Kevin Warsh was confirmed this week as the next Chair of the Federal Reserve’s Board of Governors. As we discussed in a recent article, his transition comes at a delicate time; inflation is rising, and questions about the Fed’s independence are pressing. The honeymoon period will be brief.
One of the topics that Kevin Warsh has raised is the proper size of the Federal Reserve’s balance sheet. Crisis-era programs found the Fed purchasing copious amounts of government securities, the majority of which remain in position. Warsh has questioned whether this level of support is still needed. We covered this in our essay “Will Kevin Warsh Rebalance the Fed?”
It may take time to formulate and secure endorsement for such an effort. One consideration surrounding the decision would be that reduced ownership of Treasury securities by the Fed would require other investors to absorb more of the national debt.
Finding new demand for Treasury issuance is therefore critical. Help may come from two evolving forces.
Read more: Climbing With Caution
The first is demographics. As people age, their investment time horizons shorten and their risk appetites ebb. This results in a collective shift away from equities and into bonds and cash equivalents like money market funds. This is illustrated by target date funds, whose allocations become more conservative as the account owner ages.
In the United States, the Pew Center estimates that Baby Boomers hold $86 trillion of wealth. Even a 1% shift into Treasuries would translate into substantial incremental demand for government debt. Of course, that trend would reverse when wealth transfers to the next generation.
The second source of support for government borrowing could come from stablecoins. The GENIUS Act establishes standards for stablecoins to evidence their value; backing the coins with Treasury securities is a preferred approach. It is estimated that stablecoins already account for $150 billion of government bond ownership; a recent study from the Brookings Institution suggests that this could grow considerably if stablecoins are adopted more widely.
The advance of demographics is well-understood and easy to predict. The advance of stablecoins is much less certain, but has significant potential.
Finding new buyers for Treasury debt won’t solve America’s fiscal problems. But it could save a few basis points of interest and buy a little time.
Carl Tannenbaum is the Chief Economist for Northern Trust
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