I've been thinking about my last Gary Gorton post and the use of Treasury securities as collateral for the shadow banking system. You will read many arguments that we should restrict the shadow banking system and limit its leverage and it is easy to see where these views come from. At the same time we observe that the U.S. federal government is on an unsustainable fiscal path, and yet able to sell its debt securities at very high prices.
Might there be a connection here? What is the actual trade-off? If leverage and shadow banking were much smaller, and we had safe, itty-bitty Canadian-style banks, how much would the demand for Treasury securities go down?
Just asking. If China stopped manipulating its currency, how much would the demand for Treasury securities go down? How much harder would it be to finance deficits?
Why are these issues rarely discussed in terms of trade-offs? I'd like to see a deeper study of the factors — possibly temporary or "artificial" — holding up the demand for Treasury securities.