Editor's note: Qian Zongxin is an executive director of Center for Future Financial Innovation, Renmin University of China. The article reflects the author's views and not necessarily those of CGTN.

The current international monetary system features a few key currencies that serve as vehicle currencies for international transactions and reserve currencies. Notably, the issuers of these currencies, such as the US dollar, euro, British pound, and Japanese yen, are also major suppliers of sovereign bonds which are widely held in the global financial market.

The supply of these sovereign bonds is a double-edged sword. On one hand, the growth of the global economy requires liquidity. Long-term economic growth requires investment which usually has a relatively long horizon. Such long-term investment, however, is typically not very liquid. That is, when investors have to serve current liability, it is usually very difficult to turn these long-term investments into instant money to repay short-term debt. 

Such conversion, even if it is possible, is costly, which generates unexpected losses for investors. For this reason, in addition to their long-term investment, investors usually hold liquid assets that can be cheaply and easily turned into instant money to repay short-term debt. 

In the current international monetary system, sovereign bonds issued by governments with strong credibility serve as such liquid assets. Economies that issue major vehicles and reserve currencies enjoy added credibility from their currency status. Growing international transactions generate continuous demand for international vehicle currencies. 

Particularly, cross-border long-run investment requires liquidity in the international market, which generates extra demand for liquid assets denominated in international vehicle currencies. Therefore, the major vehicle currency status of the issuing economy adds demand for the sovereign bonds issued by the same economy. The extra demand lowers the required interest payment. Lower financing cost then makes repayment easier.

On the other hand, the supply of sovereign bonds by the issuing economies of the major currencies is usually determined by those economies' domestic concerns, such as the governments' financing need and targets for macroeconomic management. Its impact on the international monetary and financial system is usually not adequately considered in the decision process. 

Therefore, the supply of liquid sovereign bonds, also known as "safe assets", is not always optimal. When the supply of such safe assets is not enough to support the demand from world economic growth, the private sector provides substitutes by financial innovations. 

However, the "safe assets" supplied by the private sector are usually not supported by collateral with comparably low credit and liquidity risk to sovereign bonds. Over-expansion of such an asset market leads to financial fragility. The subprime crisis in 2008 is a typical example. Triple-A rated private bonds, further backed by risk management instruments, such as the credit default swap, were taken to be safe. 

Counter-party risk and aggregate risk were under-estimated, leading to over-expansion of the financial market and excessive risk taking. The resulting financial crisis hit heavily not only the US economy but also the global economy. As the sovereign debt of the vehicle currency issuing economy continuously grows, concerns regarding the over-supply, rather than shortage, of the sovereign bonds of some of the vehicle currency issuing economies have arisen recently.

With fiscal sustainability, sovereign debt expansion increases the depth of the sovereign bond market and enhances the availability of collateral, which strengthens the function of sovereign bonds as safe assets. However, if the expansion of sovereign debt undermines fiscal sustainability, the credibility of these sovereign bonds will be weakened, leading to sovereign credit risk.

By 2025, the US federal debt had reached a level more than 120% of GDP. Actually, the federal debt-to-GDP ratio passed the 60% threshold set in the convergence criterion of the Maastricht treaty of the European monetary union in the first decade of the 21^st century. 

After that the debt-to-GDP ratio followed a rising trend. The international vehicle currency status of the US dollar and the perceived safe asset status of US treasury bonds helped stabilize the sovereign bond market. Dramatically, in August 2011, when the S&P global ratings cut the US sovereign credit rating from AAA to AA+, the US Treasury bond yield decreased rather than increased. The question is whether this scenario could last forever. In the short term, domestic political conflict in the US creates risk for a technical default. 

Due to the debate on whether or not to raise the US debt ceiling, 1-year US sovereign credit default swap spread increased to 177 basis points. The treasury bond yield also rapidly increased. In the long term, the growth of the world economy continuously requires more supply of international liquid assets, while the relative share of the US in global output is declining. This poses an intrinsic contradiction in the international financial market. Particularly, when monetary conditions change, high interest rates lead to a heavier repayment burden, which threatens fiscal sustainability. Moody's cut the US sovereign credit rating from Aaa to Aa1 in May, 2025, reflecting worries about the sovereign credit risk in the US.

Besides the US, Japan is another country with a high government debt-to-GDP ratio but which still managed to maintain the stability of its sovereign bond market. Besides the international status of the Japanese yen, the past monetary policy and ownership structure contributed to the stability of the market.

Due to an extended period of low inflation, Japan kept an expansionary monetary policy. The Japanese central bank and domestic financial institutions held a large share of Japanese government bonds. However, such particular factors depend on the domestic macroeconomic situation. When the inflation rate increases, and the expansionary monetary policy exits, the question "who will take the position from the central bank and domestic institutions" challenges the safe asset status of Japanese government bonds.

In summary, the vehicle currency status of the issuing economy strengthens the credibility of its sovereign bonds. The credibility of sovereign bonds then increases transaction demand for the currency. The stability of the current international monetary system relies on such mutual reinforcement. 

However, the stability of such a system still requires fiscal sustainability. The changing domestic political and economic situation of the issuing countries of major currencies and their relative share in the world economy requires a systemic overhaul. Particularly, better management of sovereign risk is required. Diversifying the supply of liquid sovereign bonds and vehicle currencies is one way to reduce the risk. 

China, with its rising share in the world economy, might contribute to this, by systematically internationalizing its currency and managing its sovereign bond supply with the idea of internalizing its impact on the stability of the world financial market.