The Stablecoin Bill Could Solve One Problem Only to Create Another — Barrons.com

By Derek Horstmeyer

About the author: Derek Horstmeyer is a professor of finance at George Mason University's Costello College of Business.

By some estimates, the U.S. Treasury will need to borrow an additional $15 trillion over the next 10 years to service the federal debt. And for every seller of debt, there needs to be a buyer.

With China pulling back as a reliable buyer of Treasury bonds, the U.S. needs to look elsewhere to unload all this coming debt issuance. In comes the Genius Act.

The bipartisan legislation, which passed the Senate in June and is likely to be voted on by the House this week, is the first-ever piece of stablecoin regulation. It would allow private entities to issue their own stablecoins, as long as they are fully backed by U.S. Treasuries. That will open the Treasury up to a whole new set of investors.

It is a neat solution for the excess debt problem: The Treasury can latch onto this new, expanding market as an outlet for the trillions of dollars of debt coming online — with little risk to the existing banking system.

A solution can't come soon enough. The yield on U.S. government long-term debt has jumped to nearly 5% this year as investors worry about the U.S.'s ability to pay back on its debt. Moody downgraded the debt in May, and there aren't many new potential buyers. China has been cutting its holdings of Treasuries for more than five years. Japan, the largest external holder of Treasuries, has seen yields on its own government's debt spike over concerns of its debt load, so it doesn't have much capacity to keep buying.

But, of course, there is the flip side to stablecoins that the Treasury should weigh. The Genius Act would allow stablecoins to propagate around the world and allow corporations to issue their own coins. This means even more Treasuries and U.S. dollars will be tied up in the shadow banking system, outside of the direct purview of the Federal Reserve and the Treasury.

Shadow banking, in this instance, creates two problems. First, stablecoins allow non-U.S.-based investors — who wouldn't otherwise have easy access to dollar holdings — to access dollar assets and U.S. debt. With stablecoins, investors in emerging markets who desire to move their holdings in their local currency into the more stable dollar can do so more easily. But that also makes external runs on Treasuries easier, since a greater percentage of U.S. debt would be held by individual investors outside the country.

Second, within the U.S. itself, the Genius Act would allow nonbanking corporations the ability to create their own forms of currency. Amazon and Walmart signaled last month that they plan to enter the stablecoin market with their own coins. These new coins will move between companies in transactions that don't touch the traditional banking sector.

The movement of a significant degree of money creation and contraction outside the regulated banking system would create a major oversight problem. On top of that, small banks may be left out in the cold, since most stablecoin companies only bank with larger, international firms.

It is a coin flip as to which of these scenarios is best. Treasury needs a place to unload all the new debt issuance coming over the next decade without triggering another rating downgrade. Without the Genius Act, it will have a near impossible task of forcing either U.S. investors or traditional sovereign nations to absorb new debt at a time when they don't seem to want any more. If the House doesn't pass the Genius Act, expect a more volatile Treasury market as the "safe haven" asset gradually loses that status.

If it does pass, prepare to see more capital flows to areas outside U.S. borders and to shadow banking areas within the U.S. In this scenario, the Fed will find itself behind the ball. It won't be as prepared to respond, should the next financial crisis fomented within the shadow banking system, just as in 2008. It may be far too late and fail to provide financial stability for an already shaky economy.

All signs point toward the bill's passage. The Fed should be prepared to demand more powers to see into shadow banking operations to counter the downsides.

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