, September, and mid-October of each year are the due dates for several key tax declarations, and the TGA balance usually increases significantly at these times. TGA also increases on the date of the Treasury's bond auction each month, which also withdraws liquidity from the market because buyers must pay for the bonds in US dollars.
Through taxation, treasury bond issuance and TGA accounts, the Ministry of Finance has gained control over the liquidity of the US dollar that is no less than that of the Federal Reserve. The basic path is: the Ministry of Finance recovers US dollars from domestic and foreign markets through taxation and issuance of treasury bonds. Although these US dollars are temporarily kept in the TGA account, they will eventually be reinvested in the market according to the fiscal budget plan to restore liquidity. Whether it is increasing military spending, targeted subsidies for chip companies, or direct subsidies to the public during the epidemic, they are all manifestations of liquidity release. The Fed's balance sheet reduction in the past two years has actually been a lonely shrinkage, because the Ministry of Finance quietly took over the baton of flooding. Without the loose fiscal policy of old lady Yellen, the US economy simply cannot withstand such a long period of monetary tightening cycle.
TGA has been maintained at the target level of $750 billion this year, which does not mean that the Treasury has not spent a penny. The fiscal budget is still being implemented according to the established plan, but the reverse repurchase account has shrunk significantly and flowed to short-term debt, maintaining the balance of the TGA account. The Treasury needs to adjust the number and maturity of bonds issued to keep TGA near its target. Because as the 25-year debt ceiling is approaching, they must reserve enough assets to pay for expenses before then. Yellen also promised to launch a bond repurchase program before the end of the year. The TGA account will be the only outlet and the last trump card from now to the beginning of next year. This period is destined to be difficult. When the debt ceiling is raised again (usually after complex political operations in Congress, which also means that QE is not far away), the Treasury will reissue additional debt to fill the TGA account. I have a hunch that the Federal Reserve will buy Treasury bonds again at that time. This is the only way out.
