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In what could cause a dollar crash is due to the ongoing money printing and devaluing the dollar. If the US dollar were to ever be removed as the reserve currency of use for trading and oil purchases, it would cause cataclysmic destruction to the economy. Rumors have surfaced over a year that countries would rather trade in other currencies and the US have debasing the dollar.

In the wake of the Financial crisis of 2007-2008, the governor of the People’s Bank of China explicitly named the Triffin Dilemma as the root cause of the economic disorder, in a speech titled Reform the International Monetary System. Zhou Xiaochuan’s speech of 29 March 2009 proposed strengthening existing global currency controls, through the IMF. This would involve a gradual move away from the US dollar as a reserve currency, and towards the use of SDRs (IMF Special Drawing Rights) as a global reserve currency. Dr Zhou argued that part of the reason for the original Bretton Woods system breaking down was the refusal to adopt Keynes’s Bancor which would have been a special international currency to be used instead of the dollar. American economists such as Brad Delong have agreed that on almost every point where Keynes was overruled by the Americans during the Bretton Woods negotiations, he was later proved correct by events.

Dr Zhou’s proposal attracted much international attention; in a November 2009 article published in Foreign Affairs magazine, economist C. Fred Bergsten argued that Dr Zhou’s suggestion or a similar change to the International Monetary System would be in the United States’ best interests as well as the rest of the world’s.While Dr Zhou’s proposal has not yet been adopted, leaders meeting in April at the 2009 G-20 London summit did agree to allow $250 Billion of SDRs to be created by the IMF, to be distributed to all IMF members according to each country’s voting rights.

The Triffin dilemma (less commonly the Triffin paradox) is the observation that when a national currency also serves as an international reserve currency (as the US dollar does today), there are fundamental 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 issuing the global reserve currency must be willing to run large trade deficits in order to supply the world with enough of its currency to fulfill world demand for foreign exchange reserves. 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: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Currency inflows and outflows of equal magnitudes cannot both happen at once.

The Triffin dilemma is usually used to articulate the problems with the US dollar’s role as the reserve currency under the Bretton Woods system, or more generally of using a national currency as an international reserve currency.

Due to money flowing out of the country through the Marshall Plan, US defense-spending and Americans buying foreign goods, the number of U.S. dollars in circulation began to exceed the amount of gold backing them up in 1959. By the fall of 1960, an ounce of gold could be exchanged for $40 in London, even though the price in the U.S. was $35. This difference showed that investors knew the dollar was overvalued and that time was running out.

There was a solution to the Triffin dilemma for the U.S.: reduce the number of dollars in circulation by cutting the deficit and raising interest rates to attract dollars back into the country. Both these tactics, however, would drag the U.S. economy into recession, a prospect new President John F. Kennedy found intolerable, although he did sign an executive order allowing the US Treasury “to issue silver certificates against any silver bullion, silver, or standard silver dollars in the Treasury.” This would create competition to the Federal Reserve Notes (dollars) that were overvalued. To maintain the Bretton Woods system and exert control over the exchange rate of gold, the US initiated the creation of the London Gold Pool and the General Agreements to Borrow (GAB) in 1961 which sustained the system until 1967 when runs on gold and the devaluation of the pound sterling were followed by the demise of the system.

In August 1971, President Richard Nixon acknowledged the demise of Bretton Woods system. He announced that the dollar could no longer be exchanged for gold, which soon became known as the Nixon shock. The “gold window” was closed. In order to maintain the Bretton Woods system the US had to:

a) run a balance of payments current account deficit to provide liquidity for the conversion of gold into US dollars. With more US dollars in the system the citizens began to speculate, thinking that the US Dollar was overvalued. This meant that the US had less gold as people starting converting the US dollars to gold and taking it offshore. With less gold in the country there was even more speculation that the US Dollar was overvalued.

b) run a balance of payments current account surplus to maintain confidence in the US Dollar.

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.

Tags: balance of payments, Bancor, Bretton Woods, Debt, dollar collapse, Financial Crisis, gold, IMF, inflation, Keynes, Marshall, Nixon, reserve currency, SDR, SDRs, treasuries, Triffin, Triffin dilemma, US Deficit, us dollar

This entry was posted on Wednesday, December 8th, 2010 at 9:19 pm and is filed under Contributors, Debt, Economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.