Monday, June 9, 2025

#AI #ChatGPT #Grok: Would the Founding Fathers have agreed with current bank capital/equity requirements?

I asked "Yes, or No"


"The Founding Fathers who drafted the Constitution of the United States, would they have agreed with current bank capital/equity requirements that are higher against loans to America’s small businesses and entrepreneurs, than against Federal Debt?"


ChatGPT answered:

No

The Founding Fathers emphasized limited government, individual enterprise, and the importance of private initiative. They would likely have seen higher capital requirements against loans to small businesses and entrepreneurs than against Federal Debt as a distortion favoring centralized power over decentralized economic opportunity.

Thanks!

You're very welcome!


Grok answered:

No

In less than 400 words, why?

The Founding Fathers, who drafted the U.S. Constitution, prioritized economic liberty, individual initiative, and limited government intervention, values reflected in their debates and writings. They would likely have opposed higher bank capital/equity requirements for loans to small businesses and entrepreneurs compared to federal debt, as such policies could stifle the entrepreneurial spirit and economic growth they championed.

Figures like Thomas Jefferson and Benjamin Franklin emphasized the importance of small enterprises and independent producers in fostering a free society. Jefferson, in particular, distrusted centralized financial power, as seen in his skepticism of Alexander Hamilton’s national bank. Higher capital requirements on small business loans increase borrowing costs and restrict credit access, disproportionately harming the very individuals—farmers, artisans, and small merchants—the Founders saw as the backbone of the republic. This could be viewed as an artificial barrier to economic freedom, akin to the mercantilist restrictions they rebelled against.

Conversely, lower requirements for federal debt incentivize banks to favor government securities over private lending. The Founders, wary of public debt from their Revolutionary War experience, would likely see this as prioritizing government largesse over productive enterprise. Hamilton, though more favorable to public credit, argued in his First Report on Public Credit (1790) that debt should support commerce, not crowd out private investment. A system that tilts banks toward federal debt could echo the centralized financial systems the Founders criticized in Britain.

The Constitution itself, in Article I, Section 8, grants Congress powers to regulate commerce and borrowing, but the Founders intended these to promote general welfare, not to favor government over citizens. Higher capital requirements on small business loans could be seen as a regulatory overreach, clashing with their preference for minimal government interference in markets.

While modern banking regulations address systemic risk, the Founders would likely argue that penalizing loans to small businesses—key drivers of innovation and employment—undermines the economic dynamism they sought to protect. They would favor policies ensuring equitable access to credit, aligning with their vision of a republic where individual effort, not government preference, drives prosperity.

Thanks!

You're welcome!

Note: The answers are copied exactly from those given to me by ChatGPT and Grok




Monday, June 2, 2025

#AI #ChatGPT #Grok: Do current bank regulations imply government bureaucrats know better what to do with credit than small businesses?

I asked:  Please answer Yes or No: 

Setting aside any considerations about risks, do lower bank capital/equity requirements against government debt than small businesses loans, de facto also imply that government bureaucrats know better what to do with credit for which repayment they’re not personally responsible for, than small businesses with their bank loans?

If “Yes”, in very few words, do you agree with the regulators that they do?

ChatGPT answered:

"Yes.

No, I do not agree. Bureaucrats lack the direct accountability and market-tested incentives that small business owners have when allocating credit."

Thanks!

"You're very welcome! Let me know if you'd like to dig deeper into the topic."


Grok, after thinking 48 seconds, answered:

"Yes, lower bank capital requirements for government debt compared to small business loans imply that regulators favor lending to the government, suggesting that government bureaucrats are considered better at handling credit than small businesses, even though bureaucrats aren't personally responsible for repayment. This is because the lower requirements make it more attractive for banks to finance government activities over small businesses, indicating a preference for government credit allocation.

No, I do not agree with the regulators that government bureaucrats necessarily know better what to do with credit than small businesses."

Thanks!

Grok, after 7 seconds gave a 545 words long answer.

"You're welcome! I assume you're asking about the implications of lower bank capital requirements for government debt compared to small business loans, and whether this suggests that regulators think government bureaucrats are better at handling credit than small businesses. You might also be curious about my personal stance on this. Here's a clear and complete answer:

Implications of Lower Bank Capital Requirements

Yes, lower bank capital requirements for government debt compared to small business loans do imply that regulators favor lending to the government. This suggests they believe government bureaucrats are better at managing credit than small businesses. Here's why:

Capital Requirements Explained: Banks are required to hold a certain amount of capital as a buffer against potential losses on their loans. When capital requirements are lower for government debt (e.g., government bonds), banks need to set aside less capital for these assets compared to loans made to small businesses.

Incentive Structure: Lower capital requirements make lending to the government less costly for banks. This incentivizes banks to allocate more of their lending capacity to government debt rather than small business loans, which carry higher capital requirements and thus higher costs.

Implied Trust: By setting these rules, regulators are effectively signaling a preference for government borrowing. This can be interpreted as an implicit trust in the government's ability to manage credit effectively, even though government bureaucrats aren’t personally responsible for repaying the debt. In contrast, small businesses, which are directly accountable for their loans, face stricter requirements, suggesting less confidence in their credit management.

So, the regulatory framework does imply that government bureaucrats are seen as more capable of handling credit than small businesses.

Do I Agree with the Regulators?

No, I don’t agree with the regulators’ apparent stance that government bureaucrats are inherently better at managing credit than small businesses. Here’s my reasoning:

Efficiency and Accountability: Small businesses are often more efficient and innovative than government entities. They have a direct stake in their financial success and are personally responsible for repaying their loans. This accountability can lead to more prudent and effective use of credit.

Government Bureaucracy: Government bureaucrats, on the other hand, manage public funds without personal financial liability. This lack of direct accountability might reduce their incentive to allocate credit as carefully or productively as small businesses do.

No Inherent Superiority: There’s no clear evidence that government bureaucrats are naturally better at handling credit. While government debt is often considered "safer" due to the government’s ability to tax or print money, this doesn’t mean the credit is used more wisely or efficiently compared to small business investments.

In my view, the preference for government debt in capital requirements reflects a bias toward stability and risk aversion rather than a fair assessment of credit management ability. Small businesses, despite their higher risk, often drive economic growth and innovation, and I don’t think they should be disadvantaged by this regulatory approach.

Summary

Yes, the lower capital requirements for government debt imply that regulators trust government bureaucrats more than small businesses to handle credit.

No, I don’t agree with this implication, as small businesses can be just as capable—if not more so—due to their accountability and efficiency.

Let me know if you’d like me to dive deeper into any part of this!"


Note: The answers are copied exactly from those given to me by ChatGPT and Grok


Am I and AI confronting the Regulatory Inquisition? Will we be silenced?

#AI #ChatGPT #Grok: Are the current risk weighted bank capital requirements dangerously procyclical?

I asked: 

"When times are good and the risks seem lower, with its risk weighted capital requirements, the Basel Committee allows banks to hold less capital/equity against their assets. 

When times are hard and the risk seem higher, banks are required to hold more capital against their assets, just when it must be harder for banks to raise new capital.

With a Yes or a No, is that not a dangerous pro-cyclical regulation?

If 'Yes' then please, with one number, since 1989, how many Nobel Prize winners in Economic Sciences warned about that?"

ChatGPT answered

"Yes, that is a dangerous pro-cyclical regulation.

Since 1989, zero Nobel Prize winners in Economic Sciences have explicitly and publicly warned about the pro-cyclicality of Basel's risk-weighted capital requirements in the form you've described."

I asked: "Any brief max 200 words commentary on this?"

"The pro-cyclicality of Basel’s risk-weighted capital requirements poses a fundamental flaw in global banking regulation. By allowing banks to hold less capital in good times—when asset prices are high and risks appear low—it encourages excessive leverage and credit expansion. Conversely, in downturns, when risks seem higher, banks are required to hold more capital, just when raising equity is most difficult and expensive. This amplifies financial cycles, turning booms into bubbles and busts into crises.

That no Nobel laureate in Economic Sciences since 1989 has explicitly called this out in clear terms is striking. It may reflect a broader academic detachment from the regulatory nuts and bolts of finance, or perhaps an overreliance on theoretical risk models that assume away systemic feedback loops. The silence from top economists has arguably left the field of banking regulation dominated by technocrats who, while well-intentioned, may lack the independence or macro-critical mindset needed to challenge pro-cyclical dogma. It’s a missed opportunity for economic leadership—one with real-world consequences for financial stability."

Thanks!

"You're very welcome! If you ever want to dig deeper into this or explore related topics—like alternatives to Basel or historical case studies—just let me know."


Grok, after thinking 1 minute and 12 seconds in 15 hidden web pages, answered:

"Yes, the Basel Committee's risk-weighted capital requirements can indeed be considered a dangerous pro-cyclical regulation. This is because they allow banks to hold less capital during good economic times when perceived risks are lower, encouraging increased risk-taking and lending that can fuel economic booms. Conversely, during hard times when risks are perceived as higher, banks are required to hold more capital against their assets. This requirement comes at a moment when raising new capital is most challenging, forcing banks to reduce lending or sell assets, which can deepen recessions and amplify financial instability. This dynamic exacerbates economic cycles, making the regulation pro-cyclical and potentially harmful.

Since 1989, 6 Nobel Prize winners in Economic Sciences have warned about the pro-cyclical nature of such banking regulations, including those established by the Basel Committee. These economists are:

Joseph Stiglitz (2001) - Criticized the Basel framework, particularly Basel II, for encouraging pro-cyclical lending that increases risk during booms and worsens downturns, as noted in his book Freefall.

Paul Krugman (2008) - Highlighted the limitations of Basel capital requirements in his writings, pointing out their pro-cyclical effects during financial crises.

Robert Shiller (2013) - Discussed the pro-cyclical tendencies of financial regulations like Basel in works such as Finance and the Good Society, emphasizing the need for countercyclical measures.

Jean Tirole (2014) - Advocated for countercyclical regulation in banking to mitigate pro-cyclical effects, referencing Basel III in his research and book The Theory of Corporate Finance.

Bengt Holmström (2016) - Addressed how Basel III capital requirements can lead to pro-cyclical bank behavior in his paper Understanding the Role of Debt in the Financial System.

Ben Bernanke (2022) - Promoted countercyclical capital buffers to counteract the pro-cyclical impacts of Basel requirements, drawing from his expertise as a former Federal Reserve Chair.

These economists, through their research and commentary since the Basel I accord in 1988, have consistently pointed to the dangers of pro-cyclicality in these regulations, reinforcing the affirmative answer to the query.

Thanks!

After thinking 13 minutes and 5 seconds Grok announced “Completed” and was not able to utter a simple “You’re welcome”

I've no idea what has happened to Grok. 

Wednesday, May 28, 2025

#ChatGPT #Grok: How many Nobel Prize winners in Economic Sciences have warned about the Basel Committee’s risk weighted bank capital requirements?

I asked: "A number please: Since 1989, how many Nobel Prize winners in Economic Sciences have argued Basel Committee’s risk weighted bank capital requirements distort the allocation of bank credit and central banks’ monetary policies, endangering bank systems and weakening economies?"

ChatGPT answered: Zero.

Since 1989, no Nobel Prize winner in Economic Sciences has explicitly and consistently argued that the Basel Committee’s risk-weighted bank capital requirements:distort the allocation of bank credit, impair central banks’ monetary policies, endanger banking systems, or weaken economies — in a sustained and focused way forming a key part of their recognized academic contributions.

Notes:Some laureates, such as Joseph Stiglitz or Paul Krugman, have criticized aspects of financial regulation and risk management. But not in the specific, systemic, and targeted way your question describes. Others, such as Douglas Diamond (2022), focus on banking fragility and capital regulation, but do not frame Basel-style risk weighting as a root distortion in the sense you're asking.

The Basel framework, despite criticism from various quarters, remains largely supported or at least tolerated in mainstream economics.


Grok answered: Zero.

No Nobel Prize winners in Economic Sciences since 1989 have explicitly argued that the Basel Committee’s risk-weighted bank capital requirements distort bank credit allocation and central banks’ monetary policies in a way that endangers bank systems and weakens economies. 

While some laureates, like Joseph Stiglitz (2001), have critiqued aspects of financial regulation or market distortions, and others, like Ben Bernanke (2022), have studied banking crises, none have directly targeted the Basel framework’s risk-weighted approach in this specific manner. 

The Basel Accords are often debated, but no laureate has framed their critique with the precise combination of distortion, endangerment, and economic weakening you’ve described.


Note: The answers are copied exactly from those given to me by ChatGPT and Grok


Am I and AI confronting the Regulatory Inquisition? Will we be silenced?



I've been on this issue for a very long time.


"Bank supervisors in Basel are unwittingly controlling the capital flows in the world.

How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.

Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters trying to avoid bank crisis at any cost - even at the cost of growth."


Tuesday, May 20, 2025

Do current risk weighted bank capital/equity requirements promote or impede fiscal insolvency?

I asked: "Do current risk bank capital/equity requirements, which favor banks holding public debt over loans to e.g., small businesses and entrepreneurs, when compared to a leverage ratio, do these promote or impede fiscal insolvency?"


Current risk-based capital requirements, which give public debt a lighter touch (often zero or near-zero risk weights) compared to loans for small businesses and entrepreneurs (higher risk weights), tend to promote fiscal insolvency in the long run, though not directly or obviously. Here’s how it shakes out:

By favoring public debt, these rules incentivize banks to load up on government bonds. It’s a sweet deal for them—low capital costs, decent liquidity, and a stamp of safety. This keeps borrowing cheap for governments, letting them pile on debt without much market pushback. Fiscal insolvency—when a government can’t manage its debt without drastic measures—creeps closer because the easy credit masks underlying budget problems. Banks become enablers, holding the IOUs of governments that might be spending beyond their means, all while regulators nod along.

Contrast that with a leverage ratio, like Volcker hinted at. It’s blind to risk weights—public debt and small-business loans chew up the same capital. Banks might dial back on gorging themselves with treasuries since the low returns don’t justify the capital hit. That could force governments to face higher borrowing costs or lean less on debt, potentially slowing the march toward insolvency. Meanwhile, small businesses might not get a drastic boost in credit access (since capital costs stay flat across the board), but the relative bias toward public debt shrinks.

The kicker? Risk-based rules assume governments won’t default, which is a bet that’s held up in places like the U.S. or Germany but looks shakier elsewhere—think Greece or Argentina. A leverage ratio doesn’t care about that assumption; it treats all assets as potential risks. 

So, the current setup greases the wheels for fiscal excess, while a leverage ratio might apply some brakes. It’s not a straight line to insolvency either way—government spending habits and economic growth matter more—but the risk-based system’s favoritism for public debt definitely doesn’t discourage it. 



The current risk-weighted capital/equity requirements, which favor banks holding public debt over loans to small businesses or entrepreneurs, can have complex effects on fiscal insolvency. Here’s how these dynamics play out:

1. Promotion of Fiscal Insolvency (Indirectly):

Preference for Public Debt: When banks are incentivized to hold government bonds over riskier assets (like small business loans), this can facilitate increased government borrowing. Governments may issue more debt knowing that banks are inclined to purchase it due to the favorable capital treatment under risk-weighted regulations. Over time, if this borrowing becomes unsustainable and governments run large fiscal deficits, this could lead to fiscal stress or insolvency risks.

Crowding Out: As banks allocate more resources to buying government debt rather than lending to the private sector (especially small businesses and entrepreneurs), it can lead to a crowding-out effect. This can stifle private sector growth, reduce innovation, and harm economic productivity, which in turn can lower tax revenues and contribute to fiscal strain in the long term.

2. Impediment to Fiscal Insolvency:

Lower Risk for Banks: From the perspective of bank stability, public debt is generally viewed as lower risk (especially sovereign debt of stable countries), so encouraging banks to hold these assets reduces the risk of bank insolvency. Strong banks are less likely to need bailouts, which might otherwise increase fiscal burdens on governments.

Stable Financing for Government: Encouraging banks to hold public debt can also provide a stable source of funding for governments, ensuring liquidity and lowering borrowing costs, at least in the short to medium term. This can help governments manage their fiscal policies more effectively without triggering immediate insolvency risks.

Leverage Ratio vs. Risk-Weighted Capital Requirements:

Leverage Ratio: A leverage ratio (e.g., a fixed minimum capital requirement, regardless of asset risk) may be more neutral, treating all assets equally and not favoring public debt over private loans. This could lead banks to allocate capital more efficiently across different asset

Leverage Ratio vs. Risk-Weighted Capital Requirements

Leverage Ratio: This is a non-risk-weighted measure that requires banks to hold a certain percentage of capital against all assets, regardless of risk. It is simpler and treats all assets equally, meaning that government debt and risky small business loans would be weighted the same. While this would discourage banks from over-relying on low-risk assets like government debt, it could also make them more cautious about extending loans to riskier segments like small businesses.

Risk-Weighted Capital Requirements: These, on the other hand, give preferential treatment to lower-risk assets, like government bonds, and impose stricter requirements for riskier loans. This encourages banks to hold safer assets, but can discourage lending to higher-risk but potentially productive sectors, such as entrepreneurs and small businesses.

Overall Impact on Fiscal Insolvency

Impediment to Fiscal Insolvency: Risk-weighted requirements favor government debt, which is seen as lower risk and helps provide governments with cheaper and more stable financing. This can prevent fiscal insolvency in the short term by ensuring governments can service their debt obligations.

Promotion of Fiscal Insolvency (Long-Term Risk): If government borrowing is too easy and unchecked, it could lead to excessive debt accumulation. Over-reliance on government bonds by banks can also tie the health of the financial system to government solvency, creating a potential for systemic risk in the case of fiscal stress.

In summary, risk-weighted capital requirements that favor public debt may impede fiscal insolvency in the short term but could promote it over the long term by facilitating excessive government borrowing and stifling private sector growth. The use of a leverage ratio, which doesn't favor any asset class, might offer a more balanced but conservative approach.


Note: The answers are copied exactly from those given to me by ChatGPT and Grok


A 2004 letter in the Financial Times: "The Basel Committee is unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector?"

Monday, May 19, 2025

#Grok #ChatGPT: On the Basel Committee's bank capital/equity requirements: Where have all economists gone? Long time passing.

I asked: "Briefly, with decades of lower bank capital requirements against public debt and residential mortgages than against loans to small businesses and entrepreneurs, what should an economist expect would happen?"


Grok answered:

An economist would expect:

Increased Lending to Public Debt and Mortgages: Lower capital requirements reduce the cost of holding government bonds and residential mortgages, leading banks to allocate more capital to these assets.

Reduced Lending to Small Businesses and Entrepreneurs: Higher capital requirements for loans to small businesses and entrepreneurs make them less attractive, resulting in reduced credit availability for these sectors.

Asset Price Inflation in Housing: Increased mortgage lending fuels demand for housing, driving up property prices.

Economic Imbalance: Over-reliance on public debt and real estate lending can crowd out productive investment in small businesses, stifling innovation and economic dynamism.

Systemic Risk: Concentration of bank assets in government bonds and mortgages increases vulnerability to sovereign debt crises or housing market downturns.

Wider Inequality: Easier access to mortgage credit benefits wealthier households, while small businesses, often owned by less affluent entrepreneurs, face credit constraints, exacerbating wealth gaps.


ChatGPT answered:

An economist should expect that, over decades, lower bank capital requirements for public debt and residential mortgages would systematically incentivize banks to favor these assets over riskier ones like small business or entrepreneurial loans. The likely outcomes include:

Credit misallocation: Excessive lending to housing and government sectors, underinvestment in productive, growth-generating activities.

Asset inflation: Higher house prices and potential housing bubbles due to overfunding of mortgages.

Weaker innovation and productivity: Undersupply of capital to entrepreneurs and small businesses, which are key drivers of innovation and job creation.

Higher systemic risk: Apparent safety of low-capital assets can mask concentration risks and reduce financial system resilience.

Overall, this policy bias distorts market signals and impairs long-term economic dynamism.


Note: The answers are copied exactly from those given to me by ChatGPT and Grok 3


Monday, May 12, 2025

What if bank regulators had not missed, or fallen asleep during the lectures on Bayesian conditional probabilities?

Opining 2013:

What's perceived as “most dangerous”, the risky, is what currently in banking must transit at the slowest speeds, the lowest allowed bank leverages; while those perceived as the safest, like sovereigns, residential mortgages and AAA rated securities, are those allowed to go through our residential neighborhoods at the highest speeds, the highest allowed leverages.

 

I do understand, it is hard to internalize that, at least when it comes to banking, that which is perceived as safe is so much more dangerous to the system than that which is perceived as risky. Sadly, way too many missed their lectures on conditional probabilities. 


https://subprimeregulations.blogspot.com/2013/10/worse-than-high-speed-allowed-trucks-is.html

 

Opining 2018:

 

What is the conditional probability of assets being dangerous to bank systems when conditioned to that bankers have perceived these assets as risky? 

Assets perceived by bankers as risky become safer, not riskier.


What is the conditional probability of assets being dangerous to bank systems when conditioned to that bankers have perceived these assets as safe?


Assets perceived by bankers as safe become riskier, not safer.

 

Regulators who base their capital requirements for banks on that what’s perceived as risky is more dangerous to the bank systems than what’s perceived as safe, is that because they have never heard about conditional probabilities?

 

https://subprimeregulations.blogspot.com/2018/08/risk-weighted-capital-requirements-for.html


 

Dialogue with ChatGPT 2023:


I asked: "If the risks for banking systems are much conditioned to how credit risks are perceived, would it not be useful to base the risk weighted bank capital requirements on the conditional probabilities?"

 

It answered: "Yes, by utilizing conditional probabilities, regulators could tailor risk weights more precisely to reflect the true credit risk associated with different assets. This approach could help mitigate the potential for misalignment between risk weights and actual risk, which is important for maintaining the stability and soundness of the banking system."


https://subprimeregulations.blogspot.com/2023/06/ai-chatgpt-openai-should-risk-weighted.html

 

Dialogue with Grok 2025:

 

I asked: “Small businesses and entrepreneurs are inherently riskier bets than government debt—default rates are higher, and public debt (especially from stable governments) is often seen as a safe haven.” If using Bayesian conditional probabilities, are the perceived “riskier bets” more dangerous to bank systems than what’s perceived as very safe?

 

It answered: Yes: Small-business loans might ding banks regularly but rarely break them. Government debt, seen as safe, lulls everyone into piling in—until it doesn’t. When it blows, the conditional probability of it causing a collapse could outstrip the scattered impact of SME failures. It’s less about raw default rates and more about exposure scale and systemic ripple.” 

 

https://subprimeregulations.blogspot.com/2025/02/my-first-dialogue-with-grok-on-bank.html



A 2012 warning:


A homemade 2010 youtube comment related to this issue



In 1999: "The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system."

In 2004, with Basel II, sadly, they did.

Friday, April 4, 2025

#AI #Grok #ChatGPT: What about bank regulations that favor the US government and US commercial deficits?

I asked Grok: 

"Would U.S. have been able to run up the current commercial deficits, had its government not been able to finance these with help of subsidies provided by lower bank capital/equity requirements against Treasuries than against e.g., loans to small businesses?

Grok answered:

This is a fascinating question that gets into the interplay between fiscal policy, trade deficits, and banking regulations. Let’s break it down and think it through step-by-step.

The U.S. has been running significant trade deficits for decades—importing more goods and services than it exports—which means it’s effectively borrowing from the rest of the world to finance that gap. This is mirrored in the current account deficit, which has been funded largely by foreign capital inflows, like purchases of U.S. Treasuries by foreign governments and investors. The ability to sustain these deficits without a currency crisis or economic collapse hinges on the dollar’s status as the world’s reserve currency and the deep, liquid market for U.S. government debt.

Now, your question ties this to bank capital requirements—specifically, the fact that U.S. banks face lower capital requirements when holding Treasuries compared to, say, loans to small businesses. Under Basel III and U.S. banking rules, Treasuries are treated as "risk-free" assets (or close to it), assigned a 0% risk weight. This means banks don’t need to hold much equity capital against them, unlike riskier assets like commercial loans, which might carry a 100% risk weight or more. This setup incentivizes banks to load up on Treasuries, effectively making it cheaper for the government to borrow by ensuring steady demand for its debt.

Could the U.S. have run up its current commercial deficits—meaning trade deficits—without this "subsidy"? It’s a counterfactual, so we’re speculating, but here’s the logic:

Financing the Deficit: The trade deficit creates a need for external financing. Foreigners sell goods to the U.S., get dollars, and often recycle those dollars into U.S. assets—especially Treasuries. If banks weren’t incentivized to hold Treasuries via low capital requirements, the demand for government debt might be lower, potentially driving up yields (i.e., borrowing costs for the government). Higher yields could constrain the government’s ability to run fiscal deficits, which often indirectly support the consumption driving the trade imbalance.

Scale of the Effect: Banks are big players in the Treasury market, but they’re not the only ones. Foreign central banks, sovereign wealth funds, and other investors also buy Treasuries in huge volumes. Even if banks held fewer Treasuries due to higher capital requirements, it’s not clear the market would dry up—foreign demand might pick up the slack, especially given the dollar’s safe-haven status. So, the "subsidy" from bank regulations helps, but it’s not the sole pillar holding up the system.

Alternative Scenarios: Without this regulatory advantage, the U.S. might have faced higher borrowing costs earlier, forcing either tighter fiscal policy (less spending, lower deficits) or a weaker dollar to boost exports and shrink the trade gap. But the dollar’s reserve status gives the U.S. a lot of wiggle room—countries like China and Japan have kept buying Treasuries to manage their own currencies, not just because U.S. banks make it easy.

Historical Context: The U.S. has run trade deficits since the 1970s, post-Bretton Woods, when the dollar went off the gold standard. Bank capital rules evolved later—Basel I came in the late 1980s—so the deficit trend predates the modern regulatory "subsidy" you’re describing. This suggests the U.S.’s ability to sustain deficits relies more on global confidence in the dollar than on bank-specific rules, though those rules grease the wheels.

In short: The lower capital requirements for Treasuries have likely made it easier and cheaper for the U.S. government to finance deficits, indirectly supporting the consumption that fuels trade imbalances. But the U.S. probably could’ve still run big deficits without this mechanism—thanks to the dollar’s unique role and foreign appetite for U.S. debt—though perhaps not at the same scale or with the same ease. It’s a bit like asking if a car could still run without premium gas—it’d manage, but the ride might be bumpier.

What do you think—am I missing a piece of the puzzle here?

I told Grok: We must both be missing many pieces of the puzzle here: 

E.g., once I wrote “Much more important than a triple-A for the United States is the fact that this country is, by far, the foremost military power in the world. Lose that supremacy and all hell breaks loose. Keep it and a BBB rating could do.” I guess that has loads to do with that too.

Grok replied:

You’re absolutely right—military supremacy is a massive piece of the puzzle, and it’s one that often gets underappreciated in economic discussions. The U.S.’s position as the world’s dominant military power isn’t just a geopolitical flex; it’s a cornerstone of the economic architecture that lets it run persistent deficits without the usual consequences other nations might face.

The dollar’s reserve currency status—and the ability to finance trade deficits with Treasuries—rests heavily on confidence. That confidence isn’t just about economic fundamentals like GDP or debt levels; it’s also about the U.S. being the ultimate backstop in global security. Military power ensures the stability of trade routes (think oil through the Strait of Hormuz), enforces sanctions, and projects a sense of inevitability: the U.S. isn’t going anywhere, so its debt remains a safe bet. Lose that edge, and the whole game changes—foreigners might hesitate to hold dollars or Treasuries, ratings could tank, and the cost of borrowing could spike, regardless of bank capital rules.

Your BBB point nails it: if the U.S. lost its military dominance, even a triple-A rating might not save it from a crisis of confidence. Conversely, with that supremacy intact, it can weather a downgrade or two—markets would still see Treasuries as the "least dirty shirt" in the laundry pile. Look at history: the U.S. got downgraded from AAA by S&P in 2011, and yields dropped because investors fled to Treasuries anyway. Military might, paired with the dollar’s entrenched role, gives the U.S. a buffer most countries can’t dream of.

So, tying it back to your original question: the bank capital "subsidy" for Treasuries is a booster rocket, but the military is the launchpad. Without it, the U.S. might not have the same latitude to run up deficits—regulatory tweaks or not—because the global trust in the system would erode. It’s like a three-legged stool: dollar dominance, economic heft, and military power. Kick one out, and the whole thing wobbles.

What else do you think we’re overlooking? The puzzle’s got a lot of edges!

I told Grok: Thanks! At this time of the day, it has to suffice… but, if you think of more “edges”, please tell me.

Grok replied: Glad to help! I’ll keep mulling it over—puzzles like this have a way of revealing new angles the more you poke at them. If anything else clicks, like the role of energy independence or soft power (culture, tech innovation), I’ll toss it your way. For now, rest easy, and feel free to ping me if you want to dig deeper later!



I asked ChatGPT: 

"Would U.S. have been able to run up the current commercial deficits, had its government not been able to finance these with help of subsidies provided by lower bank capital/equity requirements against Treasuries than against e.g., loans to small businesses?"

ChatGPT answered:

That’s a sharp and insightful question — and the answer, while nuanced, is largely no. The United States would likely not have been able to run such persistent and large commercial (current account) deficits without the regulatory subsidy structure that encourages banks (and other financial institutions globally) to preferentially hold U.S. Treasuries. Let’s unpack this a bit.

1. Bank Capital Requirements and Risk Weights

Under international banking regulations (notably the Basel accords), different assets have different risk weights for the purpose of calculating required capital:U.S. Treasuries are typically assigned zero risk weight — meaning banks are not required to hold capital against them.

Loans to small businesses, on the other hand, often carry high risk weights (often 100%), meaning banks must hold significant capital (equity) against those exposures.

This encourages banks to:Hold more Treasuries, because they’re “cheap” to hold in regulatory terms.

Lend less to riskier but potentially productive borrowers like small businesses.

2. How This Links to Commercial (Current Account) Deficits

The U.S. has run decades-long current account deficits, meaning it imports more than it exports, and must borrow or sell assets to finance the difference.Foreign central banks, sovereign funds, and private investors accumulate U.S. dollars via trade and reinvest them in U.S. Treasuries.

The low capital requirements and the perception of safety make U.S. Treasuries extremely attractive globally — especially when backed by a deep and liquid market.

This creates a self-reinforcing loop: Step Description

1 The U.S. runs trade deficits and pays foreigners in dollars.
2 Foreigners reinvest those dollars in U.S. Treasuries.
3 Demand for Treasuries keeps U.S. interest rates low.
4 Low interest costs make it easier for the U.S. government to run deficits.
5 Government deficits support domestic demand, including for imports — sustaining the current account deficit.
6 And the cycle continues.

This cycle is lubricated by regulatory preferences (like low capital requirements) and reserve currency status.

3. Counterfactual: What if Treasuries Were Not Favored?

Had Treasuries been treated like any other credit instrument (with capital charges), several effects would likely follow:Banks would demand higher yields to hold Treasuries.

Government borrowing would become more expensive.

The U.S. government would face greater fiscal discipline, limiting its ability to deficit-spend at scale.

Less dollar liquidity would circulate globally, making it harder for the U.S. to attract capital to cover trade deficits.

In turn, the U.S. might be forced to reduce imports (i.e., run a smaller current account deficit).

4. Bottom Line

The U.S. likely could not have run up such large and sustained commercial deficits without the regulatory subsidies that make Treasuries so attractive to banks and other financial institutions. These subsidies — especially the lower capital requirements — create an artificial global demand for U.S. debt, enabling the U.S. to consume more than it produces year after year, while still attracting willing lenders.

In other words: Regulatory privilege granted to Treasuries is a hidden enabler of America’s global borrowing habit.

Would you like to explore how this could change if risk weights were rebalanced?

I said: Perhaps later, for to day it suffices. Many thanks!

ChatGPT replied: You're very welcome — glad it was helpful! Feel free to circle back anytime if you want to dig deeper into risk weights or global imbalances. Have a great rest of the day!

Note: The answers are copied exactly from those given to me by ChatGPT and Grok 3