With contributions from Josh Nye, Vivien Lee, Sheena Khan and Aaron Ma

Tariff update

The tariff news cycle has slowed somewhat since the early-August tariff deals and punishments were meted out. The main stories since then are the increasingly visible economic damage from the tariffs, a court ruling that attempts to block a large fraction of the Trump tariff agenda, the incremental addition of more minor tariffs, and the narrowing gap between theoretical and realized tariff rates.

Legal ruling

On August 29, the U.S. Court of Appeals rejected the White House’s use of IEEPA tariffs in a 7-4 vote. This is the second level of court to reject the tariffs. IEEPA (International Emergency Economic Powers Act) is the legislation being used to enable country-wide tariffs, such as those that now blanket most of the world’s nations. Thus, the removal of these tariffs would be a major development. IEEPA only allows the application of tariffs in an emergency, and so the debate revolves around whether longstanding trade deficits constitutes an emergency. Different legislation is used for sector-oriented tariffs, such as on steel, aluminum, autos and copper.

We wrote at length about this subject on May 27 (see the last sub-section entitled “Legal resistance to Trump tariffs”). The story remains much the same as it did then, with a few new developments. Although the tariffs have been struck down, they will remain provisionally in effect through the middle of October, allowing the Supreme Court to be the final arbiter.

On the one hand, two consecutive courts have rejected the IEEPA tariffs, and this iteration of the Supreme Court is notionally inclined toward defending the delineation of powers – in this case, Congress’ primary responsibility for taxation and tariff decisions.

On the other hand, the Court of Appeals ruling was not unanimous, suggesting considerable legal wiggle room as to the definition of what constitutes an emergency. And the current configuration of the Supreme Court also has a rightward tilt that could favour President Trump’s policies.

That said, even if the Supreme Court blocks IEEPA tariffs, we expect substantial tariffs to be in effect in future years. How?

Trump could manage to persuade Congress to implement his tariffs using the IEEPA framework, especially for countries that have agreed to a trade deal with him.

Sector-oriented triffs could be ramped up substantially and broadened to cover additional sectors, loosely replicating the existing regime, albeit with less ability to favour one country over another.

The White House also has other tools in its tariff toolkit. The easiest path might be to use Section 122 tariffs as an interim solution: they can apply up to a 15% tariff for up to 150 days without Congressional approval. That would buy time to implement Section 301 tariffs on a more permanent basis. Section 301 tariffs are already used against China and Brazil, and are intended to address unfair foreign trade practices. They do require a significant amount of preparatory work, however, hence the potential need for interim tariffs.

Still, if IEEPA tariffs were rescinded and other forms of tariffs took their place, there would be several potential ramifications:

• The U.S. would have to compensate all of the parties that had paid IEEPA tariffs, meaning potentially hundreds of billions of dollars of reimbursements. This would be a windfall for some but create a fiscal hole for the federal government. To the extent that the cost of the tariffs had been significantly shared with consumers and foreign manufacturers, importers would actually come out ahead.

• It is legally debatable whether the temporary Section 122 tariffs could be sequenced back to stretch them out over more than 150 days. If not, there might be a gap between the end of the Section 122 stopgap tariffs and the beginning of the Section 301 tariffs. A smaller matter is that the Section 122 tariff rates would be lower than the existing IEEPA tariffs for some nations such as India, Canada, Mexico and much of Asia. All of this is relevant because if gaps form, there might be a temporary economic rebound.

New tariffs

It wouldn’t be a proper #MacroMemo unless there were a handful of new tariffs to discuss. While it has been slower going in recent weeks, there are still a few to discuss, and these combine to lift the average U.S. tariff rate up to 18.6% (see next chart).

Average U.S. tariff rate is almost 19%

Effective tariff rates estimated based on tariffs in effect as at the specified date and up to September 4, 2025; threatened rates not included. Excludes the de minimis effect - suspension of de minimis exemption for China and Hong Kong in May 2025 and effective August 29 for all other countries. All U.K steel exports to U.S. are assumed to be covered under the quota system. Expected tariff rate assumes instantaneous and complete implementation (i.e., does not account for shipping delays, implementation lags, etc.) Source: Evercore ISI Tariff Tracker, IMF, Macrobond, RBC GAM

1. De minimis exemption ended

   The U.S. de minimis tariff exemption for goods worth less than US$800 was halted for all countries beginning on August 29. Those products must now pay the same tariff rate as other goods. This will be a significant blow to small foreign businesses, small U.S. businesses and U.S. consumers.

2. Broader steel and aluminum tariffs

   Steel and aluminum tariffs were broadened on August 18 to include the metal components of a further 400 downstream products, including motorcycles, air conditioning and machinery. This increases the average U.S. tariff rate by about 1ppt.

3. Indian tariffs doubled

   On August 27, Indian tariffs were doubled from 25% to 50% as punishment for India’s continued importation of large quantities of Russian oil. The U.S. is India’s number one export destination, though India’s economy is also fairly diversified and has a significant service component (which is not tariffed).

Tariff gap

The July tariff revenue data has finally arrived for the U.S. Although it is somewhat stale upon arrival, it nevertheless reveals a few interesting things.

1. The shortfall between the theoretical U.S. tariff rate and the actual tariffs the government manages to collect fell from 5.1ppt in June to 4.5ppt in July. This indicates that the expected convergence is happening, as discussed in our prior MacroMemo (scroll to the subsection entitled “Actual U.S. tariff rate continues to run lower than theoretical rate”). Even without rising tariffs, tariff damage is increasing from one month to the next as this convergence occurs.

2. There was briefly a mystery as to how so many products were entering the U.S. tariff-free from Canada when barely more than half of what Canada sells to the U.S. was officially compliant with the USMCA (U.S.-Mexico-Canada Agreement) – the key determinant forwhether tariffs should be levied. This largely dissipated in July. Whereas just 56% of Canadian products entering the U.S. were classified as USMCA-compliant in June, the figure rose to 84% in July, and we would suspect rose further in August.

   -EL

Weak employment in context

We continue to forecast a marked deceleration in U.S. economic growth over the next few quarters, primarily due to tariff damage. The Citi Economic Data Change index highlights that this process is already tentatively underway (see next chart).

Modest deterioration in U.S. economic data is underway

As of 09/05/2025. Sources: Citigroup, Bloomberg, RBC GAM

The weakness in the underlying data is arguably most visible in the employment numbers (see next chart). August payrolls managed just 22,000 new jobs. That’s less than a third of the +75,000 consensus forecast. The consensus itself wasn’t very high when compared to job creation that more normally manages low-triple digit outcomes.

Financial markets were arguably even more distressed by the fact that the June number was revised from a modest positive to a stark 13,000 job loss. That’s the first month of net job losses since December 2020.

U.S. monthly job report shows weakness

As of August 2025. Sources: U.S. Bureau of Labor Statistics (BLS), Macrobond, RBC GAM

The composition of the report also wasn't great, with 46,800 jobs created in health care and social assistance. That’s more than twice the total net gain for the month of August. Most other sectors either showed muted gains or small losses. U.S. job creation isn’t very broadly based, as only a minority of sectors are hiring (see next chart).

U.S. monthly job report shows weakness

As of August 2025. Determined to be rising if the monthly change in the 3-month moving average is positive. Sources: Federal Reserve Bank of St. Louis, BLS, Macrobond, RBC GAM

When we break the U.S. labour market into cyclical versus non-cyclical components, nearly the entirety of job creation over the past year has been on the non-cyclical side – this is to say, economically sensitive businesses are behaving very cautiously, which isn’t a great sign (see next chart). Curiously, though, this has been the case for well over a year now. Further, the deceleration in hiring is happening because the non-cyclical components are now starting to become less robust. Again, the cyclical weakness is actually nothing new.

Growth is slowing in both U.S. cyclical and non-cyclical sector employment

As of August 2025. Sources: BLS, Macrobond, RBC GAM

1. The payrolls numbers may exaggerate the feebleness of the labour market: our RBC GAM Composite Job Growth Indicator has slowed notably but remains well ahead of payrolls (see next chart). Translation: the other job surveys, spanning the household employment survey, the ADP employment survey and weekly jobless claims, are less negative.

The U.S. labour market is softening, but less than payrolls suggest

As of August 2025. Composite indicator based on payrolls, household survey, initial claims and ADP employment. Sources: BLS, U.S. Department of Labor, ADP, RBC GAM

1. U.S. population growth has slowed due to stricter immigration controls. Accordingly, a “normal” month of job creation is smaller since there are fewer new job seekers. Whereas 150,000 new jobs per month was approximately the steady-state norm a few years ago, the U.S. may only need about 50,000 new jobs per month today to keep pace with the population. In that light, the recent job numbers are still underwhelming but not abysmal.

This interpretation matches the unemployment rate, which has risen from 4.2% to 4.3% in August. It is definitely trending higher, but is still at a relatively normal level for the moment.

What of concerns that the job numbers may have become politicized after the head of the U.S. Bureau of Labor Statistics was fired last month? It is a risk for the future, but we see no evidence that it has happened yet.

-EL

Other economic data isn’t as bad

So, is a recession on its way if job creation is sputtering? Not necessarily. Three other economic indicators are hardly rollicking but aren’t consistent with a burgeoning recession.

1. The Institute for Supply Management (ISM) Manufacturing Index actually rose slightly in August, from an admittedly weak 48.0 to 48.7. At a minimum, it isn’t a sign of a suddenly free-falling economy.

2. The ISM Services Index also rose, and by a significantly larger margin and to a healthier level. The index increased from 50.1 to 52.0, which isn’t a half bad endpoint. The new orders component went from 50.3 to 56, highlighting stronger demand.

3. The Fed’s Beige Book remained steady relative to the prior reading. Four Districts reported a slight decline in economic activity, two reported flat activity, and six managed modest gains (see next chart).

Beige Book Sentiment Indicator remains steady

As of September 2025. The indicator quantifies the sentiment of local contacts by assigning different weights to a spectrum of positive and negative words used to describe overall economic conditions in the Fed Beige Book. Sources: U.S. Federal Reserve, RBC GAM

The point isn’t that the economy is accelerating. It probably isn’t and there are always conflicting indicators in macroeconomic analysis. But these readings push back against the notion that the economy is suddenly in colossal trouble.

-EL

Fed outlook

Where does that leave the Fed? Not panicking, but certainly alert to the weak labour market and to the broader economic deceleration underway. At the Jackson Hole conference in late August, before the latest jobs announcement, Fed Chair Powell indicated that rate cuts might become necessary, that the Fed was less concerned about tariff-induced inflation due to its temporary nature, and that the balance of risks to employment had tilted in a negative direction. This subsequently proved bang on.

Looking forward, the market no longer debates whether a rate cut will occur on September 17, but instead how big the cut might be. A 25bps move is still much more likely than a 50bps cut, but the latter is not impossible. The inflation numbers released this week should help to cement one of the two outcomes.

The market also now prices further 25bps cuts on October 29 and December 10, and indeed imagines nearly six 25bps rate cuts spread out over the next year. When one combines the prospect of economic underperformance with potentially mounting political pressure, substantial rate cutting is entirely feasible. However, we presently anticipate a bit less easing than the market (though note that we were the more dovish ones until the market vastly repriced its expectations over the past few weeks).

-EL

International economic developments

Let us quickly review some key developments in a handful of core nations.

French instability:

French Prime Minister Bayrou lost a confidence vote on his proposed budget on September 8, marking the end of his nine-month term in office. President Macron will have to appoint his fifth prime minister in just the last two years.

The problem is that Bayrou had proposed a budget that included such austerity measures as eliminating two holidays, raising taxes on retirees and freezing ex-defense spending. Measures such as these were intended to help rein in the large French fiscal deficit, which the bond market has recently expressed concern about.

The next French Prime Minister will presumably have to follow a less austere path, which the public and economy will enjoy in the short run, but which bond investors may be less keen on.

German economic weakness:

While it remains credible to say that Germany will manage some fashion of economic acceleration as it loosens its debt brake and commits to more military and infrastructure spending, the recent economic data has not been especially encouraging. Factory orders fell by 2.9% month-over-month (MoM) in the latest month. Exports fell by 0.6% and imports declined by 0.1%.

Japanese politics:

Japan’s Prime Minister Ishiba resigned on September 7 in advance of a party confidence vote that was scheduled for the next day. His Liberal Democratic Party (LDP) had performed poorly in lower house elections last October and upper house elections in July.

The LDP will now have to select a new prime minister. Financial markets expressed some enthusiasm about the change, hoping for a more lenient fiscal stance and additional political pressure on the Bank of Japan to keep interest rates low.

-EL

Soft Canadian economy

As with the U.S., Canada also had a disappointing August employment report. Canada lost a stark 65,500 jobs during the month, far worse than the anticipated +5,000. While Canada’s job numbers are famously volatile, it is hard not to take the miss seriously given that it comes on the heels of a similarly poor -40,800 performance in the prior month. Even when accounting for a large gain in the month before that, the three-month moving average points toward job losses (see next chart).

Canadian employment shows recent damage

As of August 2025. Sources: Statistics Canada, Haver Analytics, Macrobond, RBC GAM

There were a few silver linings. One is that the job losses in August were concentrated in part-time and self-employed roles, which means the losses were lower quality jobs. Another is that Canada currently has virtually no population growth, so a “normal” rate of hiring could well be zero new jobs per month.

Still, jobs are being outright lost and the unemployment rate has accordingly jumped to 7.1%. This is the highest since August 2021 and a signal that the Canadian economy is grappling with a significant and rising amount of slack (see next chart).

Canadian unemployment rate has been rising

As of August 2025. Shaded area represents recession. Sources: Statistics Canada, Haver Analytics, Macrobond, RBC GAM

Turning from jobs to gross domestic product (GDP), Canada’s second-quarter GDP print came in below the consensus, with a 1.6% annualized decline. The negative size wasn’t surprising given the initial recoil when the U.S. began to threaten and then implement tariffs, but the magnitude was worse than expected.

Not long ago, we had wondered whether the Canadian economy might manage a slight rebound when tariff rates settled at a milder level initially feared. Alas, it doesn't appear that this is happening. Now, it appears third-quarter GDP print may also record a decline. The flash estimate for July was a poor -0.1% MoM, and fair-sized gains would be necessary in each of August and September to rescue the quarter. The fact that employment fell in August argues that this is unlikely for that month, at least.

Given the popular rule of thumb that a recession is two consecutive quarters of shrinking GDP, tongues will soon be wagging about a Canadian recession. In truth, the proper definition of a recession is somewhat more nuanced than that, requiring a material decline in output, significant job losses and cross-sector weakness. But even this “proper recession” is a very real possibility in the near future, even if we would assume it is fairly mild.

The market now prices a Bank of Canada rate cut at the September 17 meeting, and we believe there could be more rate-cutting than the market presently imagines over the next year.

Finally, and constituting a rare economic positive, Canada removed a significant fraction of its retaliatory tariffs on the U.S. starting September 1. This can either be viewed as a good-faith gesture as trade negotiations continue between the two countries, or as Canada matching the pre-existing U.S. policy of not tariffing most USMCA-compliant goods that transit the border.

-EL

Argentina’s economic transformation

Argentina’s economy – the third largest in Latin America after Brazil and Mexico – has undergone a significant transformation under the leadership of President Javier Milei, who took office in December 2023. Government spending and inflation are down. Price and capital controls have been relaxed. The economy and real wages are growing, and poverty has been reduced. However, fiscal austerity has been painful and unemployment is rising.

Congressional mid-term elections in the fall will be a referendum on Milei’s reform agenda. Recent state elections have pointed to some pushback, but the success of his policies will be judged over a longer timeframe.

Milei inherited a shrinking Argentinian economy saddled with significant government debt and deficits, the monetization of which caused rampant, triple-digit annual inflation. Just three years on from its ninth sovereign default, the government was using funds from yet another International Monetary Fund (IMF) program (its 22^nd) to repay earlier loans, and its international reserves were negative.

Milei had campaigned on a dramatic reform agenda that promised to take a chainsaw to public spending (he literally wielded a chainsaw at political rallies), get inflation under control, reduce burdensome regulation and replace the Argentinian peso with the U.S. dollar. While the latter proposal was abandoned in favour of a managed exchange rate regime, Milei is succeeding in implementing several aspects of his agenda, despite his party holding few seats in Congress.

Fiscal austerity: Milei’s government cut 50,000 public sector jobs, froze spending on infrastructure projects, and has reduced energy and transportation subsidies as well as transfers to provinces. Previously sizeable budget deficits have been replaced by surpluses, and the IMF says the government is on track to achieve a planned 1.6% primary surplus (before interest payments) this year. This is good and arguably the best of a bad set of options, though it does shift some of the fiscal problem to the provincial level, and flatlining infrastructure spending could bring negative consequences later.

Deregulation: Milei has eased capital controls, cut some export taxes, and reduced tariffs and import licensing requirements. He also offered tax breaks for large investments, encouraging Foreign Direct Investment (FDI) in the mining and energy sectors. But a push to privatize state-owned enterprises has received pushback in Congress – causing Milei to pivot toward public-private partnerships. Efforts to deregulate labour markets and reduce the power of unions have also faced challenges.

Lower inflation: Restricting money supply growth – putting an end to the monetization of budget deficits via money printing – has helped reduce monthly inflation to 2% from double digits previously. Abolition of rent controls has increased rental supply and reduced real rents. Inflation-adjusted wages are now rising.

Return to growth: Argentina’s economy shrank by 1.9% in 2023 and a further 1.3% in 2024, Milei’s first year in office. However, activity has picked up in 2025 with the economy now expanding at a 5% year-over-year pace, led by business investment and private consumption.

Poverty reduction: Milei’s tough medicine caused Argentina’s poverty rate to spike to 53% in H1/24 from 42% before he took office. But the poverty rate fell to 38% in H2/24 as economic reforms and efforts to reduce inflation started to bear fruit.

Exchange rate policy: A sharp devaluation of the official USD/ARS exchange rate in December 2023 closed some of the gap relative to the unofficial exchange rate. The Argentinian peso has since followed a managed peg allowing 2% depreciation per month. In April, the government further eased capital controls and adopted a managed float that effectively eliminated the unofficial exchange rate, helping to reduce economic distortions.

Milei has reined in Argentina’s budget deficits and ended debt monetization

As of 2030. Sources: International Monetary Fund (IMF), Macrobond, RBC GAM

Argentinian inflation has slowed dramatically amid Milei’s reforms

As of July 2025. Sources: Argentina National Institute of Statistics & Censuses (INDEC), Macrobond, RBC GAM

Argentina’s economy has returned to growth after contracting in 2023-24

As of June 2025. Sources: Argentina National Institute of Statistics & Censuses (INDEC), Macrobond, RBC GAM

These reforms helped Milei secure another US$20 billion loan from the IMF – Argentina is the fund’s largest debtor – and additional external support. That bolstered the government’s reserve position, although efforts to prop up the peso within the managed float system have depleted international reserves, and Argentina missed the IMF’s reserve target in mid-June. With the previous crawling peg not keeping up with inflation and thus leaving the real exchange rate over-valued, Argentina is walking a fine line between allowing further depreciation and limiting import price inflation.

Despite several successes, Milei’s austerity has been met with protests and his reforms have faced criticism and pushback. Argentina’s official unemployment rate has increased by 2.2 ppts since Milei took office. It now sits at a four-year high. Austerity has hit retirees particularly hard with pension benefits lagging inflation. Abolishing rent control has hurt some renters. There are also questions as to whether budget cuts, like pausing infrastructure projects, are sustainable. In addition to some of his deregulatory agenda being stymied, Congress is pushing back against austerity with attempts to increase pension and disability benefits.

With Argentina representing less than 1% of global GDP, its swing from contraction to expansion only adds a handful of basis points to global growth. But emerging-market bond portfolios usually care a great deal about Argentina’s performance, and any significant economic success in a long-troubled economy would be welcomed not just by the country itself, but viewed as a blueprint for the many other poor countries that have failed to climb the prosperity ladder.

That said, Argentina has attempted similar transformations in the past, only for its economic and fiscal challenges to eventually return when voters’ tolerance for the bitter medicine of such reforms wanes.

Relative to his reform-minded predecessors such as Alfonsin (1983-1989) and Menem (1989-1999), Milei is pursuing more radical policies and doing so at a greater speed. This argues the policies could succeed more quickly, turning the corner from pain to economic gains. Whether fiscal sustainability, lower inflation and poverty reduction can be maintained over several years will be the ultimate test of Milei’s policies.

But, unlike many predecessors, Milei has much less Congressional support, potentially limiting his ability to comprehensively implement the plan and thus succeed. Congressional elections in October present an opportunity to change that dynamic, though recent provincial elections point to an uphill battle.

-JN

Understanding stablecoins

Cryptocurrencies have gained a significant profile over the past 15 years. Bitcoin in particular has delivered remarkable returns for speculators despite still-limited real-world applications.

Now, a relatively new subset of cryptocurrencies called stablecoins are gaining prominence. Today, they now collectively hold approximately US$255 billion in assets. The recent passage of the U.S. GENIUS Act in July adds to their legitimacy and puts a regulatory framework around them.

How stablecoins are different

Stablecoins differ from conventional cryptocurrencies because they are not actually a different currency. Whereas the value of Bitcoin fluctuates freely relative to conventional currencies, stablecoins are meant to maintain a fixed relationship to their parent currency – in most cases, the U.S. dollar. As such, stablecoins remove the speculative element: you are unlikely to get rich (or poor) while holding them.

What’s left to distinguish stablecoins, then?

They preserve a key allure of cryptocurrencies: the potential for nearly frictionless digital transactions. In other words, they can be transacted relatively cheaply and quickly, even over international borders.

Because of their stability, stablecoins also mesh well with other blockchain applications. Taking advantage of the programmability of some blockchains, it is theoretically possible to set up a mortgage that automates the calculation of interest and penalties, receives payments, and even transfers a “tokenized” (digital version) of the deed from lender to borrower upon repayment of the loan. This is still possible without stablecoins, but having a loan priced in Bitcoins might be hair-raising given its infamous volatility.

In contrast, stablecoins offer an on-the-blockchain payment option that remains true to the real-world dollar. The capacity to program contracts and tokenize real-world assets becomes much more attractive with a stable cryptocurrency to go with them.

White House enthusiasm

The White House is enthusiastic about cryptocurrencies, as it sees the potential for regulators to help extend U.S. dominance in the space. The Trump administration appears particularly eager about dollar-backed stablecoins as these would complement and even enhance the importance of the U.S. dollar, whereas more traditional cryptocurrencies would just compete with it.

The U.S. is also reacting to similar efforts in other countries, which also hope to increase the importance of their own currencies. At a time when the U.S. dollar is arguably losing some of its sheen, U.S. dollar stablecoins could offset part of that erosion.

Inflation

Traditional cryptocurrencies are highly utopian, envisioning not just a new dominant means of exchange but a different inflation regime as well. For instance, Bitcoin targets just 0.8% inflation per year because that is the clip at which the supply of Bitcoins automatically increases. In contrast, stablecoins just go with the flow. Because they are merely piggybacking on top of existing currencies, they take whatever inflation rate the economy delivers.

In practice, stablecoins “print” more digital coins whenever demand for them rises, and destroy them whenever demand falls. But this doesn’t have a bearing on inflation because the most successful stablecoins are fully asset backed. For every dollar that goes into them, they send a dollar out to purchase some liquid, safe asset as collateral. This full backing is intended to avoid the runs that occasionally plagued earlier stablecoins that were not fully backed. There is less reason to doubt the value of your stablecoin if everyone could theoretically cash out at the same time without breaking the currency.

Economy

From a long-term economic standpoint, a stablecoin-dominated world would remove some of the frictions currently associated with financial transactions because transfers would be easier to conduct, cost less and be settled faster. This could provide a moderate boost to productivity. Of course, to get there, a significant fraction of economic actors must be willing to transact in stablecoins, which is not presently the case.

More broadly, access to capital might be democratized. Foreign economic actors would be able to gain access to the dollar-equivalents they desire, programmable loans might allow ordinary people and businesses to safely lend to one another, and microcredit might become more practical for low-income borrowers.  A more efficient and far-reaching allocation of capital is theoretically another economic positive.

There are several economic negatives that must be balanced against these potential advantages.

1. There would likely be an increase in illegal activities given the pseudo-anonymous nature of cryptocurrencies. This is to say, there might be more black-market transactions, money laundering, fraud and the like. It would be harder for governments to enforce financial rules and to collect taxes.

2. There might also be a significant distortion to the bond market and also potential damage to traditional financial institutions as they are disintermediated – both discussed in later sections of this note. In particular, one might worry that diminished financial institutions would not be able to provide as much credit to the economy, limiting economic growth.

Whereas earlier iterations of cryptocurrencies required startling amounts of electricity to process transactions, the newer versions have reduced this reliance by greater than 99%. As such, the economic and environmental negatives are now relatively small from this standpoint.

Bond market

Modern stablecoins back 100% of their coins with safe, liquid assets. In practice, Treasury bills represent about half of these holdings. Already, stablecoins in the U.S. hold US$149 billion in Treasuries, making them the 18^th largest external holder of Treasuries. Other holdings tend to be in repos and bank deposits.

This has several potential implications. The first is that the U.S. government may be able to run larger deficits without difficulty given the additional source of demand for the country’s debt. Short-term yields would be lower than otherwise, and the yield curve might be steeper than otherwise.

Of course, some of the money put into stablecoins might previously have been in a money-market fund (holding those same T-bills), or in a bank account (with a fraction of the bank assets held in bills as a reserve). Still, overall holdings of T-bills should be higher, versus lower for money market funds and bank accounts.

There is the potential for additional bond market volatility from stablecoins, as major inflows or outflows from stablecoins would also elicit large inflows and outflows from the bond market.

Financial institutions

If stablecoins gain significant traction, banks risk being disintermediated: losing some of their payments, transfers and deposit-taking businesses.

For the average shopper, credit card transactions already feel fairly frictionless. They are instantaneous, allow delayed payment of up to a month, and often provide cash-back rewards. But retailers see it differently: they must pay a significant fee and are compensated with a lag. Although debit cards are much less expensive to the vendor, they offer fewer perks for the buyer. Furthermore, shoppers using credit cards or debit cards must pay to maintain a bank account to properly access these services.

In contrast, it is theoretically possible to use stablecoins with only tiny transaction fees and with no cost for maintaining an account on a cryptocurrency exchange. Of course, cold hard cash is also relatively inexpensive to use, requires no account, and is already widely available and accepted.

For money transfers, especially large ones, traditional payment systems often charge substantial fees. These might be avoided with stablecoins. The potential to reduce the cost and time associated with cross-border transfers is particularly great. A further attraction is that these transactions can be settled at any time, not just during business hours.

Of course, it is an open question the extent to which these savings are being achieved by undercutting legacy infrastructure and profit margins (good for the user if not for the traditional financial institution), versus less desirable regulatory arbitrage in which cryptocurrency transactions bypass the usual vetting for capital controls, fraud, money laundering and other financial misdeeds (bad for society).

The potential exists for stablecoins to pull money away from banks’ deposit-taking businesses. If it were to become easy to be paid directly in stablecoins, and to buy and sell things in stablecoins, then it wouldn’t be so absurd to keep one’s short-term liquid assets in stablecoins as well. Some stablecoin issuers are now even seeking bank charters, which would blur the lines with traditional banking and constitute a new threat to traditional banks.

Banks do stand to receive some fraction of their old deposits in the form of the fraction of stablecoin assets that are then parked at banks as deposits. However these are broadly less attractive liabilities for a bank to own. They require higher interest payments than on traditional household deposits, and they are potentially flightier as well.

Can stablecoins compete with banks and fixed income products by paying interest? It’s complicated. In theory, yes, stablecoins can pay interest. After all, the underlying stablecoin assets are yield-bearing products such as Treasury bills.

In practice, though, the most popular stablecoins don’t pay interest (though some smaller ones do). In fact, as part of the recently passed GENIUS Act, the payment of interest on stablecoins has now been banned in the U.S.

But that isn’t the end of the story. It still appears to be possible for stablecoins to pay money to crypto exchanges for their services. It is also apparently possible for crypto exchanges to give bonuses or other financial benefits to parties that hold money on their exchanges. Thus, a form of interest payment might still be possible.

Furthermore, other countries’ regulators may not impose the same no-yield rule. Interest payments would certainly render stablecoins a more formidable threat to the deposit-taking businesses of banks.

Against all of these challenges, financial institutions are also in a reasonably good position to renovate their own financial operations using blockchain technology. This could unleash efficiencies and allow them to compete more effectively in payments, transfers and deposits. Several banks are already experimenting with blockchain-connected commercial products. Large banks may be more capable of making the leap than smaller ones.

Governments

While the U.S. government relishes the possibility of borrowing short-term money more cheaply than otherwise due to stablecoins’ holdings of Treasury bills, several other policy headaches arise if stablecoins proliferate:

• There may possibly be less tax compliance as economic actors bypass formal financial channels in favour of pseudo-anonymous stablecoins.

• There may possibly be more illegal activity as the underground economy, money laundering and fraud rise, again due to the pseudo-anonymous nature of stablecoins.

• The country’s financial institutions and financial system may require stabilization if significant parts of the banking business are abruptly disintermediated.

• For countries with capital controls, stablecoins threaten to undermine the government’s ability to control such flows (a potential positive for the private sector within those countries, however).

• If U.S.-dollar denominated stable coins ultimately dominate the system, the usage of local currencies could substantially decline in other countries, with varied implications. These include reduced efficacy of monetary policy in those countries, reduced ability to tax economic activity, and rendering economies more vulnerable to exchange rate swings (imagine half the economy is paid in dollars and half in pesos, and then the exchange rate moves sharply – creating myriad winners and losers).

• Governments may be less able to impose their own financial rules, as cross-national regulatory arbitrage becomes much simpler with stablecoins.

How large could they get?

No one really knows how large the stablecoin market could become. Official estimates anticipate profound growth, but in many cases simply constitute the straight-line projection of recent growth rates into the future.

Sell-side analysts project that the current $255 billion market could grow to between $500 billion and $2 trillion by 2028. The White House predicts a $3.7 trillion market by the end of the decade. For context, and constituting something of an extreme theoretical upside limit, the total value of highly liquid short-term assets in the U.S. is $14.1 trillion. We define these assets as M2 – the combination of physical currency, chequing and savings accounts, and retail money market mutual funds.

We flag the potential for stablecoins to grow somewhat less quickly than these breathless predictions, though there are certainly both upside and downside risks to our assessment. If a critical mass of usage is reached, demand could well rise more substantially than the consensus. Conversely, it may be that the potential user base proves limited and is ultimately only attractive to crypto-knowledgeable technophiles.

The fundamental question is how well stablecoins will integrate into the economy and daily life. The advantage of using stablecoins for ordinary economic transactions seems fairly small, and fungibility (the ability to swap one asset for another) is presently low. Its use in the transactions business is quite promising, but just getting going. The use of stablecoins as a substitute for bank deposits is also fairly new and of uncertain value.

Risks

Is the world more dangerous if stablecoins take a prominent position in the financial system? In some ways, yes:

• There could be financial stability problems if banks find themselves in a much weaker position, if large sums of money flow rapidly between countries, or if foreign currencies are undermined.

• There could also be financial stability problems given the potential for money to rapidly flow into and out of stablecoins (and thus into and out of the underlying assets held against those coins).

• Stablecoins would appear to permit a greater range of illegal activities. Holders of stablecoins may also be at greater risk of being hacked themselves.

• Stablecoins could suffer from a financial crisis of their own if investors were to lose confidence in the trustworthiness of their peg to the dollar.

• In the distant future, quantum computers could potentially undermine the cryptography safeguarding stablecoins.

Clearly, all of these risks need to be weighed against the potential for cheaper and better transactions, transfers, and perhaps even deposits. For the moment, it is full speed ahead for stablecoins, and so it is crucial that they are as well understood as possible.

-EL