However, after 1971 the US has abandoned the Bretton Woods (Michael Hudson calls this the superimperialism phase) and the dollar is now a fiat currency with a floating exchange rate. It is no longer pegged to anything, and there is nothing to defend. As such, the government cannot go default from overspending.

So, then, what is the role of US treasury post-1971 where the US dollar is now a fiat currency?

While technically the US government no longer need to issue bonds (debts) to “finance its spending” (more accurately, now that we have learned, to take money out of circulation), the US treasury as an institutional mechanism is still useful when serving as a drain for interbank reserves (to maintain the interest rate set by the federal government) and for the excess dollars spent overseas (Hudson’s superimperialism). In other words, the US treasury is simply serving as a drain or a “sponge” to soak up all the surplus dollars/reserves.

We will now look into each of these roles, because it is very important to get this into your head that the US treasury does NOT finance US government spending.

First, let’s look at how the US treasury helps maintain the target interest rate set by the central bank aka Federal Reserve in the US.

Have you ever taken a check to a bank and deposit it into your account? How does this “transfer of money” work, especially if the payer has an account from a different bank? Does the payer bank ships its money to the recipient bank?

The answer is no, they simply run up and down the numbers in their reserve accounts held at the central bank (Federal Reserve in the US). All commercial banks have special reserve accounts at the central bank and this is a very important part of the banking system to ensure that millions and millions of transactions taking place every day can be rapidly validated and cleared. Without such a system in place, there is no way for the government to monitor and validate billions of dollars worth of transactions that occur every single minute across the entire world, and without which some banks will very quickly run out of money when large transactions take place! Imagine what chaos that would be.

Every commercial bank is required by law to maintain a minimum (and positive) daily reserve (although technically they are only checked over the weeks or through averages over time, not every single day). This means that at the end of every day, some banks will have a surplus (more) of the minimum required reserve in their account (maybe because more checks transferred more money to their banks) and some banks will have a deficit (less) of the minimum reserve required (maybe because a lot of withdrawals took place in their banks).

In any case, the banks that do not meet the minimum reserve requirement will have to fill up that reserve account, and banks that have a surplus of reserve will be looking to lend them out (because every single excess dollar is dead money and banks really do not want to carry any dead money that does not bring any profit!)

Of course, because the central bank (Federal Reserve) will never run out of money, the commercial banks running low on reserves can always borrow from the central bank to fill them up. However, to discourage such persistent behavior of commercial banks keep running out of reserves, the central bank typically charges a penalty rate every time a commercial bank asks to draw from this discount lending (this is known as the “discount window” in technical terms).

As such, commercial banks would typically avoid borrowing directly from the central bank, and instead borrow from the interbank market that occurs within the central bank (the Fed fund market). This is where the banks with surplus reserves will be looking to lend out their extra reserves to the banks that need them. However, because of competition, and every bank really really does not want to hold even a single extra dollar above their minimum requirement for reserve balance because it doesn’t bring any profit, this competition to lend out their reserves will very quickly drive the interest rate down to 0%, and this is a problem for the central bank whose mission is to target a particular interest rate.

Let’s say the central bank (Federal Reserve) wants to target a 2% interest rate, and they want to prevent the interest rate being driven down to 0% in the Fed fund market, so here the Federal Reserve can sell government-backed securities (US treasuries) at a specific rate (say 2%) to set the minimum price of borrowing, and thus stopping the competition from driving the market interest rate down to 0%. Commercial banks with surplus reserves will now prefer to lend to the government (2% interest) than to compete in the interbank market which is being driven down to 0%. Thus, simply by selling US treasuries at a certain price, the Federal Reserve can maintain its interest rate target and ensures that no bank will lend below 2% among each other.

In other words, the US treasuries act as a drain that soaks up the excess reserves that are flowing in the Fed fund market while allowing it to target a particular interest rate.

Now, there is another role for the US treasuries that Michael Hudson described in Super-imperialism, which is to act as a vehicle/drain to soak up excess dollars that the US empire has spent overseas. Because the US federal regulations prohibit foreign governments and entities from purchasing critical assets, most net exporter economies who sold their goods and services will end up with surplus dollars (after spending their trade revenues to import whatever they need in dollars). Where else could all these dollars go? Nowhere except US treasuries because that’s where you can at least earn some interests.

This is also the reason why China has largely stopped buying US treasuries since 2013 and started to lend out their dollar revenues in the Belt and Road Initiative, because they have realized that they were simply accumulating junk papers after selling actual goods and services made using Chinese labor and resources to America. At least with BRI, you are gaining some diplomacy benefits by helping the developing countries build their infrastructures.

But the fundamental problem remains the same: this simply kicks the can down the road and the BRI countries now have to earn dollars to pay back their Chinese creditors. And this is part of the reason why all these talks about China accumulating more dollars make no sense at all.

To conclude, the US treasuries (government debt) do NOT finance US government spending, and it doesn’t matter even if nobody buys US treasuries since it only functions as a drain for the surplus dollars.

The misconceptions about it persist because many people are still thinking in gold standard/Bretton Woods terms. This works neatly into the neoliberal narrative that the US has run into too much deficits and that austerity is needed to make sure that “our country will not be owned by China and our children won’t have to pay back the debt we are accumulating.”

The US government (or any government with monetary sovereignty) is thus not constrained by such spending rules. The power of fiat currency backed by the state has been discovered many times (e.g. greenbacks during the US Civil War, Beihai currency issued by the CPC Beihai Bank in Shandong during the war against Japanese and KMT invented by the legendary Marxist economist Xue Muqiao), but the first known case of this usage in peacetime was Stalin’s war communism, 40 years before the US independently discovered it!

We now answer the question based on the wild extrapolation that somehow, this $2 billion dollar-denominated bond, if being scaled up to $100 billion dollar, will somehow wreck the US financial system.

Let’s have some perspective: the $780 billion US treasuries currently owned by China comprise about 2.7% of the total treasuries, or ~9% of all treasuries held by foreign owners, amidst a gigantic $27 trillion US treasury.

Even if China sells off its entire reserve, it would barely make a dent to the US treasury market, let alone a $100 billion bond. This is pure scaremongering tactics used especially by the Republicans to make the American people fear about a foreign threat coming to take away their life savings.

What China can do, however, is to strategically use those dollar reserves to pay back Africa’s $700 billion dollar debt, and quickly flush the region with yuan (the institutions need to be well prepared in advance, of course), and that would be a real challenge to the US hegemony in the region and tip the balance of US monetary imperialism by allowing African nations to escape the US debt trap.

However, if China had wanted to do that, they can simply do it directly. All the fantastical imagination about how China issues more dollar bonds (which effective dollarizes the world) and accumulate more dollar surplus (which would require someone or some countries to sell more shit to America in order to earn the dollars to buy the China-issued bonds) so that China can somehow use those money to help the BRI countries pay back their dollar debt (which are mostly owed to private creditors including many Chinese creditors) is quite preposterous if you think about it.

Remember that the US can pump out dollars like opening a tap, while China and the rest of the world have to earn those dollars with real labor and resources. You are already at a huge disadvantage if you try to play the dollar game. China cannot control the dollar in the same way that the US cannot control the yuan. Monetary sovereignty confers the currency-issuing government with a lot of power to perform their tasks.