The Triffin Dilemma
Greg Canavan

There is a fundamental incompatibility between the attainment of global economic stability and having a single national currency perform the role of the world’s reserve currency. This is hardly a new revelation. But events of the past few months have brought this topic back into the spotlight.

Belgian born American economist Robert Triffin first highlighted this incompatibility in the 1960s. He observed that having the US dollar perform the role of the world’s reserve currency created fundamental conflicts of interest between domestic and international economic objectives.

On the one hand, the international economy needed dollars for liquidity purposes and to satisfy demand for reserve assets. But this forced, or at least made it easy, for the US to run consistently large current account deficits.

Triffin argued that such persistent deficits would eventually put pressure on the dollar and lead to the demise of the Bretton Woods system of international exchange.

The Triffin Dilemma, therefore, argued that the demands on an international currency meant that excess supply would undermine its value.

After WWII the Bretton Woods international monetary system came into being. This was a fixed rate currency regime with the dollar as the global reserve currency. But to ensure stability and financial discipline, the major currencies were fixed to the dollar and the dollar was fixed to gold at the rate of US$35 an ounce.

This is where the Triffin Dilemma kicked in.

The US soon understood that reserve currency status allowed them to run large deficits. The deficits were ‘paid’ for by issuing dollars. When the excess dollars began showing up in global central banks, they began converting their dollars into gold. This lowered the value of the US dollar in relation to gold.

At first the authorities tried to manage the Dilemma. In 1961 they established the ‘London Gold Pool’ in an attempt to keep the dollar price of gold to $35 an ounce. This system worked for a while but fell apart by 1968 when France withdrew from the Pool.

The various nations then attempted to preserve the Bretton Woods system by maintaining a two-tiered gold market; one operating at the official $35 an ounce price while another traded gold at the market price, which was well above $35. Of course such a policy was completely unsustainable and it too failed.

Bretton Woods was on its last legs. President Nixon ended the system once and for all when in August 1971 he suspended the convertibility of dollars into gold. From that point on, the dollar was without an anchor and the global monetary system went from a fixed to floating regime.

What followed was a decade of monetary instability and record high inflation.

Perhaps surprisingly, the dollar maintained its role as the world’s reserve currency throughout the decade. Due to its economic and military might, the reserve currency status of the dollar actually grew in acceptance throughout the next few decades.

But Triffin’s Dilemma never went away. It did remain out of sight though as parties on both sides of the equation enjoyed the mutual benefits of the dollar’s reserve status.

The US benefitted by paying for imports with essentially costless dollars. In turn, the US’ main trading partners enjoyed robust demand for their products, creating employment and income growth.

The huge deficits brought about by excess US consumption produced a massive amount of liquidity throughout the global economy. While Triffin’s Dilemma would have predicted a collapse of the dollar because of the glut of dollars in the system, such an outcome didn’t eventuate.

This was primarily because the beneficiaries of US consumption didn’t want it to end. So they reinvested their excess dollars back into US asset markets, notably US Government debt. Such actions supported the dollar, kept interest rates low, and perpetuated the imbalances.

Some commentators called this apparent happy state of affairs ‘Bretton Woods II.’ As the saying goes, markets make opinions and this was a flawed opinion born out of an ignorance of what brought the first Bretton Woods system undone.

The underlying conflicts identified by the Triffin Dilemma always remained. The ease with which the US could borrow and create debt was tolerated for decades. No doubt such tolerance was due to gold no longer being a monetary anchor.