Hendrickson: So, if we think about seigniorage, in order to try to generate seigniorage— essentially, to do this effectively, to use this as a tool for emergency finance, you're not going to be just maximizing the seigniorage every single period. What you actually want to do is you want to create the biggest tax base possible. And so, when it comes to seigniorage, that means having the highest level of money demand possible. The way that you can do that is by committing to price stability during normal times. But then, when you go to war, or you have some national emergency or something like that, you need to spend a lot of money really quickly, then you can exploit that monopoly.Hendrickson: And you exploit that monopoly while you have a large tax base. But, again, you've got to go back to that commitment to price stability afterwards, because otherwise, if people know that every time there's an emergency you're going to do this, then anytime that people anticipate there's an emergency, they're going to react. Then also, you're just going to reduce your tax base over time, because you're just going to have this record of always printing money, or always debasing the currency, or something like that, during times of war, and those effects are permanent. What you want to do is actually promise to reverse any of those effects that were experienced during the war once the war is over.
.......
The cost of the US Treasury security being the global reserve asset is that, as the world economy grows, what happens to the demand for reserve assets? Well, it grows along with that growth in the world economy, and so, if the United States doesn't provide that, if they don't provide a sufficient amount of Treasuries, then yields are going to go down.
Hendrickson: That tends to incentivize governments to borrow more. "Look, we're running these massive deficits, and it's not affecting our interest rates. Maybe we should run bigger deficits." The thing is, there are lessons from the literature on the international monetary system that essentially say that when you control the supply of this global reserve asset, and this asset is a debt instrument, well, you run into a problem, because the more and more debt that you run up— at a certain point, people are going to become concerned that you won't be able to pay back that debt without resorting to devaluation. But the thing is, is that the devaluation doesn't actually have to come first, right? All that has to happen is that people start to worry about devaluation, and they start acting on it.
Hendrickson: They start selling their dollar-denominated assets, and then you have turmoil in international markets, and maybe the Federal Reserve has to intervene and buy some of these assets or settle down the Treasury market, which leads to expanding their balance sheet and leads to higher prices. And so, the point is that the system has substantial benefits. As long as the level of debt that the US has is sufficiently low, the benefits dramatically exceed the costs, at least for policymakers. We can debate some of the other secondary effects on the actual people of the United States, [but] for policymakers, as long as the debt level is low enough, they can sustain this indefinitely.
Hendrickson: The problem becomes, if debt gets sufficiently high, now the system becomes potentially, very fragile, and it becomes subject to self-fulfilling runs, and once it gets there, then we're talking [about] very costly consequences. And so, what I'm encouraging people to think about is that, yes, this foreign policy tool that we have might help us to impose sanctions. It might help us to do things— to harm people without actually having to engage in military conflict, but there are costs people might diversify away. Yes, having the global reserve asset might give the United States policymakers the ability to do all of the things that they want to do, but it's also potentially fragile, if debt levels get too high. So, there are always costs and benefits, and policymakers need to think about those things.
............
I'm not going to say it's not sustainable. What I'm going to say is that it's not sustainable under certain circumstances, and we don't want to ever find ourselves in that certain circumstance.
Hendrickson: Policymakers need to be cognizant of that, and they need to be especially cognizant of that when they're thinking about deficits and when they're thinking about debt, because there is a point at which you can have too much debt, and then it becomes unsustainable. You don't want to find yourself in that position, but also, in terms of the secondary effects, it's not at all clear that this is beneficial to the United States as a whole.
If you're looking for a more in depth study of the history of the Treasury market, I would say George Hall might be the go-to. His paper with Tom Sargent titled: Three World Wars: Fiscal-Monetary Consequences is worth a read (at least read the first paragraph and concluding remarks). https://macromusings.libsyn.com/george-hall-on-the-history-of-the-us-national-debt-and-government-financing
