Wednesday, March 25, 2009

Triffin's Dilemma

Triffin's Dilemma, identified by economist Robert Triffin, highlights a fundamental imbalance caused by a national currency acting simultaneously as a global reserve currency. Specifically it refers to the US dollar's role under the Bretton Woods agreement.

It states that the use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. Triffin noticed that the US had two competing and incompatible goals while maintaining the Bretton Woods system:

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.

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.

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