Triffin dilemma

The Triffin dilemma, less commonly called Triffin's paradox, is the problem of fundamental imbalances in the Bretton Woods system. The dilemma is named after Belgian-American economist Robert Triffin, who first identified the problem in 1960.

Thanks to money flowing out of the country through the Marshall Plan, US defence spending and Americans buying foreign goods, the number of U.S. dollars in circulation soon exceeded the amount of gold backing them up. By the early 1960s, 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 over-valued.

In August 1971, President Richard Nixon acknowledged that the Bretton Woods system was finished. 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 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 was overvalued.

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

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.

References

* [http://www.imf.org/external/np/exr/center/mm/eng/mm_sc_03.htm System in Crisis (1959-1971)]
* "Triffin, Robert." Britannica Book of the Year, 1994. Encyclopædia Britannica Online. 6 Apr. 2006 .
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