Stablecoins Won't Inflate The Money Supply. Here's Why.

Forbes

a day ago

President Donald Trump signs the GENIUS Act, a bill that regulates stablecoins.
With the recent passage of the GENIUS Act, the United States has taken its first major legislative step toward regulating dollar-backed stablecoins. The bill, signed into law by President Trump on July 18, lays out a framework that requires stablecoins to be fully backed by low-risk, liquid assets such as short-term U.S. Treasurys or cash equivalents. Issuers must meet licensing standards, comply with regulatory oversight, and undergo regular audits. The intent of the law is to integrate stablecoins into the existing financial ecosystem without destabilizing it.
As stablecoins have moved into the regulatory mainstream, a debate has ignited among economists. Will the adoption of these digital tokens expand the money supply and unleash inflation? Will stablecoins diminish the Federal Reserve's control over monetary policy? Senator Elizabeth Warren even warns crypto can 'blow up our entire economy.'
On these counts, fears are overstated. A closer look reveals that stablecoins are unlikely to fuel inflation, nor do they significantly alter the role of central banks, though the Federal Reserve's role has been evolving in recent years for other reasons.
To understand why stablecoins will not expand the money supply in any meaningful sense, one must revisit a critical development in U.S. monetary policy that took place during the 2008 financial crisis. At that time, the Federal Reserve received authority to pay interest on reserves held by commercial banks. This change made bank reserves held at the Fed essentially interchangeable with short-term government debt. Both now yield comparable rates of interest and both are considered nearly risk-free.
This change has had sweeping consequences. It neutered much of the traditional mechanism of monetary policy, whereby the Fed manipulates the supply of base money to steer short-term interest rates. Now, the modern Fed still targets interest rates, but it also allows reserve accounts to pile up by restricting lending through the payment of interest to banks.
The Fed now swaps interest-bearing central bank liabilities (reserves) for other interest-bearing securities (such as T-bills), having little to no impact on broader monetary aggregates. Meanwhile, the Fed tends to be more of a follower of market interest rates than a director of them. In essence, the Fed has become a passive balance sheet manager rather than an active creator of credit and liquidity.
The Structure of Modern Money
While some may lament the decline in central bank control, it has corresponded with an unprecedented era of macroeconomic stability. Since the introduction of interest on reserves, the U.S. has not experienced a demand-induced recession. The 2020 recession was due to a pandemic, not insufficient demand due to monetary factors. This is a near-unheard-of achievement in recent economic history, and it explains why the interest-on-reserves policy should be viewed as one of the greatest policy successes in recent memory.
With this context in mind, concerns that stablecoins will destabilize the money supply look misplaced. Under the GENIUS Act, stablecoin issuers are required to back their liabilities 100 percent with safe, liquid assets. Since these assets consist of U.S. Treasurys and central bank reserves, which are already functionally equivalent in today's environment, the issuance of stablecoins merely transforms one form of existing money-like instrument for another. In other words, stablecoins repackage already-existing base money and close substitutes into tokenized forms of money that facilitate faster and cheaper payments. They do not constitute a net expansion of government financial liabilities and private credit.
Some might point out that unlike reserves or T-bills, U.S. stablecoin accounts won't pay interest (at least for now). This is an important difference, but not one that fundamentally alters the monetary picture. True, the assets and liabilities of stablecoin issuers are not perfectly interchangeable. The non-interest-bearing nature of most stablecoins makes them less attractive as a store of value than their underlying reserves. But for some transactional purposes, like cross-border payments, stablecoins may still be preferred at times for their technical attributes. From a macroeconomic standpoint, what matters is that their issuance neither injects new money into the economy nor changes the overall purchasing power in circulation.
Modern money creation is primarily driven by the credit decisions of commercial banks responding to market demand. This is a legacy of fractional reserve banking. However, stablecoin issuers under the new regulatory regime will not operate a fractional reserve model. Their 100 percent reserve backing ensures that they do not multiply credit in the traditional banking sense. As such, they do not contribute to the 'pyramid' of credit that some monetary theorists warn about.
The Real Source of Risk
The GENIUS Act actually tightens the relationship between money and its underlying assets, making the monetary system arguably more conservative. This does not mean there are no risks associated with stablecoins.
If confidence in the U.S. government's creditworthiness were to erode, there could be runs on stablecoins. For example, if Treasurys are no longer viewed as risk-free, stablecoin issuers might face liquidity crises. Investors who try to redeem Treasurys for U.S. dollars might see the value of Treasurys decline. This would make it harder for stablecoin issuers to meet redemptions, as users demand cash for their tokens. At some point, the Federal Reserve might have to step in to act as lender of last resort, providing liquidity to ease the credit crunch.
The real risk in this scenario relates to the creditworthiness of the U.S. government, not from stablecoins themselves. As long as U.S. debt is viewed as reliable, stablecoins should remain safe and continue to expand without fueling inflation. They may increase economic activity by facilitating new kinds of transactions, but they are unlikely to cause broad-based price increases or liquidity crises.
Indeed, the larger risk to monetary stability today is not private stablecoin issuers but Congress. As the Fed's policy toolkit has been constrained, fiscal authorities have become the de facto 'conductors' of aggregate demand. The inflationary surge and subsequent reversal during the Biden administration demonstrated the extent to which spending bills and stimulus programs can now drive price levels.
Thus, the stablecoin debate must be seen in proper perspective. It is not about whether the private financial system will usurp the Federal Reserve. That transition, to an extent, already happened in 2008. Instead, the focus of discussion should be on integrating this new technology into an evolving monetary system in a manner that is transparent and secure.
The GENIUS Act succeeds on this front. It creates a clear regulatory path for stablecoin issuers and embraces innovation without sacrificing financial stability. The law could certainly be improved upon. Perhaps stablecoin issuers should eventually be allowed to pay interest, or, more controversially, to hold fewer safe reserves and engage in more traditional lending. These issues are worthy of debate. But for now, the policy direction is sound.
Stablecoins are not a threat to the money supply. They are a reflection of how that supply has changed in recent years. So long as investors understand this, there is little reason to fear stablecoins' ascent.