The Triffin dilemma or Triffin paradox is the conflict of economic interests that arises between short-term domestic and long-term international objectives for countries whose currencies serve as global reserve currencies. This dilemma was identified in the 1960s by Belgian American economist Robert Triffin, who pointed out that the country whose currency, being the global reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfill world demand for these foreign exchange reserves, thus leading to a trade deficit.
The use of a national currency, such as the U.S. dollar, as global reserve currency leads to tension between its national and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account, as some goals require an outflow of dollars from the United States, while others require an overall inflow.
Specifically, the Triffin dilemma is usually cited to articulate the problems with the role of the U.S. dollar as the reserve currency under the Bretton Woods system. John Maynard Keynes had anticipated this difficulty and had advocated the use of a global reserve currency called ‘Bancor’. Currently the IMF’s SDRs are the closest thing to the proposed Bancor but they have not been adopted widely enough to replace the dollar as the global reserve currency.
In the wake of the financial crisis of 2007–2008, the governor of the People’s Bank of China explicitly named the reserve currency status of the US dollar as a contributing factor to global savings and investment imbalances that led to the crisis. As such the Triffin Dilemma is related to the Global Savings Glut hypothesis because the dollar’s reserve currency role exacerbates the U.S. current account deficit due to heightened demand for dollars.
Onset during Bretton Woods era
Due to money flowing out of the country through the Marshall Plan, U.S. military budget and Americans buying foreign goods, the number of U.S. dollars in circulation exceeded the amount of gold that was backing them up in 1959.
By the autumn of 1960, an ounce of gold could be exchanged for $40 in the London market even though the official rate in the United States was $35. This price difference was due to price controls on gold in the US which was fixed by the US government in 1933 following the implementation of Executive Order 6102. In USD terms, the price of gold had not changed in 27 years, but this did not allow true price discovery by the free market. This price was fixed following the enactment of E.O. 6102, where the US government purchased gold from US citizens under threat of fines and/or jail time at a rate of $20.67/oz, then quickly revalued the gold to $35/oz.
The solution to the Triffin dilemma for the United States was to reduce dollars in circulation by cutting the deficit and raising interest rates to attract dollars back into the country. Some economists believed both these tactics, however, would drag the U.S. economy into recession.
In support of the Bretton Woods system and to exert control over the exchange rate of gold, the United States initiated the London Gold Pool and the General Agreements to Borrow (GAB) in 1961 which sustained the system until 1967, when runs on gold and the devaluation of the pound sterling were followed by the demise of the system.
The balance-of-payments dilemma
In order to maintain the Bretton Woods system, the U.S. had to run a balance of payments current account deficit to provide liquidity for the conversion of gold into U.S. dollars. With more U.S. dollars in the system than were backed with gold under the Bretton Woods agreement, the U.S. dollar was overvalued. This meant that the United States had less gold as foreign governments started converting U.S. dollars to gold and taking it offshore. Foreign speculators were not a direct part of the gold flow out of the US, as under the Bretton Woods Agreement, only governments could exchange US currency for physical gold. Additionally, while the Bretton Woods Agreement was in place, direct speculation by US citizens who were banned from owning any gold other than jewelry following Executive Order 6102 which was enacted in 1933 by President Franklin D. Roosevelt and enabled the US Government to confiscate all gold coinage, gold certificates, and gold bullion held by any citizen, did not contribute to the price imbalance and arbitrage opportunity via a wide disparity of gold prices between the US and other markets. A price ceiling had been enacted which fixed the price of gold at $35/oz USD following the previously mentioned gold confiscation from US citizens in 1933. As with all price controls, this caused supply and demand imbalances and an arbitrage opportunity which rapidly depleted the United States gold reserves. This led to less gold in the country and caused the US Dollar to become more overvalued, leading to a self-propagating cycle. Furthermore, the US had to run a balance of payments current account surplus to maintain confidence in the U.S. dollar.
As a result, the United States was faced with a dilemma because it is not possible to run a balance of payments current account deficit and surplus at the same time.
The Nixon shock
In August 1971, President Richard Nixon acknowledged the demise of the Bretton Woods system. He announced that the dollar could no longer be exchanged for gold, which soon became known as the Nixon shock. Although it was announced as a temporary measure, it was to remain in effect. The “gold window” was closed.
Implication in 2008 meltdown
In the wake of the financial crisis of 2007–2008, the governor of the People’s Bank of China explicitly named the Triffin Dilemma as the root cause of the economic disorder, in a speech titled Reform the International Monetary System. Zhou Xiaochuan’s speech of 29 March 2009 proposed strengthening existing global currency controls, through the IMF.
This would involve a gradual move away from the U.S. dollar as a reserve currency and towards the use of IMF special drawing rights (SDRs) as a global reserve currency.
Zhou argued that part of the reason for the original Bretton Woods system breaking down was the refusal to adopt Keynes’ bancor which would have been a special international reserve currency to be used instead of the dollar.
American economists such as Brad DeLong agreed that on almost every point where Keynes was overruled by the Americans during the Bretton Woods negotiations, he was later proved correct by events.
Zhou’s proposal attracted much international attention; in a November 2009 article published in Foreign Affairs magazine, economist C. Fred Bergsten argued that Zhou’s suggestion or a similar change to the International Monetary System would be in the best interests in both the United States and the rest of the world. While Zhou’s proposal has not yet been adopted, leaders meeting in April at the 2009 G-20 London summit agreed to allow 250 billion SDRs to be created by the IMF, to be distributed to all IMF members according to each country’s voting rights.
On April 13, 2010, the Strategy, Policy and Review Department of the IMF published a comprehensive report examining these aforementioned problems as well as other world reserve currency considerations, recommending that the world adopt a global reserve currency (bancor) and that a global central bank be established to administer such a currency. In this report, the current issues with having a national global reserve currency are addressed. The merits, difficulties and effectiveness of establishing a multi-currency reserve system are weighed against that of the SDRs, or “basket currency” strategy, and those of establishing this new “global reserve currency”. A new multilateral framework and “multi-polar system” for managing capital flows and national debts is also called for, but the IMF cautions that it prefers a gradual shift to this new framework, rather than a sudden change.
- ^While named for Triffin, “French economist Jacques Rueff described the fatal weakness of foreign-exchange reserves in a 1932 lecture.” John D. Mueller, Wall Street Journal, October 8, 2018, page A19.
- ^Jamil Anderlini in Beijing (2009-03-23). “China calls for new reserve currency”. Financial Times. Retrieved 2009-04-13.
- ^Zhou Xiaochuan. “Reform the International Monetary System” (PDF). Bank for International Settlements. Retrieved 2010-01-11.
- ^The reason why is simple enough to understand: To maintain the reserve currency status, money-as-debt must be created to maintain international liquidity (provide the money for transactions to take place). This debt accumulates over time, and eventually becomes large enough that international creditors begin to question whether or not it can ever be paid back. When that day comes, the status of that currency as a reserve currency is called into question. Hence the “dilemma” in the name. “Review of Robert Skidelsky, John Maynard Keynes: Fighting for Britain 1937–1946”. Brad Delong, University of California at Berkeley. Retrieved 2009-06-14.
- ^Geoff Dyer in Beijing (2009-08-24). “The dragon stirs”. Financial Times. Retrieved 2009-09-18.
- ^ Fred Bergsten (Nov 2009). “The Dollar and the Deficits”. Foreign Affairs. Retrieved 2009-12-15.
- ^IMF Strategy, Policy and Review Department, Approved by Reza Moghadam (2010-04-13). “Reserve Accumulation and International Monetary Stability” (PDF). IMF Strategy, Policy and Review Department. Retrieved 2010-04-13.
Ofer Abarbanel is a 25 year securities lending broker and expert who has advised many Israeli regulators, among them the Israel Tax Authority, with respect to stock loans, repurchase agreements and credit derivatives. Founder TBIL.co STATX Fund.