From Barbarians to the Menger Trilemma

How digital dollars expose the tension between dollar dominance, financial stability, and the Fed’s size.

In my last post, “Barbarians at the Fed’s Gate,” I explored how the rise of dollar-based stablecoins could erode the Federal Reserve’s low-cost “currency franchise” while simultaneously pulling it toward a larger balance sheet. That essay focused on how the widespread adoption of stablecoins—bolstered by the GENIUS Act and innovations like “skinny” Fed master accounts—could reshape both the composition and cost of the Fed’s liabilities. In this follow-up, I pick up where that story left off: if stablecoins really do take off, they could supercharge the Fed’s balance sheet by making it an even more central safe-asset intermediary for the global financial system. But before we get to a supercharged Fed balance sheet, we need to consider why stablecoins are likely to create net new demand for Fed liabilities in the first place.

Stablecoins and Net New Demand for Fed Liabilities

So how will dollar-based stablecoins create net new demand for Fed liabilities? I see several channels through which this could happen. First, in emerging economies where dollar access remains constrained, every new stablecoin minted represents fresh demand for Fed liabilities via the safe-asset collateral backing it.

Second, strict regulations on euro-based stablecoins and an underpowered euro CBDC have left a vacuum in Europe that dollar-based stablecoins are filling. Consequently, as Luis Garicano notes, Europe’s digital future looks increasingly like a dollar-dominated one. This too will increase demand for Fed liabilities.

Third, dollar stablecoins will likely amplify the dollar’s existing global network effects by embedding it more deeply into trade, remittances, and savings as more transactions go on-chain. A bigger global dollar system, in turn, means additional demand for Fed liabilities.

Finally, the well-understood but unspoken belief that the Fed will stand behind dollar-based stablecoins in a crisis—just as it has for other money market assets in past crises—reinforces their safety premium, driving further adoption and increased demand for Fed liabilities. The GENIUS Act and the expected arrival of skinny master accounts make these developments even more likely.

What Type of Fed Balance Sheet Expansion?

If stablecoins mean greater demand for Fed liabilities, then what kind of balance sheet expansion might this entail? In my view, there are two ways for understanding this process. One view—rooted in the “safe asset shortage” narrative—sees the Fed’s balance sheet expanding to meet an excess demand for safe and liquid assets, with quantitative easing (QE) functioning as a kind of public intermediation service that supplies the safety that private markets cannot. The other view—anchored in concerns about fiscal dominance—sees the Fed’s balance sheet growing in response to an excess supply of safe assets, as mounting public debt pressures the central bank to absorb and manage an expanding stock of treasuries.

Stablecoins may intersect both of these dynamics: they could amplify global demand for dollar safety even as they deepen the channels through which the Fed intermediates the government’s swelling debt. In the sections that follow, I unpack each of these perspectives in turn and explain how stablecoins might blur the boundary between them.

Safe Asset Shortage QE

The safe asset shortage view of QE can be understood from both a cyclical and structural perspective. The cyclical view is best illustrated by the Great Financial Crisis of 2007-2008. In the years leading up to it, the private sector produced a large stock of assets that appeared safe: AAA-rated mortgage-backed securities and their structured offspring. These “private-label” safe assets met global demand for safety, liquidity, and yield, functioning as close substitutes for treasuries. When they collapsed in 2007–2008, it significantly reduced the global supply of safe assets (Caballero, Farhi, and Gourinchas, 2017) and pushed investors into treasuries and other government-backed instruments, driving down interest rates.

With yields falling, the government’s borrowing costs collapsed, making fiscal expansion both easier and more politically palatable. Congress responded by running large deficits financed by issuing treasury securities that, in turn, helped fill the vacuum left by the destruction of private safe assets. The Fed then stepped in as the system’s balance-sheet intermediary: it absorbed treasury issuance through QE, transformed them into bank reserves, and thereby met the global demand for safety and liquidity. In other words, the Fed’s balance sheet grew during the post-2008 period because the global financial system demanded more safe, dollar-denominated claims than could be supplied by the private sector.

The structural version of this story goes back even further. Starting in the mid-twentieth century, the U.S. economy has been running a persistent imbalance between the demand for and supply of safe assets. As Auclert, Malmberg, Rognlie, and Straub (2025) document, the value of desired asset holdings by households and foreigners—what they call “asset demand”—rose by roughly 400 percent of GDP since 1950, while the supply of assets, composed of government debt and private capital, increased by only 100 percent of GDP. The result was a steady decline in the natural real rate of interest, or r-star, as asset demand decisively “won the race.” It was not until the GFC, however, that the pressures of this race were manifested on the Fed’s balance sheet.

From this long-run perspective, quantitative easing in the United States can be seen not simply as a crisis-era intervention, but as the monetary system’s adaptation to a chronic shortage of safe assets—the Federal Reserve expanding its balance sheet to create the forms of liquidity and collateral the private sector could no longer reliably supply.

The U.S. experience fits within a broader global pattern. Across advanced economies from 2008 to 2019, the size of central bank balance sheets relative to GDP was negatively related to the average inflation rate. Countries with the lowest inflation—such as Switzerland and Japan—ended up with the largest balance sheets, while those with higher inflation, like New Zealand and Australia, required much smaller interventions. This pattern is precisely what the safe-asset-shortage view would predict: central banks expanded their balance sheets most aggressively where the demand for safe, liquid assets—and thus the disinflationary pressure—was greatest.

In this sense, dollar-based stablecoins can be seen as the latest manifestation of the global search for safety that has driven the Fed’s balance sheet growth since 2008. By creating new digital dollar claims ultimately backed by Fed liabilities, they extend the safe-asset-shortage dynamic into the blockchain era—channeling global demand for dollar liquidity through crypto assets. If this demand continues to grow, the Fed could once again find itself expanding its balance sheet to accommodate the world’s appetite for dollar safety, this time through stablecoin intermediation rather than conventional QE.

But there is another way to read the future of stablecoin-driven QE, one rooted not in excess demand for safety but in the excess supply of public debt that must be absorbed and managed.

Fiscal Dominance QE

From this perspective, balance sheet expansion is not about meeting global demand for safe assets, but about sustaining government solvency and managing an ever-larger stock of Treasuries.

The United States is entering such an era. The Congressional Budget Office projects that over the next decade public debt will climb near 120 percent of GDP, primary budget deficits will add about $20 trillion in debt, and interest payments on the debt will reach almost $2 trillion a year by the end of the period. In this environment, the Treasury’s financing needs are becoming the gravitational force of the macroeconomic system—and the Federal Reserve risks being pulled into its orbit. As the stock of Treasury securities balloons, the Fed faces growing pressure, explicit or implicit, to ensure that the market can absorb the supply without destabilizing yields.

We have been here before. Between 1942 and 1951, the Federal Reserve pegged Treasury yields across the curve to support wartime financing, standing ready to buy whatever amount of government debt was needed to keep short-term rates at ⅜ percent and long-term rates at 2.5 percent. This arrangement expanded the Fed’s balance sheet. It also subordinated monetary policy to fiscal needs until the 1951 Treasury–Fed Accord restored its independence. Arguably, a milder version of this dynamic resurfaced during 2021–2022, when pandemic-era borrowing surged and the Fed’s balance sheet ballooned in tandem. As George Hall and Thomas Sargent have documented in a series of papers, the Fed in this period looked less like it was leading policy than financing it.

While both episodes were justified by extraordinary circumstances, they illustrate the same underlying mechanism: fiscal needs draw the central bank into a supporting role. In this sense, they represent examples of fiscal-dominance QE—Fed balance sheet expansion driven by the necessity of managing an excess supply of safe assets.

Stablecoins fit into this narrative because while they represent a true innovation in payment technology, they also provide a means to support U.S. fiscal pressures. Proponents of the GENIUS Act—the law that brings stablecoins into the U.S. regulatory perimeter—have been remarkably candid about this fiscal benefit. Treasury Secretary Scott Bessent, for example, hailed stablecoins as “a revolution in digital finance” that will “buttress the dollar’s status as the global reserve currency… and lead to a surge in demand for U.S. Treasuries, which back stablecoins.” Similarly, White House Crypto Czar David Sacks emphasized that stablecoins “could create potentially trillions of dollars of demand for U.S. Treasuries, which could lower long-term interest rates.”

Stablecoins, in other words, may cause the Fed’s balance sheet to expand both to accommodate global demand for safe dollar assets and to simultaneously facilitate the absorption of ever-growing treasury issuance. What appears as financial innovation in the private sector thus doubles as a new mechanism of fiscal intermediation operating through the plumbing of the digital dollar system.

Stablecoins, then, may become the bridge between the safe-asset-shortage and fiscal-dominance worlds: private instruments that generate public demand for Fed liabilities, even as they tether the central bank more closely to the Treasury’s balance sheet. The endgame may be a Fed balance sheet that is both structurally larger and more politically entangled—a central bank at the center of a digital safe-asset empire, but one increasingly constrained by the fiscal foundations that sustain it.

The Menger Trilemma

The discussion above points to a growing tension for observers like me who value dollar dominance yet prefer a lean Federal Reserve balance sheet: satisfying both preferences may be inconsistent with financial stability. The larger and more interconnected the dollar system becomes, the greater the demand for Fed liabilities to anchor it. The Great Financial Crisis made this clear. The system’s expansion had been sustained by private safe assets that ultimately proved fragile. When they collapsed, public safe assets had to fill the void, and the Fed stepped in as the system’s balance-sheet intermediary. Financial stability required a larger Fed balance sheet to meet the world’s appetite for dollar assets.

Stablecoins are the next chapter in this story. They promise to extend the reach of the dollar into digital networks, embedding it even more deeply in global finance. Yet the very innovation that expands the dollar’s domain also magnifies the system’s dependence on the Fed. Each new stablecoin minted—backed by public safe assets—tightens the link between private digital money and the public balance sheet that underwrites it. Digital-dollar innovation, therefore, does not resolve the tension between dollar dominance, a small Fed, and financial stability—it intensifies it.

This tension suggests a trilemma. We can have a small Federal Reserve balance sheet and dollar dominance, but then we risk the kind of financial fragility seen in 2007–2008. We can have a small Fed and financial stability, but only by allowing the dollar’s global role to shrink and reducing the global demand for dollar assets. Or we can have dollar dominance and financial stability, but only by accepting a permanently larger Federal Reserve footprint. It appears, in other words, that the dollar’s global reach requires that the institution sustaining it must grow in proportion to its reach.

Every trilemma needs a name. Let’s call this one the Menger Trilemma. Carl Menger taught that money emerges as the most saleable asset—the good everyone wants because everyone else accepts it. The global dollar system represents the fullest realization of that principle: the dollar has become the world’s most saleable and most networked asset. Yet this very success imposes limits of its own. The more universally the dollar serves as money, the more institutional scaffolding is required to sustain financial stability. Menger, a champion of spontaneous market order and minimal state intervention, might have admired the dollar’s organic rise but recoiled at the scale of central bank support now required to maintain it. Put differently, Menger would have preferred all three goals—dollar dominance, financial stability, and a small Fed balance sheet—but been disappointed to learn he could only pick two. The Menger Trilemma, then, captures this irony: the more complete the market acceptance of the dollar, the larger and more indispensable the state apparatus must become to maintain its stability.

Conclusion

In the end, the forces of safe-asset scarcity and fiscal abundance may converge in shaping the Fed’s digital-era balance sheet—one expanding both to satisfy the world’s hunger for dollar safety and to manage the government’s growing debt supply. The result is the Menger Trilemma in motion: the global dollar’s dominance, the financial system’s stability, and the size of the Fed’s footprint are now bound together. How this balance evolves remains uncertain. The rise of tokenized bank deposits could anchor much of digital-dollar activity within the U.S. banking system, easing some of the pressures on the Fed. But if those private innovations fall short, the logic of the trilemma will reassert itself—the more the world seeks safety in the dollar, the more it will depend on the Federal Reserve to provide it.

Update: Fed Governor Stephen Miran recently spoke on this topic too: A Global Stablecoin Glut: Implications for Monetary Policy.