Dollar Hegemony ② — Understanding the Plumbing

The force sustaining dollar hegemony is not military power or economic scale. It's plumbing.

The market where global financial institutions borrow and lend trillions of dollars overnight — this is the repo market (Repurchase Agreement market). The mechanics are simple:

① A sells a US Treasury to B
② Simultaneously, A promises to repurchase the same Treasury at a slightly higher price tomorrow (or on a set date)
③ The price difference = the repo rate = interest

From B's perspective, it's a one-day collateralized loan. From A's perspective, it's pledging Treasuries to borrow cash. The global repo market exceeds $10 trillion in estimated size.

The critical factor is collateral quality. The most preferred collateral in this market is the US Treasury — virtually zero credit risk, extremely high liquidity. In other words, you need US Treasuries to borrow dollars. This is how dollar hegemony is maintained through plumbing.

The Federal Reserve is the institution that creates dollars. But the way it supplies dollars is far more complex than simply 'printing.' The key is the balance sheet.

How QE (Quantitative Easing) works:
The Fed buys Treasuries from the market → pays for them with bank reserves → dollars enter the economy.

How QT (Quantitative Tightening) works:
The Fed lets Treasuries mature without reinvesting, or actively sells → Treasuries return to the market → bank reserves shrink → dollar liquidity in the economy contracts.

Before the 2008 financial crisis, the Fed's balance sheet was approximately $900 billion. At its 2022 peak, it reached $9 trillion — a 10× expansion in just 14 years.

The Fed isn't the only variable moving dollar liquidity. The Treasury General Account (TGA) quietly moves markets.

The TGA is the checking account the US Treasury holds at the Fed. Tax receipts and bond issuance flow in; government spending flows out. Simple in principle — but changes in this balance directly impact market liquidity:

- TGA balance falls → government spending increases → dollars enter the economy → liquidity rises (easing effect)
- TGA balance rises → bond issuance or spending cuts → dollars absorbed from economy → liquidity falls (tightening effect)

Tuesday morning, September 17, 2019. The US repo market froze.

Overnight repo rates that had been hovering around 2% surged to 10% during the morning session — five times higher than the prior day, more than four times the Fed's upper policy rate (2.25%). The world's largest short-term funding market nearly seized up.

Two events collided simultaneously:

① Corporate tax payment deadline — Large corporations drained cash from banks to pay taxes, rapidly depleting bank reserves
② Treasury auction settlement — Large-scale Treasury issuance settlement absorbed cash from the system

When the two hit together, bank reserves fell below the critical threshold. Banks unwilling to lend in repo pulled back — and rates exploded.

The Fed immediately launched a $75 billion overnight repo operation the next day, continuing interventions for months. In October 2019, it began purchasing $60 billion in T-bills monthly. Chair Powell called this "NOT QE" — but it was effectively a mini-QE.

The lesson: QT has a hard floor. When reserves fall below a certain level, the plumbing clogs. To prevent recurrence, the Fed established the Standing Repo Facility (SRF) in 2021.

Now we return to the core question from Part 1: why does the world keep buying US Treasuries even as the total exceeds $36 trillion?

Through the plumbing lens, the paradox dissolves.

More US debt issuance → more collateral in the repo market → smoother global short-term dollar funding → more dollar demand → stronger dollar hegemony. Growing debt doesn't weaken dollar hegemony — the mechanism actually reinforces it.

This is what the Triffin Dilemma looks like translated into plumbing language. As the reserve currency issuer, the US is structurally required to run current account and fiscal deficits to supply the world with dollars (= liquidity). The very act of supplying dollars means accumulating debt. And that debt (Treasuries) becomes the fuel for the repo market, regenerating dollar demand.

In 2026, Kevin Warsh was nominated as Fed Chair — a former Fed Governor (2006–2011) and JP Morgan investment banker. Trump's choice.

Warsh matters because his monetary policy philosophy differs fundamentally from Powell's.

Warsh's direct impact on dollar liquidity:

Faster QT → More Treasuries in market (more repo collateral) + shrinking bank reserves → upward pressure on short rates → global dollar liquidity tightening

Long-term rates → Rising Treasury supply + inflation fears → higher 10-year yields possible → dollar strengthening pressure

One irony: if aggressive QT drains bank reserves too quickly — another 2019 repo crisis could emerge. Warsh knows this risk, and the SRF (Standing Repo Facility) provides a backstop — but where exactly the critical threshold lies will be tested in real time.

When the dollar liquidity plumbing tightens, pressure leaks at the weakest link. In global financial markets, those weak links are emerging market assets and short-term dollar funding markets.

Cross-Currency Basis Swaps (CCBS): One of the most precise gauges of stress in dollar hegemony's plumbing — the 'premium' non-dollar institutions pay to borrow dollars short-term. Near zero in normal times; spikes during QT overshoot or crisis. During the 2008 financial crisis, the JPY CCBS reached -100bp. EUR hit -70bp. The wider this spread, the more dollar borrowing costs exceed the policy rate benchmark.

EM capital flows: When the Fed runs QT, markets shift into risk-off mode — capital exits EM equities and bonds and flows into US Treasuries. This is what the 'Dollar Smile' theory describes: the dollar strengthens when the US economy is very strong and when it's very weak. Emerging market currencies sit on the other side of that smile.

The Warsh regime's global impact: Aggressive QT + rules-based policy increases market predictability but reduces dollar liquidity flexibility. If the Fed's room for 'discretionary' intervention narrows in a crisis, EMs face faster and deeper dollar funding stress. The countries first in line — Turkey without a swap line, Argentina with heavy dollar debt, Russia under sanctions — feel the plumbing crack earliest.