1/In the Eurozone, unconventional monetary policy leads to large cross-border fiscal transfers because it allows the periphery to borrow from the core at belo-market rates. We quantify these transfers. 2/ The Eurosystem’s balance sheet had grown to 56% of GDP in the Eurozone by the end of 2021. Most of this growth has happened through an expansion of the national central bank (NCB) balance sheets, because NCBs carry out 90% of the asset purchases. The ECB funds its asset purchases mostly by issuing bank reserves in core countries. The NCBs of core countries accumulate claims on the NCBs of periphery countries intermediated by the ECB.2 These intra-Eurozone claims are referred to as Target2 assets and liabilities.

For example, between 2014 and 2021, the Bundesbank has funded its balance sheet expansion mainly by issuing bank reserves, while the Banca d’Italia has done so by issuing Target2 IOUs.

What can we learn from the high-frequency response in bond and currency markets to the tariff announcement about the status of the US dollar as the global reserve currency?

Short paper.
tinyurl.com/tr8u383w
joint work with Arvind Krishnamurthy, Zhengyang Jiang (@ProfJiang ), Rob Richmond (@rrichmond ), and Chenzi Xu (@chenzix)

We conclude that the tariff announcements have led investors to question the role of the dollar as the reserve currency. This explains why the dollar has depreciated by 3.4% between April 4 and April 14 in spite of rising US rates. As a result, the willingness of foreign investors to pay extra for the safety of dollar safe assets has declined. Our measure of this willingness to pay is the 1-year US Treasury basis, measured against the German Bund, plotted in black in the Figure below. The basis (left vertical axis) is the yield on the synthetic Treasury constructed from the German bund minus the yield on the actual Treasury. The decline in the Treasury basis explains the depreciation of the dollar over the past few weeks, in spite of rising rates.

🧵 below.

Plot of 1-year Treasury basis against German Bund. Defined as German yield (hedged into USD) minus US Treasury yield (left vertical axis). Euro/USD exchange rate (right vertical axis). 1/ On April 2, President Trump announced the reciprocal tariffs to be imposed on a long list of countries. On April 4 China retaliated. The VIX, a measure of implied volatility in the US stock market, more than doubled and peaked at 52 on April 8, 2025, up from 21 on April 2. This means that stock investors estimated the annualized volatility of S&P 500 stock returns to be around 52% per annum. Between April 4 and April 14, the US dollar depreciated by 3.6%. The depreciation of the dollar was surprising to market participants. Normally, in times of global volatility, such as during the GFC of 2008 and the onset of the pandemic in March of 2020, the dollar appreciates as dollar-denominated assets benefit from a flight to safety. Not this time around.

Don't blame the plumbing of Treasury markets, blame Congress and the White House. Not the unwinding of the basis trade in US Treasury markets, but the response to a large, macro shock.

March 2020 was the first sign of cracks in the global safe asset supplier armor. April 7 and 8 2025 provide more evidence. Late-stage exorbitant privilege.

A 🧵

When USTR yields spiked on Tuesday, everyone was pointing to the unwinding of basis trades by hedge funds. While that may have contributed to the spike in yields, the fundamental shock was a macro shock.

If the US disentangles itself from the global financial system, and runs current account balances with ROW, then the ROW cannot be counted to absorb all of that new issuance coming down the pipeline. The demand curve for USTR shifts inwards as a result. Furthemore, there is a ton of evidence that the ROW were inelastic or price-insensitive buyers of USTR. This happens at a time when Congress is set to extend the TCJA, adding $ 37 trillion in new deficits over 30 years, and pushing the debt/GDP ratio above 200% by .

As a result, if you're holding long bonds, then the rational response in this macro environment is to sell, in anticipation of increases in yields.

Just for context, according to the Flow of Funds, the ROW holds $8.494 trillion in Treasurys, compared to $3.821 for the Fed, $2.681 for households, and $4.479 trillion for money market and mutual funds. Holdings plotted below.

If you insist on current account balances or surpluses for the US, then foreigners will likely not be net buyers of USTR in the future. In fact, Americans will likely become net buyers of foreign bonds. All that issuance will have to absorbed by Americans. 2/For the past 75 years The US has been the global safe asset supplier. And that’s a great position to be in.

The Great Financial Crisis is a good example. Lehman failed in September of 2008. Foreign investors started buying Treasurys in bulk. In the fourth quarter of 2008 alone, foreign investors absorbed $270 billion in Treasurys, more than half of the $ 554 billion that had been issued by the Treasury. Throughout the 2008-2009 GFC, foreign investors were strong buyers of Treasurys.

After Congress passed the TARP bill (Emergency Economic Stabilization Act of 2008), the 10-year Treasury yield continued to decline by another 200 bps. The federal government was about to run deficits in excess of 9% of GDP in 2009 and 8.9% in 2010, unprecedented in peacetime. In spite of the massive issuance ahead, the Treasury market was happy to absorb all of this without forcing yields higher.

That is part of the exorbitant privilege of the US in the international financial system.
In the past, whenever the U.S. Treasury needed to dramatically increase issuance, as it did during the GFC, it could count on foreign investors to show up and start buying, at least if the crisis was global in nature. These investors are not particularly price-sensitive either. Safe-asset buyers are distinct from other investors. They are not simply trading off expected returns against risk. In fact, they are perfectly happy to forego some expected return in exchange for the safety and liquidity of Treasurys. You can think of that as foreigners paying a user fee for Treasurys!

Often, the advice US economists have for fiscal policymakers abroad (including the Eurozone) misses the mark because other countries can't go out and issue a ton of debt in global recessions without driving up yields. They call it exorbitant privilege for a reason.

Yes, debt has been the ruin of great powers. In "Exorbitant Privilege Gained and Lost: Fiscal Implications", forthcoming in the JPE, we study the experience of the Dutch Republic and the UK.

Both were able to borrow a lot at low yields, more than warranted by fundamentals. The UK lost that privilege around the interbellum. The Dutch Republic around the end of the 18th century.

Bondholder losses and financial repression ensued.

The US then took over the baton from the UK as the world's safe asset supplier after WWII and was able to borrow a lot more than warranted by fundamentals in the past decades. But the appetite for Treasurys among investors has waned, especially abroad.

papers.ssrn.com/sol3/papers.cf…

Treasurys are on sale. It used to be the case that if you compared US Treasurys to other securities, the US Treasury would always be expensive, compared to:

1/ foreign bonds: actual Treasury were typically more expensive than synthetic US Treasury constructed from e.g. a German Bund using currency risk hedges (i.e., the yield on Treasury lower than yield on synthetic Treasury).
2/ corporate bonds: actual Treasury were typically more expensive synthetic US Treasury constructed from AAA corporate bonds using credit risk default swaps (i.e., the yield on Treasury lower than yield on synthetic Treasury constructed from AAA corporate).
3/swaps: actual Treasury were typically more expensive than synthetic US Treasury position using swap (i.e., yield on Treasury lower than swap rate or positive swap spread).

All of these yield spreads have now flipped signs at longer tenors. Actual Treasurys are now typically cheaper than the synthetic versions (or, equivalently, actual yields are higher than synthetic yields).

You can construct 'plumbing' explanations for each of these, but taken together, they suggest that the increased Treasury supply has pushed down the convenience yields investors get from the safety and liquidity of US Treasurys.

As global government bond supply increases and central banks have stopped buying, US Treasurys are now cheap relative to equivalent instruments.

Demand for the safety and liquidity of Treasurys is downward sloping. That was always a key problem with the r
🧵 with some pictures. 1/ Compared to foreign bonds: The n-year Treasury basis is defined as the difference between the n-year foreign Treasury yield plus a currency forward contract that hedges the foreign exchange risk (i.e., the synthetic Treasury yield) and the actual n-year US Treasury yield.

A positive basis means the actual Treasury yields are lower. We use safe government bonds for G-10 countries to measure foreign government yields, so that default risk is small.

At 5-year and 10-year tenors, the basis is negative, while it's close to zero at the 1-year. Figure from @ProfJiang and @rrichmond's new paper.
papers.ssrn.com/sol3/papers.cf…

2024 may also be remembered as the year U.S. fiscal exuberance died.

post-mortem 🧵 on how we got here.

Right now, with the 10 year US Treasury yield trading well above 4.5% and the federal government spending roughly the equivalent of the defense budget just on interest expenses, a fairly broad-based consensus seems to be developing among economists that the fiscal path we’re on is in fact not a sustainable one, as Jay Powell pointed out 4 weeks ago. r
The figure below plots the federal government's interest expense as a fraction of US GDP. 2/But until last year, there was broad-based fiscal exuberance in the US. Not just the “Learn to love trillion dollar deficits” variety of the Modern Monetary Theory fringes.

Even among mainstream economists there was widespread fiscal optimism. “Put bluntly, public debt may have no fiscal cost” (Olivier Blanchard's AEA presidential address, 2019). The underlying idea was that we can just roll over deficits permanently because the US govt's cost of funding is always lower than the growth rate of the economy, r