Triffin’s Dilemma and the Dollar

By Ichiro Suzuki

Capital is flowing out of China slowly in recent years or in part due to the new trend of de-globalization or stalling of globalization at the very least, or robust spending of Chinese tourists in a variety of popular overseas destinations. In response to it, Beijing is tightening its grip on the country’s capital account for fear of depletion of foreign exchange reserves as well as weakening of its currency. This conduct is not in line with the pledges made to the International Monetary Fund (IMF) several years ago upon the renminbi (RMB)’s inclusion into the special drawing rights (SDR), the Fund’s international monetary reserve consisting of major currencies. For years Beijing coveted that the RMB be a part of the SDR. At this juncture China does not afford to liberalize the capital account, allowing the RMB to free-float sending the currency down most likely. The current situation on the RMB was hardly thinkable in the years that preceded RMB’s admission into the SDR. Back then, China’s economy was roaring at double-digit numbers or in their neighborhood with ballooning current account surpluses. Much larger presence of the RMB in the international market seemed inevitable. There was even a wild speculation that the RMB would one day replace the USD as the world’s reserve currency. Today, such a possibility does not have to be debated until Beijing lifts capital control measures. That the RMB becomes a reserve currency is a stretch by a wide margin and is a much, much longer shot than China’s rise to become the largest economy. Belgian-American economist Alfred Triffin once advocated a theory on reserve currencies that is known as ‘Triffin’s Dilemma’. There is no doubt that a reserve currency has to have sufficient credibility to be entrusted as an international means of transactions and a store of value. In addition, a reserve currency has to be supplied in a sufficient quantity in order to underpin global economic growth. The greater an amount of a currency is supplied to the market, the weaker its value becomes. A greater amount of a currency is supplied in the form of external deficits. A country that supplies a reserve currency to the global economy is required to run current account deficits, and still the currency must not lose the market’s trust. These two propositions contradict entirely. It is for this reason of supplying money that the gold standard was abandoned in the middle of the Great Depression. Due to supply constraints of gold, or any other precious metal, the monetary authorities back then found it impossible to stimulate the economy under the gold standard regime. As long as fixed exchange rates to the gold stayed in place, monetary conditions remained despairingly tight amid the deepest economic downturn in history. Prior to the 20th century, sufficient number of new gold or silver mines were found and new mines made it possible to expand the monetary base to underpin expansion of economic activity. In the 16th and 17th century, gold and silver production sky-rocketed in the newly conquered Latin America, and drove economic growth in Europe. In fact, excessive inflows of precious metals from Latin America drove up inflation rate in Europe. In ancient days, Rome plundered neighboring regions and countries for new supply of gold and silver, underpinning the empire’s economic growth. Today, the U.S. prints dollar notes to increase money supply to in order to support greater economic activities. To the rest of the world, dollar notes are provided in the form of trade deficits. From this perspective, Europe’s single currency does not qualify to be a reserve currency. Europe’s, Germany’s to be specific, persistent current account surpluses tighten monetary conditions, withdrawing euro notes from the market. China is far from being prepared to fill the U.S.’s shoes with no intention of lifting foreign exchange controls. China is not willing to run large scale current account deficits, either, though the once eye-popping current account surpluses, at 10% of the economy, have largely disappeared by the end of 2019. (Surpluses are set to rise again in 2020 due to the coronavirus effects that keep Chinese tourists at home.) Toward the end of the Roman Empire, its currency suffered debasement through reduced gold or silver content in their coins. This debasement led to higher inflation and economic doldrums and eventually caused the Empire’s collapse. However, long after the Empire’s fall, Roman coins were still used in international trade. This shows how sticky the status of a reserve currency is. China may become the world’s largest economy one day, but the greenback is likely to remain as the world’s reserve currency for decades after that one day. While China is not capable of supplying liquidity to the global economy, the RMB’s credibility has not risen four years after the currency’s entry into the SDR. The RMB’s share stands at a paltry 2% both in global trade and central banks’ reserves. Vladimir Putin is willing, at least on the surface, to receive the RMB for crude oil Russia exports to China. Putin’s willingness pleases the senior partner of the anti-American alliance. However, holding a large amount of a currency that lacks liquidity costs something to Russia financially. Russia would have to put up with a few inconveniences, i.e. higher hedge costs and spreads incurred at the time of the RMB’s conversion into the euro or the greenback that are more useful than the RMB. The EU is by far the largest trade partner for Russia, accounting for nearly half of the country’s trade. The largest trading partner certainly has no interest in receiving the RMB for industrial goods and agricultural products they export to Russia. Then, the RMB that Russia received from China has to be converted into the euro, at some costs. The same is true for Belt & Road Initiative (BRI) aid recipient countries that choose to hold the RMB in the country’s FX reserve, essentially to please China than for economic reasons. The Trump Administration has been aggressively taking advantage of the greenback’s reserve currency status. It has already raised eyebrows of many finance ministers. If the U.S. goes too far on weaponization of the dollar, the rest of the developed world might one day get united for an alternative. And this is still easier said than done. However beautifully and meticulously designed the replacement system might be, it might still fall short of winning the market’s trust. The market might find a glitch or two in a system that is supposed to be the pinnacle of engineering. The greenback has functioned so well for such a long time, deeply imbedded in the hearts and minds of users around the world. After all, the British pound served as the world’s premier reserve currency until the British Empire collapsed after WWII, well over half a century after the U.S. overtook the U.K. as the largest economy in the late 19th century. A reserve currency could fade only very slowly if it ever does. About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.

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