Triffin dilemma
Encyclopedia
The Triffin dilemma 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.
, 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.
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.
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 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.
Dr Zhou's proposal attracted much international attention; 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.
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 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.
Reserve currency
A reserve currency, or anchor currency, is a currency that is held in significant quantities by many governments and institutions as part of their foreign exchange reserves...
, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian
Belgium
Belgium , officially the Kingdom of Belgium, is a federal state in Western Europe. It is a founding member of the European Union and hosts the EU's headquarters, and those of several other major international organisations such as NATO.Belgium is also a member of, or affiliated to, many...
-American
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
economist Robert Triffin
Robert Triffin
Robert Triffin was a Belgian economist best known for his critique of the Bretton Woods system of fixed currency exchange rates. His critique became known later as Triffin's dilemma.Triffin received his doctorate degree from Harvard University in 1938 and taught there from 1939 until 1942...
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
Foreign exchange reserves
Foreign-exchange reserves in a strict sense are 'only' the foreign currency deposits and bonds held by central banks and monetary authorities. However, the term in popular usage commonly includes foreign exchange and gold, Special Drawing Rights and International Monetary Fund reserve positions...
) 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
Balance of payments
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
, specifically the current account
Current account
In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...
: 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
Bretton Woods system
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
, or more generally of using any national currency as an international reserve currency.
Onset during Bretton Woods Era
Due to money flowing out of the country through the Marshall PlanMarshall Plan
The Marshall Plan was the large-scale American program to aid Europe where the United States gave monetary support to help rebuild European economies after the end of World War II in order to combat the spread of Soviet communism. The plan was in operation for four years beginning in April 1948...
, US military budget
Military budget
A military budget of an entity, most often a nation or a state, is the budget and financial resources dedicated to raising and maintaining armed forces for that entity. Military budgets reflect how much an entity perceives the likelihood of threats against it, or the amount of aggression it wishes...
and Americans buying foreign goods
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...
, the number of U.S. dollars
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
in circulation began to exceed the amount of gold
Gold
Gold is a chemical element with the symbol Au and an atomic number of 79. Gold is a dense, soft, shiny, malleable and ductile metal. Pure gold has a bright yellow color and luster traditionally considered attractive, which it maintains without oxidizing in air or water. Chemically, gold is a...
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
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
.
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
London Gold Pool
The London Gold Pool was the pooling of gold reserves by a group of eight central banks in the United States and seven European countries that agreed on 1 November 1961 to cooperate in maintaining the Bretton Woods System of fixed-rate convertible currencies and defending a gold price of US$35 per...
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
Pound sterling
The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...
were followed by the demise of the system.
The Nixon Shock
In August 1971, President Richard NixonRichard Nixon
Richard Milhous Nixon was the 37th President of the United States, serving from 1969 to 1974. The only president to resign the office, Nixon had previously served as a US representative and senator from California and as the 36th Vice President of the United States from 1953 to 1961 under...
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
Nixon Shock
The Nixon Shock was a series of economic measures taken by U.S. President Richard Nixon in 1971 including unilaterally cancelling the direct convertibility of the United States dollar to gold that essentially ended the existing Bretton Woods system of international financial exchange.-Background:By...
. The "gold window" was closed.
In order to maintain the Bretton Woods system, the US had to do two things:
- run a balance of paymentsBalance of paymentsBalance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
current accountCurrent accountIn economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade , net factor income and net transfer payments .The current account balance is one of two major...
deficit to provide liquidity for the conversion of gold into US dollars. With more US dollars in the system the citizens began to speculate, thinking that the US dollar was overvalued. This meant that the US had less gold as people started converting the US dollars to gold and taking it offshore. With less gold in the country there was even more speculation that the US Dollar was overvalued.
- run a balance of payments current account surplus to maintain confidence in the US dollar.
Obviously, the US was faced with a dilemma because it is not possible to run a balance of payments current account deficit
Balance of payments
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...
and surplus at the same time.
Implication in 2008 meltdown
In the wake of the financial crisis of 2007–2008, the governor of the People's Bank of ChinaPeople's Bank of China
The People's Bank of China is the central bank of the People's Republic of China with the power to control monetary policy and regulate financial institutions in mainland 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
Zhou Xiaochuan
Zhou Xiaochuan is a Chinese economist, banker, reformist and bureaucrat. As governor of the People's Bank of China since December 2002, he has been in charge of the monetary policy of the People's Republic of China....
's speech of 29 March 2009 proposed strengthening existing global currency controls, through the IMF
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
.
This would involve a gradual move away from the US dollar as a reserve currency and towards the use of Special Drawing Rights
Special Drawing Rights
Special Drawing Rights are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund . Not a currency, SDRs instead represent a claim to currency held by IMF member countries for which they may be exchanged...
(IMF Special Drawing Rights) as a global reserve currency
World currency
In the foreign exchange market and international finance, a world currency, supranational currency, or global currency refers to a currency in which the vast majority of international transactions take place and which serves as the world's primary reserve currency...
.
Zhou argued that part of the reason for the original Bretton Woods system breaking down was the refusal to adopt Keynes' Bancor
Bancor
The Bancor was a supranational currency that John Maynard Keynes and E. F. Schumacher conceptualised in the years 1940-42 and which the United Kingdom proposed to introduce after the Second World War...
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.
Dr Zhou's proposal attracted much international attention; in a November 2009 article published in Foreign Affairs
Foreign Affairs
Foreign Affairs is an American magazine and website on international relations and U.S. foreign policy published since 1922 by the Council on Foreign Relations six times annually...
magazine, economist C. Fred Bergsten
C. Fred Bergsten
C. Fred Bergsten is an American economist, author, and political adviser. He has served as Assistant Secretary for International Affairs at the U.S. Treasury Department and has been director of the Peterson Institute for International Economics, formerly the Institute for International Economics,...
argued that Dr Zhou's suggestion or a similar change to the International Monetary System
International monetary systems
International monetary systems are sets of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between nation states. They provide means of payment acceptable between buyers and...
would be in the best interests in both the US 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
2009 G-20 London summit
The 2009 G-20 London Summit is the second meeting of the G-20 heads of state in discussion of financial markets and the world economy, which was held in London on 2 April 2009 at the ExCeL Exhibition Centre. It followed the first G-20 Leaders Summit on Financial Markets and the World Economy, which...
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 currency called the "Bancor
Bancor
The Bancor was a supranational currency that John Maynard Keynes and E. F. Schumacher conceptualised in the years 1940-42 and which the United Kingdom proposed to introduce after the Second World War...
" 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.
See also
- Bretton Woods systemBretton Woods systemThe Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century...
- Exorbitant privilegeExorbitant privilegeThe exorbitant privilege is a term coined in the 1960s by Valéry Giscard d'Estaing, then the French Minister of Finance.This quote is generally misattributed to Charles de Gaulle, who is said to have had somewhat similar views....
- Reserve currencyReserve currencyA reserve currency, or anchor currency, is a currency that is held in significant quantities by many governments and institutions as part of their foreign exchange reserves...
- Dollar hegemonyDollar hegemonyDollar hegemony is the hypothesized monetary hegemony of the US dollar in the global economy. Henry C.K. Liu popularized the term in the article "Dollar Hegemony has to go" in Asia Times, April 11, 2002...