The Safe Assets that weren't.
After WWII, the US took over the baton from the UK as the world’s purveyor of safe assets. The dominance of the dollar was more or less codified in the Bretton-Woods agreement of 1944. John Maynard Keynes, who was leading the negotiations for the British at Bretton-Woods, was lobbying for a multi-polar system without a special role for any single currency, but ultimately the US delegation’s proposal carried the day.1 Only the dollar was to be convertible in gold. Other countries were required to hold their foreign currency reserves in dollars. Back in 1960, Robert Triffin, a Belgian born Yale economist, had predicted that this arrangement would be short-lived. To keep the world supplied with enough dollars, the US would have to keep running balance of payment deficits, ultimately leading investors to question the gold backing of all those dollars being recycled abroad. He was proven right within a decade. This time around, the same questions are being asked about the backing of US Treasurys.
Even after the collapse of Bretton-Woods in 1971, the dollar remained the dominant currency in international capital markets. As part of this arrangement, the US was also tapped to be the world’s sole banker in charge of supplying the RoW (rest of the world) with safe dollar-denominated assets. The RoW now holds well over $21 trillion in safe US assets, including US Treasurys, Agency bonds, US money market funds and deposits as well US corporate bonds, as shown in Figure 1. To replenish the RoW’s stash of safe assets, the US has been running large current account deficits since the 1980s, spending more on cheap toys and cars abroad than what it’s earning abroad in selling movies and laptops. As a result, the US was issuing IOUs to the RoW for 4 decades. After years of current account deficits, the US net foreign asset is deeply negative, also around $21 trillion dollars.
The US is in the business of exporting safety and liquidity services by selling safe bonds to the RoW. As Greg Ip put it in the WSJ,” the US is selling bonds and other IOUs to the RoW, not cars.” Countries that have been selling cars and cheap toys to the US and running large current account surpluses, like Japan and China, are buying these IOUs.
The US federal government is the largest supplier of safe assets to the RoW. Close to half of the dollar-denominated safe assets are held in the form of US Treasurys or US agency bonds. That makes the RoW by far the largest holder of US Treasurys (see Figure 2), larger than the Fed, and larger than all money market and mutual funds combined. Japan, the largest foreign owner of US Treasurys, now owns 1.2 trillion worth of Treasurys. Figure 3 plots net purchases of US Treasurys by different sectors of the economy. Throughout the 2000s, the RoW was absorbing most of the Treasury’s issuance!
This has been a great deal for the US federal government. The Treasury could always count on foreign investors to show up and gobble up its issuance of Treasurys at high prices, especially when financial markets were experiencing bouts of volatility. A striking example was the Great Financial Crisis of 2008-2009. Some highly levered financial institutions like Lehman and Bear Stearns were packaging mortgages and other securities in order to manufacture more Treasury-like dollar-denominated safe assets. When Lehman failed in September 2008, foreign investors fled to the safety of safe assets manufactured by the Treasury, even though the crisis started in the U.S. and the US federal government was about to embark on a huge unfunded fiscal expansion. And US Treasury yields declined. Foreign investors were running towards the fire to seek shelter in the safety of Treasurys, away from private label safe assets.
In 2005, just three years prior to the failure of Lehman, Ben Bernanke gave his famous “Global Savings Glut” speech in remarks titled “The Global Saving Glut and the U.S. Current Account Deficit”. Bernanke argued that the US was running persistent current account deficits precisely because the RoW, especially emerging markets, was sitting on a pile of excess savings they wanted to park in safe dollar assets. In the 2010s, the strong, price-inelastic foreign demand for Treasurys contributed to a climate of fiscal exuberance in the US. Some economists inferred that the US government had extra fiscal capacity as a result. In his 2019 AEA Presidential Address, Olivier Blanchard conjectured that the US government’s funding costs would always remain below the growth rate of the economy, and governments could just grow their way out of debt.
Policy makers in DC eagerly used the extra fiscal space granted by foreign bond investors to run deficits for the next two decades. Bond markets seemed oblivious to the US’ fiscal fundamentals, which tends to happen when you’re the world’s safe asset supplier.
Until recently, the RoW had always been willing to pay extra for Treasurys. If you start from a German bund, and swap the Euro coupon payments into dollars, you’ve created synthetic US Treasury. We can compare the price of the synthetic security to the price of the real one. Historically, the synthetic Treasury has always been a bit cheaper than the real thing. Equivalently, yields on the actual Treasury have been lower than the yields on the synthetic Treasury. The US Dollar Treasury basis, plotted in Figure 5, measures this yield difference against a basket of G-10 currencies for different tenors. The basis measures the return foreign investors are willing for the safety of holding real US Treasurys, compared to these fake Treasurys we’ve constructed from foreign sovereigns. The basis only measures the Treasury component of the safe asset premium or convenience yield, not the dollar component.
The US is selling expensive bonds to the RoW. By selling these securities at a premium, the US earns seigniorage revenue on all of its outstanding safe assets. In the runup to the GFC, private firms like Lehman wanted to compete with the Treasury by manufacturing more of these dollar-denominated safe assets to try and harvest part of these convenience yields.
During the GFC, the basis spiked at more than 100 basis points at the short end of the yield curve, as foreign investors fled to the safety of US Treasurys. These episodes tend to go hand-in-hand with large appreciations of the dollar (see Figure 6). US Treasury yields declined as the dollar appreciated. As foreigners’ demand for safe assets increases, the dollar appreciates to clear the market for dollar-denominated assets. You can think of the value of the dollar as being backed by future convenience yields on safe assets.
However, the Treasury basis has been declining in the last 10 years, especially at the longer end of the yield curve. Treasurys are no longer trading at a premium compared to other G-10 sovereigns. In fact, at the 5-year and 10-year horizon, they’re trading at a substantial discount. The yields on US Treasurys are now higher than those on other safe dollar-denominated bonds constructed from foreign sovereigns in the G-10. We could also compare Treasurys to synthetic Treasurys constructed from AAA corporate bonds with some credit insurance.
Standard demand and supply intuition goes a long way. If demand for safety and liquidity services of Treasurys is downward sloping, just like the demand for apples and bananas, then the massive increase in federal debt held by the public supply from 40% of GDP before the GFC to more than 100% now should be expected to drive down the price of safety and liquidity, i.e., the convenience yield foreign investors earn by holding Treasurys. And the debt/GDP ratio is projected to increase to more than 120% in 2035 by the CBO.
We’ve also seen evidence that the usual flight-to-safety mechanism has stopped working. When COVID-19 started to spread around the world in March of 2020, foreign investors actually started to sell Treasurys (see Figure 3). 10-YR Treasury yields spiked by more than 60 bps in a few trading days. In April of 2025, the mechanism was tested yet again. When the Trump administration announced its intention to impose punitive trade tariffs on a host of countries, the VIX spiked. The dollar depreciated even as US Treasury yields were increasing relative to foreign yields (see Figure 8). That’s the exact opposite of what we had come to expect.
But there is a deeper issue. Treasurys are no longer viewed as safe, zero-beta assets by market participants. That is not surprising. The Treasury cannot manufacture zero beta assets when the government engages in repeated unfunded fiscal expansions of the sort we’ve seen during COVID. Safe debt requires that central banks are firmly in the driver’s seat, with the governments constantly adjusting primary surpluses to make sure that the debt remains safe. That’s clearly not happening in the US. When that does not happen, yields have to increase in response to adverse fiscal news, in order to mark the debt to market. There are clear signs that investors no longer think Treasurys are safe. The correlation between stocks and bonds has turned positive since the pandemic.
In the GFC, investors started to question the safety of privately manufactured substitutes for Treasurys. This time around, investors are questioning whether the Treasurys themselves are safe. Ultimately, Triffin has been proven right yet again. In order to supply the RoW with enough of these dollar safe assets, the US government has stretched itself financially.
Ben Steill wrote a beautiful account of the stand-off between the U.S. and the U.K. in the “The Battle of Bretton Woods.”
Where do hedge funds fall in figure 2?
Thanks. Helpful, Also, US government not exactly going out of its way to court positive vibes amongst major buyers of US Treasuries.