Triffin Dilemma (Reserve Currency Paradox)
Robert, Baron Triffin was a Belgian-American economist who was openly against the Bretton Woods monetary system. Triffin dilemma or else Triffin paradox refers to countries whose currencies are used as global reserve currencies, like the United States and the US dollar.
Describing the Triffin Dilemma
Identified in the 1960s, the Triffin dilemma describes a situation where there is a conflict of interest between short-term domestic objectives and long-term international objectives. These are some facts regarding the country that is issuing the global reserve currency:
(1) The need for an extra supply of foreign exchange reserves
The country issuing the global reserve currency must supply other countries with an additional supply of its currency to meet the international demand for foreign exchange reserves.
(2) The creation of a trade deficit
The need to create an excess supply of foreign exchange reserves leads to a trade deficit.
(3) The conflict of interest creates the Triffin dilemma
When a national currency is used as the international reserve currency, there is an emerging conflict of interest for the dominant country, between serving its domestic monetary policy, and at the same time preserving its international monetary role. This dilemma is called the Triffin dilemma.
The Bretton Woods System
Established in 1944, the Bretton Woods agreement proposed a new monetary system that was designed to rule the commercial and financial relations among the leading countries of the time, the USA, Western European countries, Canada, etc.
According to the Bretton Woods system, all participant countries were obligated to link their currencies to gold and prevent competitive currency devaluation. The agreement also led to the foundation of the:
- IMF (International Monetary Fund)
- IBRD (International Bank for Reconstruction and Development)
In 1971, president Nixon pulled the United States out of the Bretton Woods system. By 1973, the Bretton Woods system was officially ended and replaced by the current free-floating fiat currency system.
Two (2) Robert Triffin's Predictions of 1959
In 1959, in front of the ‘Joint Economic Committee’ of the Congress, Robert Triffin made two predictions:
(i) The Bretton Woods system was doomed to fail
In 1971, the Bretton Woods system collapsed and Robert Triffin’s prediction proved correct.
(ii) The role of the US dollar as a global reserve currency will mathematically lead the United States to record deficits
Nowadays, the United States runs the largest current account deficit in the world’s history.
Key Points of the Triffin Dilemma
- The country issuing the global reserve currency must supply other countries with an additional supply of the currency, in the form of foreign exchange reserves
- A global reserve currency leads the issuing country to a trade deficit, as this country must provide an excessive supply of the national currency to meet the international demand for foreign exchange reserves
- The more popular a global reserve currency becomes, the more expensive the exchange rate and the less competitive the domestic exporters become
- It is challenging for any Central Bank issuing the global-reserve currency (i.e. FED) to balance domestic monetary goals and international objectives
- It is difficult for any Central Bank issuing the global-reserve currency to deal with high domestic inflation
- There can be a significant conflict of interest between national monetary policies and the international demand for the global reserve-currency
Triffin Dilemma -Final Thoughts
The Triffin’s Dilemma emerges as every country in the world is incentivized to issue the global reserve currency, but at the same time, this country must serve also its domestic monetary objectives.
Sooner or later there is a conflict of interest between domestic and international monetary objectives. The key economic variable that may signal a monetary transition is inflation. If inflation surges, the issuer of the global reserve currency must choose either to help the domestic economy or to serve its international role.
Issuing the global reserve currency is a great responsibility, as it means the domestic monetary policy becomes an international matter. This situation leads to less monetary flexibility and the creation of a number of monetary risks for the world as a whole.
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■ Triffin Dilemma (Reserve Currency Paradox)