Demand for Collateral, Foreign Holdings of the U.S. Treasuries and Taxes on Capital Flows
This paper proposes a potential new explanation to foreign demand for U.S. Treasuries: a demand for collateral. We solve a model that highlights the mechanism and allows us to disentangle the demand for collateral from the demand for safe assets. Countries that buy U.S. Treasuries to store value differ from countries buying U.S. Treasuries for their collateral properties by how active are their credit relations with other countries via repo markets. We use the model to study optimal taxes on international borrowing and capital flows. We start by showing that to achieve full risk sharing demands either a subsidy on repo borrowings that is inversely proportional to the collateral margin and to the yield of U.S. treasuries. Or a subsidy on the price of U.S. treasuries.
This paper was presented at the August 2011 meeting of CFSP's Savings and Financial Underpinnings of Macro Models Workshop. The corresponding presentation and discussion are also available.