The U.S. Treasury is becoming a "shadow central bank," eroding the independence of the Federal Reserve's monetary policy.

The U.S. Treasury continues to expand the scale of Treasury bond financing, making its function increasingly resemble that of a de facto monetary issuing institution, and gradually intervenes in the Federal Reserve's domain through quasi-monetary policy operations.

On September 2, Bloomberg macro strategist Simon White pointed out that this trend will structurally increase inflationary pressures, weaken the Federal Reserve's policy independence, and pose greater risks to market stability and real returns on stocks and bonds.

Currently, Treasury bonds account for 22.7% of the outstanding U.S. debt, exceeding the informal 20% limit set by the Treasury Department. If the portion held by the Federal Reserve is excluded, this ratio rises to 24.1%.

White believes that as the fiscal deficit continues to expand, this ratio is expected to climb further, and the policy interest rate will no longer be just a core variable of monetary policy, but will become a key anchor point for determining fiscal stability.

This structural shift means that the Federal Reserve will face stronger political and fiscal resistance if it attempts to control inflation through interest rate hikes. This is because raising interest rates directly increases the government's financing costs, effectively tightening fiscal policy and thus putting counter-pressure on monetary policy.

White stated frankly that, given the continued expansion of Treasury bond issuance, finding an interest rate level that simultaneously meets inflation targets, maintains financial stability, and prevents government borrowing costs from spiraling out of control is crucial . He said:

It may be an impossible task at all.

From financing instrument to "shadow currency": The evolution of the role of treasury bills

Treasury bills have traditionally been a standard tool for short-term financing for the U.S. government, but White points out that the Treasury Department is looking to replace long-term bonds with Treasury bills to absorb the financing needs arising from the expanding fiscal deficit.

From the Ministry of Finance's own perspective, this strategy has a clear financial logic:

Short-term debt financing costs are typically lower than long-term debt , and treasury bills are geared towards a broad pool of funds that prefer low-duration assets;Compared to long-term bonds, treasury bills have a smaller diversion effect on bank deposits , which helps maintain market liquidity and real economy spending.In addition, this approach also avoids, to some extent, the political sensitivity of openly implementing financial repression , although the Treasury’s expansion of its bond repurchase program has been seen as a substantial step in that direction.

However, in White's view, Treasury bills are no longer just ordinary short-term financing tools. According to Perry Mehrling's monetary hierarchy theory, at the top of the financial system are Federal Reserve reserves, followed by "shadow money" such as bank deposits, repurchase agreements, and money market fund units.

Treasury bills, due to their extremely short maturity and very low valuation uncertainty, typically enjoy zero discount in the repurchase market and can be reused multiple times without loss of value through the collateral re-pledging mechanism.

White points out that this makes Treasury bills function more like money itself, a liquidity instrument that can be used for final settlement.

The re-pledge mechanism amplifies the effect, and the supply of money-like instruments quietly expands.

White specifically emphasized the crucial role of the rehypothecation mechanism in this process.

In the repurchase market, dealers can obtain collateral from their proprietary holdings of government bonds or borrow it through reverse repurchase operations and then pledge the latter to other counterparties.

According to a 2021 academic study cited by Bloomberg, between 2015 and 2021, U.S. Treasury collateral was re-pledged an average of three to five times ; in other periods, this figure has been estimated to be even higher by various sources. In other words, dealers are effectively amplifying the amount of available collateral in the market.

White points out that for long-term Treasury bonds, the discount rate gradually erodes the actual value of the collateral with each round of re-pledging; however, Treasury bills, with a zero discount rate, can be repeatedly pledged without value loss. This characteristic allows Treasury bills to continuously replicate themselves in the financial system, creating a money-like liquidity expansion effect.

Historically, the rise in the proportion of treasury bonds to total outstanding debt has often been a leading indicator of the rise in structural inflation.

White argues that there is a reasonable transmission path behind this: increased liquidity pushes up asset prices, amplifies the wealth effect, while artificially suppressing the cost of capital, ultimately transmitting to the real economy and pushing up the overall price level.

The Federal Reserve is caught in a dilemma, and its policy independence is fundamentally challenged.

White believes that the expansion of Treasury bill issuance poses a fundamental constraint on the Federal Reserve's policy space.

When more public debt is directly linked to short-term interest rates, each rate hike by the Federal Reserve immediately increases government interest payments, effectively tightening fiscal policy. This mechanism objectively creates political pressure, making it more difficult for the Federal Reserve to act decisively when inflation rises.

White directly pointed out that as the proportion of Treasury bonds continues to rise, "the Federal Reserve may no longer be able to set policies in the optimal way to achieve its inflation target in the future."

At the same time, increased Treasury bill supply could also trigger vulnerabilities in the short-term funding market. If the new supply drives up Treasury bill yields, money market funds may shift funds from the repo market to Treasury bills, thereby reducing liquidity supply in the repo market.

White specifically pointed out that given the current low ratio of the combined size of the Federal Reserve's reserves and reverse repurchase facilities to GDP, the risk of this capital migration causing short-term funding market tensions is particularly alarming.

At the financing structure level, the Ministry of Finance itself will also face greater vulnerability. Treasury bill issuance means more frequent and larger-scale auctions, and any rise in inflation expectations will be immediately reflected in borrowing costs. Even if the Ministry of Finance intends to reduce long-term bond issuance, if the term premium rises sharply, long-term financing costs may ultimately rise instead of falling.

White's conclusion is quite pessimistic: as the proportion of Treasury bonds increases, policy rates will simultaneously bear the dual functions of monetary policy and fiscal stability. Finding an equilibrium interest rate level that satisfies all three—inflation target, financial stability, and fiscal sustainability—is likely an unsolvable problem.

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