America’s Crisis Has Already Begun
Martin Wolf warned the next financial crisis would begin in America. It already did — in April 2025. And America started it.
Grüezi!
Martin Wolf wrote in the FT that the next financial crisis is most likely to start in America. Of course, he’s right.
But it’s not because America is borrowing too much, or that it’s politically divided, or fiscally stretched. It’s because the machinery which lets America keep borrowing has changed — and most of the people who depend on it haven’t noticed.
US debt is absorbed by the “Treasury market.” That sounds neat and tidy.
In reality it’s dealers financing inventories in repo, hedge funds arbitraging tiny price gaps with borrowed money, foreign central banks holding reserves, money-market funds supplying dollar cash.
Behind all of that stands the Federal Reserve, ready to step in when private balance sheets retreat.
That’s how the world’s biggest economy and biggest borrower keeps on borrowing.
It’s also how the world’s biggest economy and biggest borrower will get into trouble.
1. More Fires. Fewer Firefighters.
For most of the post-war period, America’s borrowing had a simple absorber: primary dealers.
These are the two dozen big banks authorised to trade directly with the Federal Reserve. JP Morgan, Goldman Sachs, Morgan Stanley, Citi — the names around the table in The Big Short.
They bought up Treasuries when others wanted to sell, held them on their balance sheets, financed those holdings in repo, and sold bonds on. Their balance sheets were giant stabilisers smoothing the market. They made federal debt continuously tradable.
Since then the Treasury market has tripled — from around $10 trillion before the financial crisis to over $30 trillion today.
But according to Stanford’s Darrell Duffie, relative to the size of the Treasury market, the big banks’ balance sheets have shrunk by roughly three-quarters since 2007.
The fire’s three times bigger but the fire brigade is a quarter of the size.
Thank the financial crisis. In the clean up, the largest US banks were required to hold capital against the total size of their balance sheets through a rule called the supplementary leverage ratio.
The point of the rule was to stop banks levering up against assets they’d decided were safe — a habit that had not gone well in 2008.
Here’s how it works. For every dollar of assets a bank holds — loans, bonds, anything — it has to set aside a fixed amount of its own capital to act as a cushion. But it doesn’t matter what the asset is. A risky corporate loan and a US Treasury bond both count the same.
That made holding Treasuries expensive. Every safe Treasury on a bank’s books took up space that could have been used for riskier, higher-yielding loans. So banks held fewer of them.
Instead, a large part of the marginal absorption now comes from hedge funds, many based in the Cayman Islands, running the Treasury basis trade.
A fund buys a Treasury bond and sells a futures contract — a binding agreement to deliver that same bond at a set price on a set date a few months later. The futures price is fractions of a penny on the dollar higher.
So the fund borrows heavily in repo to make the return worthwhile. The biggest funds put up $1 of their own capital to control $18 of Treasuries. That’s how trillion dollar positions get built.
Between 2022 and 2024, while the Fed was shrinking its own balance sheet, Cayman hedge funds took in 37 per cent of America’s new Treasury debt — as much as all other foreign investors combined.
A tourist destination with more palm trees than people is the largest foreign holder of US Treasuries in the world. Bigger than Japan, China, and Britain.
This is the financial system we have.
The marginal buyer of US debt is now often a leveraged fund earning a small spread with a lot of borrowed money. That works when volatility is low and repo funding is cheap.
What does that look like from inside a fund? On Monday morning, the algorithms running a $10 billion Treasury book hit a new margin requirement — 4 per cent instead of 2, posted overnight by the repo desk. The fund needs another $200 million in cash by close of business.
The capital isn’t sitting around — the whole point of the trade is that it’s leveraged. So the machine sells $500 million of Treasuries to raise the margin and reduce the position. The sale moves the price down, because every fund running the same trade is running the same code.
The remaining $9.5 billion now marks lower. The repo desk recalculates. More margin by Tuesday. By Wednesday funds are selling not because anyone wants to, but because they have to.
None of this requires a crisis. Just a bad day.
The IMF modelled a version. An 80 basis point yield rise combined with fund outflows of the kind seen in March 2020 could force nearly $200 billion of Treasury sales by US mutual funds alone.
The problem isn’t only the size of the sale. It’s that every seller needs liquidity at exactly the same moment.
The old market depended on middle-aged men you could gather round a table in a crisis.
The new market depends on mathematical models behaving themselves.
2. Self-Inflicted Shocks
The first real test of the patched system came in April 2025, with the tariff announcements.
Treasuries did what Treasuries should — investors piled in for safety and prices rose. For two days.
Then, like a risk asset, they reversed. By 8 April, yields had jumped 60 basis points in four trading sessions.
The dollar fell against the euro and yen in the same window, and kept falling for weeks. Equities sold off.
For thirty years the world had treated US Treasuries as the asset you bought when everything else looked uncertain. After 2 April, that wasn’t quite true any more.
The risk that had crept into the market wasn’t a credit or default risk — America wasn’t going to miss a coupon payment. It was a political risk.
A US administration prepared to upend the rules of international trade overnight was one the world was going to think harder about lending to.
Hedge funds running swap-spread trades were forced to liquidate. Foreign holders raised currency hedges, which meant selling dollars forward at scale.
Behind the scenes, Treasury Secretary Scott Bessent reassured market participants that buybacks would be expanded if needed, and the Fed signalled — without saying so publicly — that the SRF was open and could be used.
The market stabilised within a fortnight. The new system absorbed a shock without emergency intervention.
But it was also a small, self-inflicted shock — the US government wobbling its own bond market with its own tariff policy. And what unwound wasn’t the trillion-dollar Cayman Islands basis trade. It was a smaller, related bet on swap spreads. The big position is still there. Untested.
The main shock absorber is less solid than it looks too. The SRF — meant to be the always-open backstop — is barely used. If you have to borrow from it, everyone notices. Especially regulators.
The Treasury market used to have depth. Things might lurk in the deep, but the depth itself was real. Now it has band-aids and an administration with a chainsaw.
If the band-aids fail, the Fed faces the old choice. It can buy Treasuries directly, as it did in March 2020. That was the Covid moment. Lockdowns were spreading. Investors everywhere wanted cash, and the only way to get cash was to sell whatever was easy to sell. Treasuries were easy to sell — until they weren’t.
The Treasury market briefly stopped functioning altogether. The Fed bought more than $1.5 trillion of Treasuries in three months and around $360 billion in a week. That was the central bank catching a falling knife with both hands.
Or it can stand back. Let yields rise. Let the dollar fall. Let leveraged funds and foreign holders sell into the storm.
Both options are bad.
The first ends with the Fed looking like the central bank of an emerging market — independent in theory, credibility gone in practice. The dollar weakens. Inflation roars back. Savers lose.
The second is an act of discipline that someone else pays for. Borrowing costs spike across the economy. Mortgages reprice. Companies that need to roll over their debt either pay much more or fail. The federal deficit gets worse, because debt-service costs rise faster than tax revenue. Recession arrives in earnest.
Either way, the world’s reserve asset goes through something it hasn’t been through since the 1970s. And either way, the choice will be made by people in a room — not by machines.
3. Treasury Market Repercussions
A Treasury market crisis isn’t one event. It’s a sequence of balance-sheet reactions running through four channels at once.
The first is at home. Repo financing gets more expensive. Hedge funds running the basis trade are forced to sell. Dealers can’t absorb the supply. Yields rise further. The unwind feeds itself.
The other three are abroad.
European insurers and Japanese life funds, holding trillions in Treasuries, raise their currency hedges — meaning they sell dollars forward at scale.
European banks that lend dollars globally without creating dollars find their funding drying up, and start watching the Fed-ECB swap line.
Gulf central banks see their reserves losing value and their currency pegs under pressure at the same time.
This is why the Treasury market matters beyond Washington. Yes, it’s where America borrows. But it’s also the collateral and liquidity system through which everyone else funds themselves, hedges themselves and stores their national wealth.
When that system comes under strain, Europe gets a dollar-funding problem. The Gulf gets a reserve and peg problem. Corporates get a hedge and refinancing problem.
Each needs its own preparation. The next sections take them in turn.
4. No European Central Borrowing
European banks borrow dollars from markets they don’t control and rely, in extremis, on the Fed-ECB swap line. A US Treasury market crisis therefore becomes a European banking problem.
Europe has a strong central bank. What it doesn’t have is a strong borrower. The ECB has a big balance sheet, swap lines, supervisory power over the major eurozone banks, collateral frameworks, and settlement infrastructure.
What it doesn’t have is a common safe asset issued at scale, the European answer to US Treasuries.
Europe’s political problems are holding back European financial plumbing.
The US Treasury market is the world’s reserve asset by default — not because it’s flawless, but because there’s nothing else of comparable depth, scale and history.
The pool is enormous, the trading is continuous, the bonds are accepted as collateral everywhere. Even now, it’s still the only game in town.
Europe has to borrow huge amounts in the next decade. It has to rearm against Russia. It has to pay to make its energy cheaper.
It has to absorb the consequences of an American security guarantee that may or may not still exist by 2030.
None of this is optional. All of it is going to be financed by debt.
Borrowed jointly, that debt could become the safe asset the world needs and Europe lacks.
It won’t happen, of course. Europe will continue to treat common debt as a moral argument about fiscal virtue rather than as financial infrastructure.
Germany will object. The Netherlands will object. Europe’s “frugal four” will remind everyone that borrowing is a sign of weakness. Bonds will be issued nationally, at twenty-seven different yields, with no common safe asset emerging from any of it.
Meanwhile European banks would face dollar-funding stress if US money-market funding tightened. They’d take mark-to-market losses if Treasury holdings fell.
And European banks are vulnerable in their own right. The IMF reckons that in a 1970s-style scenario where inflation rises and growth stalls, a fifth of the world’s banking system would burn through their capital cushion fast enough for governments to have to consider stepping in. A lot of European banks are in that fifth.
Europe knows, fixes are under way. The ECB is expanding a facility that lets non-eurozone central banks like the UK’s borrow euros against collateral, useful for steadying neighbours when dollar markets seize up. A digital euro is being designed, with a target launch around the end of the decade.
Neither answers the actual question, which is whether a single euro-area bond — issued jointly, at scale, against a shared revenue stream — could give the world an alternative to American Treasuries.
Europe isn’t building at the scale the risk implies.
Europeans understand the problem perfectly. They know the solution. They’re just waiting for the scale of crisis that might enable it.
5. Tunnels Not Exits
The Gulf isn’t trying to escape the dollar. It’s trying to escape the conditions that America applies to those using it.
The region holds its reserves in dollars, pegs its currencies to the dollar and owns large dollar-denominated sovereign portfolios. A Treasury shock that weakens the dollar and hits US equities damages the reserve book and the sovereign-wealth book at the same time. None of that is escapable in the medium term.
But while the Gulf lacks Europe’s institutional depth, it has the opposite advantage. So while Europe debates and divides over how to diversify, the Gulf is quietly building ways around American oversight.
The most concrete example is mBridge. It lets central banks pay each other across borders without using dollars, and without going through a system the US monitors and controls. The central banks of China, Hong Kong, Thailand and the UAE can now wire each other directly, in their own digital currencies, with no US “big brother” watching.
It has cleared more than $55 billion in transactions, 95 per cent of them in digital yuan.
mBridge moves money. It doesn’t store it. What it does, though, is reduce the leverage Washington has over the countries that use it. That’s the prize.
The UAE has gone furthest. It positioned itself inside mBridge from the start. It approved a regulated dirham-pegged stablecoin in December 2024. And it has been quietly testing how much American discretion it can route around — the question of whether SWIFT is mandatory, the regulatory tolerance for non-dollar settlement, the practical limits of US reach.
Separately, it has been probing the other half of the same question: in a real dollar squeeze, would Washington help, and at what price? The Emiratis are running an experiment in taking back control of their cash.
Saudi Arabia allowed its 50-year exclusive dollar oil-pricing arrangement to lapse in June 2024 — which signalled more than it meant, since pricing oil in non-dollars was already legal and rarely done. In 2023, it signed a $7 billion currency swap with the People’s Bank of China. Its industry minister said the kingdom was “open to ideas” on petroyuan invoicing.
Saudi reserves remain dollar-denominated. The Public Investment Fund is deeply exposed to US assets, especially US technology. And the budget needs oil prices well above current levels just to balance.
Behind both countries sits China. Since 2009, Beijing has built a swap-line network reaching around 40 central banks — liquidity insurance in euros, yuan, and occasionally dollars sourced through other routes. Those lines don’t replace Fed swap lines. But they do give participating states a number to call that isn’t in Washington.
That’s why the UAE matters and Saudi Arabia doesn’t, yet. The UAE has plugged into the network. Saudi Arabia has talked about it. The infrastructure for an alternative, dollar-conditional world is being built, and it has a postcode in Beijing. The Gulf countries that are inside it have options. The ones that aren’t are still posturing.
The Gulf’s overall exposure is threefold. Reserves lose value when the dollar falls. Pegs come under pressure when defending them gets expensive. Sovereign funds — heavily concentrated in US tech stocks — take losses on the asset side at the same time the reserve side is losing value. A Treasury shock hits all three at once.
The UAE has started tunnelling. Saudi Arabia is still talking about digging.
Neither has a viable exit from the dollar system. But one has more options if the dollar system becomes conditional.
6. Orders-Based Rule
Jerome Powell’s term as Fed Chair ends on 15 May 2026, but he’ll remain on the Board of Governors after stepping down — the first outgoing Chair to do so since Marriner Eccles in 1948.
His successor, Kevin Warsh, was advanced from the Senate Banking Committee on 29 April 2026 and awaits a full Senate vote.
If Powell was the rules-based order, Warsh’s will be orders-based — and the concern is that those orders will come from the Oval Office.
Mr Trump wants lower interest rates. Cheap money means cheap mortgages, cheap business borrowing, more jobs, happier voters. Higher rates mean recessions, and recessions cost elections.
The job of an independent Fed Chair is to be the person in the room who can say no — to raise rates when the economy is overheating, even when the President is demanding a cut.
Take that person out of the room, or replace them with someone who won’t say no, and the market notices immediately.
Inflation expectations rise. Investors demand higher yields on long-dated bonds to compensate for the inflation they now expect.
The dollar weakens because it’s no longer a credibly-managed currency. Reserve managers around the world start asking awkward questions about whether they should be holding quite so much of an asset whose issuer has lost monetary discipline.
A Fed Chair who jumps when the President calls isn’t a Fed Chair the market can trust. The question is — which one is Warsh?
7. Euro-Prepping
For Europe, the channel is dollar funding.
European banks need dollars they can’t create. Deutsche Bank, BNP Paribas, Santander and the rest all lend dollars to companies and governments around the world.
The banks fund those loans by borrowing short-term dollars in New York — mostly from American money-market funds, the cash-management vehicles that hold trillions on behalf of US corporations and pension funds. The banks roll this borrowing every few weeks. In calm markets, it works fine.
In a panic, US money-market funds get nervous and refuse to roll the next round of lending to Europeans. The dollar loans are still on their books — but the funding for them has just disappeared.
The banks now face a tough choice. Find dollars somewhere else, immediately, at any price. Or start calling in those loans.
This is where the Fed-ECB swap line comes in. The Fed lends dollars to the ECB. The ECB lends them on to European banks. The banks keep their books open. The crisis stays contained.
It worked in 2008, it worked again in 2020.
The question is whether it works the same way under a Trump administration.
Should Europe act surprised if the next swap-line deployment comes slower, with more strings attached?
The first line of defence is making sure euros move freely between European central banks. The ECB already has a facility — EUREP — that lets non-eurozone central banks like the Bank of England, the Swiss National Bank and the Riksbank borrow euros against collateral. It needs to become permanent, unconditional, and bigger.
Why? Because that’s how Europe makes dollars without asking Washington.
When the Fed swap line is slow or stuck, European banks can still get dollars — by borrowing euros from the ECB, then swapping those into dollars in the forex market.
It’s the financial equivalent of a backdoor.
But the backdoor only works if euro liquidity is flowing freely to begin with. If the ECB is slow to lend euros to its neighbours, the chain seizes up before it can substitute for the missing Fed lifeline.
Trump can slow a swap line. He can’t stop the ECB lending euros to the Bank of England.
The longer game is the digital euro and a common safe asset. A digital euro gives the ECB something independent of US-dominated card networks and dollar correspondent banking.
A jointly issued, at-scale euro-area bond — backed by a shared revenue stream — would give the world somewhere other than the Treasury market to park reserves.
Both need to start now.
Wolf was right that the next crisis would start in America. The harder thing to say is that it has already begun — launched from the White House.
The dollar system isn’t about to collapse. The old assumptions are.
Treasuries are unlikely to remain indefinitely as the automatic, apolitical shock absorbers of the financial world.
Best prepare.
Thanks for reading!
Bis bald,
Adrian