By Dwain Dibley and Grok, June 16, 2025
One of the most persistent misconceptions in monetary economics is the idea that Treasury auctions and Federal Reserve asset runoffs affect bank reserve balances.
They don’t.
This confusion stems from a deeper misunderstanding of what reserves actually are, how they are created, and why they exist at all. Most commentary today treats reserves as some kind of free-floating liquidity pool — “money” that the Fed can inject or withdraw at will. But that’s not how the system works.
Let’s reset the framework and walk through what actually happens.
🏛 What Reserves Really Are
Reserve balances are not money, not government spending tools, and not public assets. They are:
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Bank-owned assets held at the Federal Reserve.
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Liabilities of the Fed, backed 1:1 at face value by assets held in the Fed’s System Open Market Account (SOMA).
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Used only for final settlement of obligations between banks.
The only way reserves come into existence is when a bank gives something up — either by:
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Selling assets to the Fed (e.g. Treasury securities during QE), or
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Borrowing from the Fed (e.g. discount window lending).
In exchange, the Fed creates a new liability (reserve balances) backed by the incoming asset. Reserves cannot leave the interbank system, and the Fed cannot use them for any purpose. They are accounting claims that facilitate interbank payment, not transferable funds.
📌 Reserves are not money. They are asset-backed settlement claims, issued by the Fed in return for something of value.
🏦 Treasury Auctions — No Reserves Involved
When the Treasury issues new securities at auction, here’s what happens operationally:
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Investors (banks, dealers, MMFs, pensions, etc.) place bids.
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If an investor wins, their custodian bank facilitates settlement.
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On settlement day, the investor’s deposit account is debited, and the Treasury General Account (TGA) is credited at the Fed.
At no point are reserve balances involved in this process.
In fact:
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Not all Treasury auction participants have reserve accounts.
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The Fed does not accept payments from nonbanks directly.
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Treasury auctions settle via the commercial banking system — using bank deposits, not reserve balances.
When a bank is involved (as custodian), the Fed adjusts the master account of that bank, which may or may not include a change in the reserve subaccount. In most cases, it does not. The transaction is simply a shift from one Fed liability (the bank’s master account) to another (the TGA).
🔍 Treasury auction settlement involves deposit credit and liability transfers — not the reserve system.
📉 Fed Balance Sheet Runoff (QT) — Not a Reserve Event
When a Treasury security held by the Fed matures:
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The security rolls off the asset side of the Fed’s balance sheet.
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There is no “payment” made to the Fed.
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The matched liability (typically reserves held by banks) remains unaffected unless a separate transaction removes it.
There is no redemption, no reserve adjustment, and no transaction between the Fed and Treasury. The asset simply expires.
🔥 Fed runoff is a passive asset reduction, not a financial flow. It does not “drain” reserves from the banking system.
💱 FX Swaps — Yes, Reserves Are Created, But Only With 1:1 Asset Offset
This is one case where reserve balances are created outside QE or lending, but still fully asset-backed.
When the Fed conducts a foreign exchange swap with another central bank:
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The Fed creates reserve balances and credits them to a designated U.S. bank.
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In return, the Fed books an asset: a foreign exchange receivable, fully collateralized and short-dated.
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The reserve liability is backed at face value by the FX swap asset.
This is not “liquidity injection” in the free-money sense — it is a balanced exchange of claims, with the Fed holding a receivable and the counterparty holding temporary reserves.
When the swap unwinds, the reserves are removed, and the FX receivable is extinguished.
💡 FX swaps create reserves only because they also create a new Fed asset. The 1:1 asset backing is never broken.
📊 So When Do Reserve Balances Actually Change?
Let’s break down the only legitimate sources of reserve balance changes, and debunk the common myths:
✅ Events That Truly Change Reserve Balances
| Event | Effect on Reserves | Explanation |
|---|---|---|
| Fed Open Market Operations (QE/QT) | ✅ Yes | Buying adds reserves, selling removes them. Always 1:1 against SOMA assets. |
| Discount Window Lending | ✅ Yes | Bank borrows and posts collateral; reserves created and backed by the loan asset. |
| FX Swaps | ✅ Yes | Reserves created and backed by short-term FX receivables from foreign central banks. |
| Currency Withdrawals | ✅ Yes | Physical cash withdrawals reduce reserve balances via a liability swap (reserves to currency). |
❌ Events That Do Not Change Reserves
| Event | ❌ Effect on Reserves? | Why Not? |
|---|---|---|
| Treasury Spending | ❌ No | The TGA is debited, and a bank’s master account is credited. Reserve balances are not necessarily touched. |
| Tax Payments | ❌ No | Bank debits customer deposits and sends payment to the TGA. This is a deposit transfer, not a reserve movement. |
| Treasury Auctions | ❌ No | Settlement uses deposit credit from custodian banks. Reserves are not transferred. |
| Fed Runoff (QT) | ❌ No | Maturing assets roll off the balance sheet passively. No payment occurs, and reserves remain unchanged. |
| Reverse Repo Operations (RRP) | ❌ No | Shifts the form of Fed liabilities (reserves to RRPs), but does not reduce total reserves held by depository institutions. |
🧠 Why This Matters
The myth that reserves are constantly moving in and out of existence based on fiscal operations has led to poor analysis and policy confusion. The truth is far simpler:
🧾 Reserves exist only because banks voluntarily gave the Fed something of value.
They do not enter or exit the system through Treasury activity, taxation, or asset maturities.
Recognizing this structure clarifies everything from the Fed’s limited powers to the mechanics of sovereign debt issuance.
📌 Conclusion
Reserve balances are not money. They are not government funds. They are not fiscal tools.
They are claims on Federal Reserve assets, issued only when a bank gives up something real, and used only for interbank payment.
Every dollar of reserves is matched by a dollar of SOMA assets — at face value — and this 1:1 parity is what keeps the system coherent.
So next time you hear that Treasury auctions are “draining reserves” or that Fed runoff is “pulling liquidity” out of the system, remember:
Reserves don’t move unless a Fed asset does — and even then, only when a bank chooses to make that trade.
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