The Triffin Dilemma and Trade Deficits

The Triffin Dilemma refers to the conflict of interest that arises when a country's currency is the global reserve currency. To meet international demands for a currency, the country with reserve status needs to run deficits. This has led to the US running to meet global demand for the USD. It was first identified by economist Robert Triffin in the 1960s, where he argued that for a country to be the reserve currency, it must fill the foreign exchange reserves, resulting in an inevitable trade deficit. With globalisation and increased international trade, the requirement for USD grows, and now its deficits sit at more than US$1 trillion per annum. 

Bretton Woods, Bancor and the Triffin Dilemma

In 1944, Keynes identified this dilemma (though he did not name it), anticipating the difficulty the USD would face under the Bretton Woods system. Ultimately, this collapsed due to the emergence of the Triffin Dilemma. The USD became worth less than gold, and the system collapsed. When Bretton Woods was established, Keynes cited the need for a global reserve currency. He proposed a global trade medium called the ‘Bancor’ to run alongside the reserve currency.

Bancor was not a currency but rather a unit of account to track international flows of assets and liabilities; countries in deficit would be charged in order for them to take action to restore a balance of trade. American economist and writer Ben Steil summarised this as follows:

‘Each item a member country exported would add bancors to its ICB (International Clearing Bank) account, and each item it imported would subtract bancors. Limits would be imposed on the amount of bancor a country could accumulate by selling more abroad than it bought, and on the amount of bancor debt it could rack up by buying more than it sold. This was to stop countries from building up excessive surpluses or deficits. Each country's limits would be proportional to its share of world trade’.

As Trump looks to rein in excessive deficits and restore trade balance, the world will face a similar set of circumstances to when Bretton Woods collapsed, as global liquidity is withdrawn and moves back to the US.

To move money back to the world, assets will need to be bought in USD, raising asset prices but localising wealth within the US – something the rest of the world is not going to accept without a fight.

2008 Global Financial Crisis

The 2008 Global Financial Crisis has been blamed on the Triffin Dilemma by Zhou Xiaochuan, the Governor of the People's Bank of China at the time. When the US overbuilt housing and asset prices began to collapse, USD needed to be repatriated into the US to ‘plug the hole’ draining the world economy of USD. Since then, every event that has caused a depreciation in asset prices has been met with a loosening of liquidity, driving asset prices higher and higher, especially in the US.

The collapse of Bretton Woods - The Nixon shock

In August 1971, Nixon effectively ended the Bretton Woods system due to excessive war spending deficits and a US recession with no liquidity from the Federal Reserve the system collapsed with countries asking for redemption of their gold in USD causing a bullion run – notable example being the French sending a warship to New York, which was turned away – with the US defaulting on its debt. In response to the collapse – the rest is history, so to speak – the Petrodollar was established, the gold may or may not be in Fort Knox, and the issue was deferred.

Equalisation of Deficits – New Currency

What becomes more and more clear is that the world is walking a tightrope right now, reliant on US liquidity that dries up during a trade war. With the US running larger and larger deficits, the world needs a solution. Trump is currently attempting to bring USD back to the US for ‘Make America Great Again’ prosperity, but his prosperity will come at the expense of the rest of the world and global asset ownership. If Trump wants world peace and equalisation of deficits, the only solution appears to be a return to a currency system similar to the gold standard or possibly a system like Bancor. Whatever it is, time will tell, as history has shown time and time again – reserve currencies fail eventually, which is why holding safe-haven assets like gold and silver remains essential.