Thursday, May 05, 2011

US dollar: Forty Years of the Triffin Dilemma

The Economist calls the angst of the falling US dollar as “Forty years of hurt”

The Economist writes,

THE dollar’s recent decline has taken it to new lows. The chart shows the nominal exchange rate, in trade-weighted terms (ie, against the country’s trading partners). The index is now 30% below its level when the Bretton Woods system was abandoned in the early 1970s and the dollar has halved since 1985, when leading nations adopted the Plaza Accord to drive it lower. There was a rally in 2008 when the dollar attracted “safe haven” flows during the financial crisis, but that now looks like a blip in a 40-year decline. A weak currency should be good news for a country’s exporters, but that hasn’t stopped America from running a persistent trade deficit. And America’s creditors are having to cope with the unappealing combination of holding low-yielding Treasury bonds in a depreciating currency.

In my view, this has been forty years of the Triffin dilemma, where the international reserve currency suffers from the strains of conflicting national and international interests.

Triffin Dillemma, as Wikipedia writes,

is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (i.e. the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfil world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit


The Triffin Dilemma has vastly exacerbated the diminishing purchasing power of the US dollar since the Nixon shock or when the President Nixon closed the gold window in August 15, 1971.

This, by giving the US Federal Reserve the ability to inflate the US economy (overvalue the currency), as well as, the worlds’; given her privilege of Seigniorage profits.


And part of such tensions has been vented through a gamut of global bubbles and the attendant bailouts and other redistributive policies.


A US dollar today is only worth 18 cents in 1971 dollars, that’s according to the CPI inflation calculator from the US Bureau of Labor and Statistics.

As the US Federal Reserve continues to prop up her financial system, this declining trend of the US dollar’s purchasing power should persist.

And so with all paper currencies which are founded on politics rather than the markets.

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