The Greek Drama got me to thinking about the calls for a new Bretton Woods and the US role as the global reserve currency. It gives the US an advantage of seniorage, which in a fiat currency (as compared with specie) lets it print more Dollars than ever come back home to cause inflation, as a float must remain out of the US to be used for global trade, particularly in oil. Yet this purported advantage ends up creating a persistent trade deficit, where the gap is not really due to loss of trade but due to excess demand for Dollars. (The accounts must balance – a Dollar surplus begats a trade deficit.)
Under Bretton Woods, the US avoided this for years due to returns on overseas investments, repatriating Dollars back home, but the debt-driven hunger of the expanding welfare state eventually overwhelmed that and threw the US into a persistent trade deficit. The expansion of government, particularly the “guns & butter” Great Society in the ’60s, resulted in gold flowing out, and the US having to ‘cheat’ on the gold standard to stem the flows. Eventually Bretton Woods broke down, and Nixon went off gold. Memories my be short, but did you know that the US sent gunboats to South Africa around 1968 to force them to release gold they were hoarding? Such was how low we sunk, and with it the Dollar.
The floating exchange system that replaced it was brilliant – thanks, Milton! Rather than having fixed exchange rates and relying on the flows of gold in and out, leading to gold gamesmanship and cheating on the standard, floating rates punish poor government policies much more quickly by sinking currencies. Within a broad currency like the Euro region, the punishment comes from the bond market, but more slowly. (We can see this drama unfold with Greece.)
Floating rates can be self-correcting process, as falling currencies enhance exports, which can cause the currency to rise again. Floating rates can act like tariffs to protect developing countries, whose cheap currencies make imports expensive, and drive the internal economy towards import-substitution and later export-expansion. It is probably lost to political memory that the Repubs used to be the party of tariffs to protect nascent industry, and the Demos the party of hard money to protect the value of King Cotton. The parties somewhat have flipped, where the Repubs support free trade, and the Demos support easy credit to pay for the welfare state; but it was Nixon who went off gold, and Clinton who pushed for NAFTA.
Floating rates, however, have one troubling flaw: having the USD the reserve currency means US domestic policy gets exported to the rest of the world. Off gold in ’71, we exported our inflation. Saved by Volcker in ’79, we drove too strong a currency. Worried about Japanese imports in ’86, we coordinated a devaluation of the Dollar in half (in a year!). What followed was the crash of ’87, the Japanese bubble of ’89, the S&L crisis, and the seeds of the Greenspan Put, which created the moral hazard that we now call the Greatest Asset Bubble of All Time in the 2000s.
Compounding this flaw is the capability of mercantilist economies to peg their currencies to the Dollar and preclude the readjustment of floating rates; if they peg low enough, they have erected effective tariffs to protect their internal markets, created incentives for high savings (which are cycled back into business investment), and baked-in a competitive export advantage. In places like China, mercantilist currencies would normally have risen against the Dollar and Euro to compensate for the huge reserves they have accumulated.
The Triffin dilemma, less commonly called Triffin paradox, is the fundamental problem of the United States dollar’s role as reserve currency in the Bretton Woods system, or more generally of a national currency as reserve currency. Briefly, the use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: to maintain all desired goals, dollars must both overall flow out of the United States, but must also flow in to the United States, which cannot both happen at once.The dilemma is named after Belgian-American economist Robert Triffin, who first identified the problem in 1960.
Harrison goes on to explain:
[T]he reason credit has surged dramatically over the last generation has much to do with the monetary system; unless we successfully reflate asset prices, the claims on dollar-based assets cannot be met under this jerry-rigged monetary system with the U.S. dollar at the core. I see this as a Ponzi scheme which is now in its final chapter.
He sees two ways out: follow the easy money path and keep pumping out US-denominated debt (the course we are on) until it blows up; or follow the Volcker path of backing the Dollar and risking a deflationary spiral. Neither are attractive, and neither would fix the Triffin Dilemma.
Let me propose a way out: an independent global currency against which all others would float. This approach can distance the rest of the world from US domestic politics, and get the US off the hook of running persistent trade deficits in order to provide persistent Dollar surpluses.
I have mentioned that I have a bet that we will be back on some form of gold by the end of this decade, but neither that bet – nor this proposal – necessitates the classic gold standard, nor the bastardized Bretton Woods gold-exchnage standard. Gold can play a role in this new global currency without going back to fixed exchange rates. Gold in effect would circulate with fiat currencies, and help keep the float honest.
To make the new system work, the US would have to be a major backer, and likely the Fed (or several central banks acting in concert) would have to become the lender of last resort of the world. I have thought that politically the US would oppose such a new system vigorously, down to the last ounce of value in the Dollar; in other words, we would have to be forced by our trading partners into the new system. If the global economy falls into a double-dip after the huge monetary and fiscal stimulus, the political dynamic of shock & awe in the failure of reflation & easy credit should be much more open to a new direction. Paradoxically, our potential failure leads me to have more hope in this change.
Dubai, then Greece, then perhaps the other PIIGS; this is much broader and worse than prior financial crises like the Asian Flu. The last time we had broad repudiation of debt and sovereign defaults was in 1931, and it resulted in the abandonment of the gold exchange standard. This time it might drive a similarly radical change of the world financial system.