The Triffin dilemma (or the Triffin paradox) is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfil world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit.
The use of a national currency (i.e. the US dollar) as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Currency inflows and outflows of equal magnitudes cannot both happen at once.
The Triffin dilemma is usually used to articulate the problems with the US dollar's role as the reserve currency under the Bretton Woods system, or more generally of using any national currency as an international reserve currency.
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Due to money flowing out of the country through the Marshall Plan, US military budget and Americans buying foreign goods, the number of U.S. dollars in circulation began to exceed the amount of gold backing them up in 1959.
By the autumn of 1960, an ounce of gold could be exchanged for $40 in London, even though the price in the U.S. was $35. This difference showed that investors knew the dollar was overvalued and that time was running out.
There was a solution to the Triffin dilemma for the U.S.: reduce the number of dollars in circulation by cutting the deficit and raising interest rates to attract dollars back into the country. Both these tactics, however, would drag the U.S. economy into recession.
To maintain the Bretton Woods system and exert control over the exchange rate of gold, the US initiated the creation of 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.
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. The "gold window" was closed.
In order to maintain the Bretton Woods system, the US had to do two things:
Obviously, the US 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.
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.[1] [2]
This would involve a gradual move away from the US dollar as a reserve currency and towards the use of Special Drawing Rights (IMF Special Drawing Rights) 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 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.[3]
Dr Zhou's proposal attracted much international attention;[4] in a November 2009 article published in Foreign Affairs magazine, economist C. Fred Bergsten argued that Dr Zhou's suggestion or a similar change to the International Monetary System would be in the best interests in both the US and the rest of the world.[5] 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[6] examining these aforementioned problems as well as other world reserve currency considerations, recommending that the world adopt a global currency called the "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.