Triffin’s Dilemma
The essence of the Triffin Dilemma is that any reserve-currency system is unsustainable.
The Triffin Dilemma is the inherent conflict of a reserve-currency country’s domestic policy with international monetary order.
The dilemma is created because foreign official dollar reserves must equal the net exports of the rest of the world—which in turn must equal the deficit in U.S. net exports.
(Revised on June 20, 2020 and marked with this date.
Revised on Jan. 12, 2020 and marked with this date.
Revised on Dec. 21, 2019 using magenta font.
Revised on Nov. 19, 2019 using purple font.
Revised on Oct. 5, 2019 using blue font.)
Revised on Jan. 12, 2020 and marked with this date.
Revised on Dec. 21, 2019 using magenta font.
Revised on Nov. 19, 2019 using purple font.
Revised on Oct. 5, 2019 using blue font.)
Introduction
Why am I writing about Triffin's Dilemma?
Because I think it will help in understanding Trump's tariffs on Chinese exports. I believe tariffs will contribute to US dollar strength. Here's why. Tariffs will cause the American consumer to reduce his purchases of imported goods. As he reduces these purchases, he will send fewer dollars overseas. This will cause the supply of overseas dollars to shrink. As a result, the US dollar will strengthen. (Anytime supply shrinks, price rises, all else being equal.) Going back to Econ 101 and the chart showing an upward-sloping supply curve along with a downward-sloping demand curve, we can say the following: The only situation were the US dollar won't strengthen in the face of decreased supply is if the demand for US dollars were to fall. So long as the rest of the world remains interested in investing in the US, buying American goods, or trading in commodities priced in dollars, this demand won't fall.
We will see that Triffin's dilemma suggests that because the US is removing dollar liquidity from the global arena, instability could ensue.
How did I first hear about Triffin's Dilemma?
I first heard about Triffin’s Dillemma maybe a year ago from an interview with Mexican businessman Hugo Salinas Price (http://www.plata.com.mx/enUS/More/353?idioma=2). Then I heard Brent Johnson of Santiago Capital mention it in an interview on RealVision with Grant Williams when discussing “Dollar Weaponization” (https://youtu.be/kT32yPO2PCU). So I decided to find out more about Triffin’s dilemma. I have summarized my findings here.
Naive Google search
I started with a Google search on "Triffin's Dilemma", but was disappointed with the top search results, which included links to Wikipedia and Investopedia. They left me more confused than before. Some writers use phrases without defining them, such as “the U.S. exporting inflation through its Current Account deficit,” whereas my own finding has been that inflation arises in both the U.S. and foreign countries as a result of a U.S. Current Account deficit. More on this later under John D. Mueller's talk.
What sources did I end up using for this blogpost?
Here's a list of my sources for those who want to read them directly instead.
- IMF: https://www.imf.org/external/np/exr/center/mm/eng/mm_sc_03.htm
- This page provides a terse definition of Triffin's Dilemma. A good reference.
- Blog post at DailyReckoning: https://dailyreckoning.com/the-triffin-dilemma
- This blogpost recounts the story of the run on U.S.-held gold in the early 70's which was caused by a glut of U.S. dollars in foreign hands and which led to Nixon closing the gold window (i.e. devaluing the dollar). It is the Triffin Dilemma in action.
- BIS paper by Bordo and McCauley: https://www.bis.org/publ/work684.pdf
- This is a serious paper. I relied on it for building the foundations for a proper understanding of Triffin's Dilemma. (BIS stands for Bank for International Settlements.)
- John D. Mueller talk: https://eppc.org/publications/solving-the-triffin-dilemma/
- This is a serious talk. I relied on it for improving my intuition.
- Mueller has 35 years' experience in economics and financial-market forecasting as detailed here.
"Ok, I'm bored already or rather impatient. What is the one-line conclusion of it all?"
A vote in favor of gold. For holding gold. It predicts a prominent role for gold in the future.
Main Discourse
IMF's Description of Triffin's Dilemma
"If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.
If U.S. deficits continued, a steady stream of dollars would continue to fuel world economic growth. However, excessive U.S. deficits (dollar glut) would erode confidence in the value of the U.S. dollar. Without confidence in the dollar, it would no longer be accepted as the world's reserve currency. The fixed exchange rate system could break down, leading to instability."
Terminology
Readers who aren't familiar with the terms Current Account and Capital Account or how they relate to exports, imports, investments, and savings are encouraged to jump to the Footnotes section first and then come back here and resume reading.
Readers who aren't familiar with the terms Current Account and Capital Account or how they relate to exports, imports, investments, and savings are encouraged to jump to the Footnotes section first and then come back here and resume reading.
Discussion
We are living at a point in time where the Federal Reserve's balance sheet has ballooned from under $500 billion (prior to 2008) to just under $4 trillion after peaking at $4.5 trillion in 2014. All due to Quantitative Easing. See here for example: https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
Similarly, the size of U.S. national debt has been increasing. The U.S. national debt (or Treasury securities outstanding) stands at $22 trillion. See the following sources: https://www.usdebtclock.org,
https://www.treasurydirect.gov/govt/reports/pd/mspd/mspd.htm
https://www.treasurydirect.gov/govt/reports/pd/mspd/mspd.htm
This all raises concerns about confidence in the value of the U.S. dollar, as outlined in the 2nd paragraph of the above quote from the IMF (highlighted in yellow).
BIS paper by Bordo & McCauley, Dec 2017
Why this paper? The Introduction Section provides a good answer to “What is Triffin’s Dilemma?” Please take a moment to become familiar with Triffin’s Dilemma by reviewing the Introduction Section of this paper ...
Let’s jump to the Conclusion Section where we find the following:
“The Triffin dilemma as stated by Padoa-Schioppa (2011) is certainly correct – and perhaps a truism: “there is an irremediable contradiction between the issuing country’s internal domestic requirements and the external requirements of the world using it.”
In other words, Triffin's Dilemma is valid. Some people have challenged its validity, but this paper says that it is valid.
Side note: Link to the Padoa-Scioppa (2011) paper itself: http://institutdelors.eu/wp-content/uploads/2018/01/speech-tps-louvainlaneuve-25.02.2010.pdf
The somewhat good news, again from the Conclusion Section [emphasis mine]:
“What we know for sure is that the US current account is wider than panel regressions would predict. In any case, it is hard to get excited about the US net liability position if it is still generating net investment income.”
(I have defined "current account" and covered its relationship to "investment" in the Footnotes section at the very end.)
The bad news:
“[We admit that there are] dilemmas posed by a national currency that is used globally as store of value, unit of account and means of payment. The reserve currency is a global public good, provided by a single country -- the US -- on the basis of domestic needs.”
Side note: Padoa-Scioppa favors the SDR, as detailed here (2011): http://global-currencies.org/smi/gb/telechar/news/Rapport_Camdessus-integral.pdf
Mueller's talk, April 2017
My Google search results included the following talk by John D. Mueller, dated April 2017: https://eppc.org/publications/solving-the-triffin-dilemma/
Here, we learn many things.
The following is shocking! No history lessons required?
“Beginning in 1972, the University of Chicago’s economics department abolished what had previously been a degree requirement: that in order to earn a Ph.D., you had to have mastered the history of economics. All other economics departments in the country, as far as I can tell, soon followed that example. Perhaps the history of economics was already moribund. But by successfully campaigning for that change, George Stigler committed a deliberate act of amnesia among economists regarding exactly what economics is all about.”
Once the U.S. got off the gold standard in 1970, its federal budget deficits soared. Mueller details it as follows.
“As a factual matter, in American history, a precious-metal standard has prevented monetary authorities from monetizing federal budget deficits. From 1790 to 1970, under a metallic standard (always gold and/or silver), the federal government averaged an annual surplus of 0.4% of GDP. During periods of paper money from 1790 to 2015, there has been an average deficit of 2.7% of GDP. To show that the monetary standard is the cause, I also compare summary numbers for federal with state governments, since under the Constitution the latter cannot issue inconvertible paper money. From 1979 to 2015 at the same time—therefore, under exactly the same economic conditions— as the federal government was running deficits averaging 3% of GDP, state governments averaged deficits of only 0.3% of GDP. This was not because state legislators are smarter or more virtuous than members of Congress, but rather because state governments are prevented from printing money to finance their budgets (as the American colonial governments frequently did).”
Analogous to federal budget deficits and more relevant to Triffin's Dilemma is the US current account deficit. Here's its chart as sourced from: http://bruegel.org/wp-content/uploads/2018/11/PC-20_2018_final.pdf.
We see that the US current account deficit has been on a downtrend (of increasing deficits) since 1970.
Next, let's look at US inflation. The next chart is from Mueller's talk.
Note that since sometime in the 1930's or 40's, the CPI has been increasing whereas before that time, it has been virtually flat. (I have defined CPI in the Footnotes section at the very end. Here, it suffices to say that a flat CPI means no inflation and a linearly increasing CPI on a log scale -- the chart's y-axis is on a log scale -- means a constant inflation rate.)
The period of inflation starting in 1970 coincides with growing US current account deficits (which we saw in the chart before this one). We are led to conclude that expanding the US dollar supply has been inflationary, and this makes good common sense: having more dollars chasing the same quantity of goods means that the price of those goods has to rise, all else being equal. Mueller says, “As you can see [from the above chart], episodes of serious inflation in American history occurred only with paper money." (Not entirely true, but close. Reading off the chart, that is.)
Mueller then asks, "Can the US dollar supply be used to predict inflation?" His answer is, yes! And quite nicely. And the inflation lag is 2 years. This is true at least for the period considered by Mueller: 1965-1983.
“This [next chart] is a bit grainy, because it comes from a 1991 Wall Street Journal op-ed article. The slide shows that the World Dollar Base (the sum of the U.S. domestic monetary base and foreign official dollar reserves) has been an excellent predictor of commodity price inflation, particularly food and energy price inflation, in dollar terms, [and with a lead of 2 years].”
"The chart compares the growth of the World Dollar Base, lagged about two years, and its ultimate impact on food and energy price inflation. In that case, the surge in foreign official dollar reserves occurred in 1986-1988, as the mostly unanticipated consequence of the Plaza Accord of 1985, about which Jim Baker spoke in such glowing terms in the video we saw earlier this morning. In response to the dollar’s decline, foreign central banks, led at the time by the Bank of Japan, purchased massive amounts of U.S. dollar securities (mostly U.S. Treasury debt), to try to stem the rise of their currencies against the dollar. The result, as the chart shows, was the 1989-91 inflation and 1991-92 recession, which ended the presidency of George H.W. Bush in 1992."
Referring to a long-term chart of the US dollar, we note that the dollar peaked in value in March 1985 and then followed a downward path all the way to July 1995.
(I can't help but think that when one country devalues -- i.e. increases its money supply -- other countries follow because they don't want to see their currencies appreciate because an appreciating currency could slow down their economy by making it harder for them to export their production.)
Mueller goes on to observe that inflation is stronger in US than foreign countries with pegged currencies.
“While the 1991 chart from the Wall Street Journal shows that growth of the World Dollar Base affects world commodity prices in dollar terms (and therefore prices in any countries whose currencies are tied to the dollar), the next chart shows that prices rise faster and farther in the reserve-currency country [i.e. U.S.] itself than in other countries.”
"As the chart shows, while the price of German manufactured goods (black) roughly tripled from 1955 to 2015, the price of American manufactured goods (gold line) has more than sextupled."
Me thinking out loud:
Recently, namely in the past 3-6 months, central bankers and economists have been perplexed by the absence of inflation in the U.S. For example, the Fed has said that the U.S. economy can't meet the Fed’s 2% inflation target. This is one of the reasons given for the Fed having turned dovish last January (2019), which was earlier than expected. The Fed's plan last year was to continue to raise interest rates through this year and into the next. Their revised plan calls for something like a single rate hike in the next 12 months.
See chart of US inflation in the past 2 years here: https://twitter.com/Schuldensuehner/status/1130215050277543937
Furthermore, the situation in the rest of the world is worse. A large amount of bonds (something like $10 trillion) carry negative yields. See here for 5 central banks with negative interest rates. Inflation is virtually dead.
Now, in the 1970’s, the expansion of the World Dollar Base did cause serious inflation (and which was eventually curbed by Paul Volcker in the early 1980’s). So, given the monstrous $20 trillion expansion of central bank balance sheets, including the Fed’s, since 2008, it begs the question as to why inflation has been absent and also, whether someday inflation is going to raise its ugly head. The explanation provided so far by pundits is that the extra liquidity has made its way into assets as opposed to the real economy, having given rise to asset price inflation across the board (i.e. across stocks, bonds, and real estate).
Hoisington, the bond manager, has an explanation for why inflation has been absent. More on this in the Footnotes section at the very end.
End of me thinking out loud.
Essence of Triffin’s Dilemma, according to Mueller:
“The Triffin Dilemma is the inherent conflict of a reserve-currency country’s domestic policy with international monetary order.”
“[U]nder the international gold standard, there was no Triffin Dilemma, because the whole world ran a trade surplus with itself, which was equal to the net increase in monetary gold.”
“The essence of the Triffin Dilemma is that any reserve-currency system is unsustainable, because reserves are bought and repayable in goods. This means that the net increase in foreign official dollar reserves must equal the net exports of the rest of the world—which in turn must equal the deficit in U.S. net exports.”
Savings and investment are linked to the Current Account Deficit, as Mueller explains [emphasis mine].
“The trade balance of any country must equal the net value of that country’s saving over investment. There is nothing necessarily alarming in a trade deficit in itself. Despite tariffs (often high ones), the United States ran current account deficits totaling 69% of GDP from 1790 to 1895—because U.S. investment exceeded domestic saving by that amount. From 1896 to 1970, U.S. current account surpluses totaled 116% of GDP, because U.S. national saving exceeded investment by that amount. However, from 1971 through 2015, U.S. current account deficits totaled 93% of GDP because of the Triffin Dilemma: The increase in official dollar reserves must equal the rest of the world’s surplus (and America’s deficits) in net exports.”
What are the alternatives?
“There are, and have always been, three main alternative solutions to the Triffin Dilemma, whether in the 1920s, in 1983, and today.”
"Once you have eliminated the impossible, what remains, however improbable, is the truth."
“After sifting the arguments and facts, [Mueller] concluded more than three decades ago, and remain[s] convinced, that the final option, a multilateral gold standard, is the only solution to the Triffin Dilemma which has worked, and can still work, in the real world.”
Random thoughts, mine
Triffin’s Dilemma creates a motive for suppressing the gold price by the U.S. A suppressed gold price hides the dollar’s weakness. It makes the dollar appear stronger than it really is.
Footnotes
Definition of Current Account Balance: A country’s monetary value of Exports minus Imports. A country that imports more than it exports will have a Current Account deficit, such as the U.S. today. Also known as Trade Balance. Also known as Balance of Payments. (One can think of it as the nation’s Income Statement. Exports create revenues, imports create expenses, income equals revenues minus expenses.) More details here: https://en.m.wikipedia.org/wiki/Current_account
The Current Account is a measure of flow of trade.
Relationship between Current Account and Capital Account: their sum must be zero. In other words, the Current Account balance always equals minus the Capital Account balance. The Capital Account balance is equal to Investments minus Savings. (This is analogous to a partner's capital account in a partnership.) More details here: https://www.investopedia.com/ask/answers/031615/whats-difference-between-current-account-and-capital-account.asp
The Capital Account is a measure of flow of capital.
Current Account balance = minus Capital Account balance,
which is the same as saying
Exports - Imports = Savings - Investments
Definitions of Savings & Investment: Savings is the postponement of Current Consumption. Investment is the purchase of Durable Goods i.e. equipment for production or residential and nonresidential structures. Please see here and here for a more detailed explanation of their difference.
(Loose ends. I'm not particularly satisfied with the above definition of Capital Account as Savings minus Investments. The following Wikipedia articles on Capital Account and Current Account could be helpful.
Very briefly, Wikipedia's alternate definition of Capital Account seems more relevant and is
Capital Account = Foreign Ownership of US Assets minus US ownership of Foreign Assets,
so
minus Capital Account = US ownership of Foreign Assets minus Foreign Ownership of US Assets,
so
Exports minus Imports = US ownership of Foreign Assets minus Foreign Ownership of US Assets,
which makes more common sense.
Here's a chart of what amounts to effectively the US Capital Account:
The fact that it is negative means foreign ownership of US assets exceeds US ownership of foreign assets. However, what I find a little troubling that the amount of the Capital Account is much more than the Current Account Deficit that was charted earlier in the chart entitled "Figure 11: US Current Account Deficits."
Resolution of the troubling observation: The Current Account Deficit chart is an annual measure whereas the Capital Account chart is a cumulative measure.
)
Definition of CPI: CPI stands for Consumer Price Index. Conceptually, the CPI is chosen to have an arbitrary value (e.g. 100) at the start of some arbitrary year (e.g. 1950). Then, if consumer price inflation ends up being X% (e.g. 3%) during that year, the value of CPI is increased from 100 to 100+X% (e.g. 103). After N years of inflation at X% per year, the value of CPI would end up being 100*(1 + X%)^N (e.g. 100*(1.03)^N. The graph of (1+X%)^N is an exponentially increasing line while the graph of the logarithm of (1+X%)^N would be an upward-sloping straight line.
The inflation between dates D1 and D2 can be inferred by reading the CPI on these two dates, measuring their difference and normalizing by the CPI level on date D1.
Hoisington's explanation for lack of inflation:
In its quarterly reviews (which may be found here), Hoisington uses the Equation of Exchange, defined below, to explain why inflation has been absent in the U.S. since 2008. Hoisington claims that the absence of inflation can be attributed to the decrease in the velocity of money.
The Equation of Exchange is MV = PQ. In words, it says that the product of the money supply (M) and velocity (V) equals the product of prices (P) and quantity (Q) where the product PQ is none other than nominal GDP. If M increases and if V remains unchanged, then the product PQ has to increase. Typically an increase in M leads to an increase in P, i.e. causes inflation. (More details on this equation may be found here).
Hoisington explains that since 2008, even though U.S. money supply (M) has increased dramatically, velocity (V) has fallen so much that the product MV has remained virtually unchanged. (I'm guessing that this requires making an independent observation on V instead of inferring it from the calculation of PQ/M.) Hence, virtually no change in PQ as well. Since 2008, Q has not decreased -- we haven't had a fall in real output, so we can rule out the case of P rising with Q falling in order to keep the product PQ unchanged. Since the product PQ has remained virtually unchanged and Q hasn't fallen, together they imply that P hasn't risen, i.e. there hasn't been any inflation.
The Fed has engaged in massive liquidity injection in the form of quantitative easing since 2008, but this hasn't caused much if any inflation. The reason is because there is a very strong deflationary force at work. In the absence of this liquidity injection, we would have experienced deflation.
This strong deflationary force is attributable to the presence of elevated debt levels that are associated with the fact that we are living through the last stages of an 80-year debt cycle.
Given that we haven't experienced much inflation since 2008 through today (Oct 2019), imagine what would happen in a recession. Typically, you get mild inflation in periods of growth and then you raise rates in order to slow down the economy and curb inflation. But since we haven't had much inflation during the last decade which can be characterized as one of mild growth, then perhaps we ought to expect larger than usual deflation during the next recession. I.e. everything shifts down.
Source: Please search my Tweeter feed on my recent Tweets from Dalio. Use "Dalio from:haditaheri" as your search string.
Mueller's opinion of U.S. policy-makers:
"Having given up after several years of trying to persuade U.S. policy-makers to change the world monetary system, four of us with connections to Jack Kemp (Lew Lehrman, Jeff Bell, I, and Frank Cannon) formed a business to predict the consequences of the inevitable economic policy mistakes. Most of our clients were money managers (banks, insurance companies, mutual and hedge funds) but also some governments."
How the Triffin Dilemma affects Currencies: An article on Investopedia.
Interesting Charts from St. Louis Fed:
Money Supply
US dollar money supply, 1960 - 2019. Prior to 1960, it probably makes sense to look at the US Monetary Gold Stock as a proxy for money supply.
Ask yourself, by what factor has the money supply increased since a starting date of your choice.
Source: here and here.
CPI and Inflation Rate
Ask yourself, by what factor has the CPI increased since a starting date of your choice.
Source: here and here.
Velocity of Money
Velocity data before 1960 doesn't seem to be available.
Source: here.
[Added on June 20, 2020]: Other experts worth listening to: Lyn Alden (dollar bear), Brent Johnson, Santiago Fund (dollar bull), Jeffrey Snider, Alhmabra Investments (bull or bear???), Luke Gromen (dollar bear). They can all be found on Twitter.
Velocity of Money
Velocity data before 1960 doesn't seem to be available.
Source: here.
[Added on June 20, 2020]: Other experts worth listening to: Lyn Alden (dollar bear), Brent Johnson, Santiago Fund (dollar bull), Jeffrey Snider, Alhmabra Investments (bull or bear???), Luke Gromen (dollar bear). They can all be found on Twitter.
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