Where did the money go? A survival guide for a future "dollar shortage".

Author: Tiezhu Ge on Crypto

At the start of the year, at the invitation of TalkJ, I met with @TJ_Research , @qinbafrank , and @viviennaBTC.

We had a very enjoyable and insightful discussion about the macroeconomic situation for next year.

I'd like to take this opportunity to share a more comprehensive view on the macroeconomic situation next year.

This is a series covering dollar liquidity, US Treasury bonds, and the US dollar, interspersed with perspectives on monetary and fiscal policies. Due to space limitations, much of the content cannot be elaborated upon here. Analyzing liquidity, US Treasury bonds, and the US dollar is a vast financial undertaking; I have only grasped the basics and hope to offer some insights.

I. A Deeper Understanding of Dollar Liquidity: The Impact of the Federal Reserve and G-SIB on Dollar Liquidity

In the opening article of 2025, we systematically discussed how the Federal Reserve's balance sheet affects dollar liquidity (see link at the end of the article). However, in today's market where fiscal policy is gradually taking over, simply analyzing the Federal Reserve is far from enough.

From a balance sheet perspective, dollar liquidity is not merely a numerical measure of the Fed's balance sheet. It should be defined more as the willingness and ability of financial intermediaries (especially G-SIB banks) to expand their balance sheets under current risk appetite.

The entire financial system is essentially a series of nested balance sheets, with each layer representing a repayment commitment from the entity above it. Although the Fed's role as lender of last resort remains important, in practice, the dollar does not flow directly from the Federal Reserve to the market. It must be transformed into tradable and leveraged financial liquidity in the financial market through the balance sheets of large banks, influenced by regulatory constraints and capital requirements, using the dollar as an intermediary.

In other words, the perceived liquidity and actual availability of dollars in the financial market depends not only on the Fed, but also on whether banks, as intermediaries, are willing and at what cost to actually release these dollars.

This issue becomes particularly critical after we realize that the banking system’s reserve balances have fallen to a level that still appears ample but is no longer marginally loose.

The market's reaction to dollar liquidity is highly asymmetrical: in other words, a slight easing has little market reaction, but a tightening can be very disruptive. This situation is expected to persist for some time in 2026, making the analysis of bank balance sheets, particularly from the perspective of dollar liquidity, crucial.

II. Deconstructing Dollar Liquidity: Nominal Liquidity and Available Liquidity.

A well-known formula for measuring total dollar liquidity is: Fed balance sheet total - TGA (Treasury General Account) - Overnight reverse repos (RRP). This formula worked well until 2025 because banks had excess reserves, and balance sheets did not constrain the dollar's intermediary capacity. In other words, nominal liquidity was roughly equal to actual availability.

Entering the second half of 2025, the market's dollar liquidity has essentially shifted from being constrained by quantity to being constrained by intermediaries. Simply put, banks' dollar intermediary capacity has been severely limited. This is analogous to the relationship between water level and water pressure.

Globally, G-SIBs (systemically important banks) are largely subject to a series of regulatory standards set by the BIS (Bank for International Settlements).

The main focus after 2010 was the new Basel III agreement. In essence, this agreement aimed to curb banks' expansionist ambitions through various regulatory indicators. The core indicators introduced leverage ratio (SLR) and liquidity coverage ratio (LCR/NSFR) requirements, specifically targeting major banks and raising their capital requirements and comprehensive risk coverage.

Therefore, under this regulatory requirement, from a balance sheet perspective, banks must consider how much capital they need to allocate and whether it will affect the achievement of regulatory targets.

The SLR definition is simple: Tier 1 capital / all on- and off-balance sheet assets (Treasury bonds, loans, derivatives, etc.). Generally, this ratio is 3%, but for large banks (those with a scale of over $250 billion), it's 5%. Under this formula, holding US Treasury bonds and making loans have the same capital requirement.

The result is that at certain critical junctures, under the constraint of capital occupation, banks will inevitably choose high-ROI businesses; low-yield government bond market making, repurchase, and other similar activities will decrease.

The key focus of this analysis is the Treasury repurchase (Repo) market. Participants in the Repo market are primarily MMFs, banks, and hedge funds. Banks act as market makers. At the end of the quarter, to meet regulatory requirements, when hedge funds borrow money from banks by pledging Treasury bonds, these pledged bonds are added to the bank's balance sheet, simultaneously consuming Tier 1 capital.

When a bank's capital requirements or balance sheet space become limited, the bank, as the lender, will either stop lending or significantly raise interest rates.

The result is that some hedge funds, in order to survive (such as through magnet calls), have no choice but to liquidate their holdings in Treasury bonds at any cost. This leads to a surge in US Treasury yields, accompanied by a surge in the SOFR rate.

Another very important factor is the requirement of RLAP (Regulatory Regulations on Intraday Liquidity). The regulations require that at any time of any trading day, there must be sufficient, readily available, high-quality liquidity to cope with capital outflows in extreme circumstances.

Therefore, although you can see that banks' reserves are not low, a portion of them are locked up; in other words, banks tend to maintain a larger amount of reserves. This, in turn, will have an impact at the end of the quarter and other key points in time.

III. How to analyze the tightness or looseness of US dollar liquidity

Before discussing the dollar liquidity monitoring indicators further, there is another key variable that needs to be clarified: the pressure on offshore dollars.

From the perspective of the global dollar system's operating mechanism, the dollar does not circulate solely within the United States. On the contrary, a significant amount of dollar credit is created, rolled over, and leveraged outside the US. This offshore dollar system heavily relies on foreign exchange swaps and cross-currency financing to borrow dollars.

Non-US banks, lacking a base of US dollar deposits, convert their local currency liabilities into US dollar liabilities through Fx Swap. Therefore, objectively speaking, it responds to changes in liquidity more quickly than onshore US dollars.

Therefore, we can roughly derive a simple analytical framework for analyzing dollar liquidity: offshore funding costs - onshore repurchase pressure - bank balance sheet behavior - asset price reaction.

1) Offshore USD: Cross-currency basis (core: USD/JPY basis/ EUR/USD basis), which represents the cost of bank borrowing in the offshore market to access USD; and the FX Swap point, the more negative the former, the larger the latter. This basically indicates that offshore financing pressure is rising at the current stage.

2) Onshore USD: The core analysis focuses on the repo market, primarily examining the deviation between SOFR and IORB, along with the MOVE index. If SOFR consistently exceeds policy levels, it indicates banks are unwilling to lend funds. For a deeper analysis, one can monitor Treasury auctions and repo market interest rates; significant fluctuations or increases in these rates also indicate financing pressure.

3) Bank balance sheet behavior: for example, an increase in RRP is not accompanied by an increase in Repo, or a rapid increase in SRF usage, etc.

In addition, a decline in the intermediary capacity of liquidity can also lead to some anomalies not seen at other times. For example, a simultaneous drop in both stocks and bonds may not be due to inflation, but rather to a tight repurchase market. Another example is an abnormal widening of credit spreads, and it's even possible that economic data is good, but liquidity is tighter.

For some time now, the market has been discussing the possibility of the US easing its SLR (Standard Lending Rate) in 2026. Essentially, this would loosen restrictions on dollar liquidity intermediaries, expand balance sheet space, and prevent a sudden spike in financing rates at a critical juncture, thus avoiding a deleveraging chain reaction. However, considering the current dollar weakness, the continuously expanding fiscal deficit, the room for interest rate cuts, and the midterm elections, possible scenarios include:

1) The problem of indigestion of US Treasury bonds: Even if interest rates are cut to around 3.0%, it will still be very difficult for long-term bonds to decline smoothly, and even the tail end of bond auctions may not look good. The absorption capacity of the primary market itself has become the biggest constraint.

2) Changes in TGA accounts will have a greater impact on the market. With RRP exhausted today, TGAs may have a greater impact on changes in repo rates than before.

3) Changes in the Repo market: With massive amounts of debt meeting funds that urgently need leverage, the market may face greater volatility at the end of the quarter and tax payment dates. At the same time, margin calls in basis trading may become the biggest tail risk.

Without loosening of the SLR (Standardized Lending Facility), loose monetary policy and tight credit will dominate the market scenario for some time, and the asymmetry of risk will be extremely prominent in terms of liquidity. Under this tight balance, banks' willingness to expand their balance sheets will be suppressed, the correlation between stocks and bonds will become less meaningful, and they are more likely to collapse simultaneously. The failure of the 64-portfolio strategy may continue.

For ordinary people, cash remains an important defense mechanism; therefore, gold and commodities can serve as very effective hedging tools. At the same time, when analyzing an asset, it's crucial to pay attention to where it falls in the liquidity transmission chain. For example, altcoins or assets with low liquidity are prone to depletion and flash crashes.