A Solution to “Triffin’s Dilemma?”

Has the United States dollar conquered “Triffin’s dilemma”?

That is… is the dollar safely and securely perched atop the global monetary system?

Today we turn away from the bright, sunlit world of appearance… and seek our answer in the “shadows.”

For “the eye is always caught by light,” as author Gregory Maguire styles it — “but shadows have more to say.”

To these shadows we shall listen.

Belgian economist Robert Triffin argued decades ago that:

If a nation’s currency is to put in double duty as a global reserve currency, the issuing nation must print drowning amounts — far beyond its national needs.

Why? To keep global trade going along.

The Burden of a Global Currency

A failure of its printing press would deprive the world of required funds. And the gears of global commerce would grind down.

That is, the issuing nation must issue heroic amounts of currency to hold global trade together.

An Argentina, for example, may wish to purchase oil from a Saudi Arabia. But Saudi Arabia — understandably — may not accept Argentine pesos in exchange.

But if Argentina dangles out United States dollars instead, these Saudi Arabia can use.

Multiply this example in countless directions and you have the flavor of it.

Why then the dilemma?

Because the nation ladling out the reserve currency must run chronic current account deficits.

Triffin argued these chronic deficits would eventually bring down tremendous weights upon the currency.

That is, the currency’s vastly excessive supply would fatally undermine its value.

This currency would plunge toward nothingness. Interest rates would go skyshooting as the world emptied overboard the increasingly worthless paper.

Hence… Triffin’s dilemma.

But come pull up to the facts…

Why Hasn’t the Dollar Collapsed?

The United States has piled up record current account deficits lo these many years — twinned with a $23 trillion national debt.

And trillion-dollar annual budget deficits run out to the distant horizon.

Yet — yet — the dollar has rarely been mightier. And interest rates have rarely sunk lower.

10-year Treasury yields scrape along under 2%. And 30-year Treasury yields?

They run scarcely higher… at 2.24%.

That is, debt has never scaled such dizzied and obscene heights. Yet the dollar remains king, as deeply enthroned as ever.

And interest rates wallow near record lows.

Where then is the long-lamented death of the dollar? Where is the mass exodus from the greenback?

Shrieks about its looming demise have gone out for decades.

Yet here it stands.

It is true, this central bank or that central bank may reduce its dollar holdings. It may heave part of its Treasury holdings out the door.

But it makes no nevermind, argues Jeffrey Snider of Alhambra Partners…

Central Banks Aren’t Central

That is because central banks are no longer central — as Mr. Snider has previously argued in these pages. The dins, clamors and carrying-ons of the central banks signify nothing:

The central bank is not central… The thing people have the most trouble with is the idea that central banks are not central. It flies in the face of everything you have been taught and told your whole life. There is no money in monetary policy; it is entirely psychology…

Monetary policy contains no money; it runs entirely on expectations. Therefore, according to this view, what ultimately matters is how you perceive monetary policy…

How we perceive monetary policy?

Then you might act in anticipating all that “money printing” was going to have stimulative and even sharp inflationary effects. You might then pull forward purchasing activity, or, if a business, hiring and production, before the expected higher costs arrived.

Just so. But it has clearly failed.

If central banks are no longer central… what then is central?

As Snider has also argued in these pages, here is the answer:

The “shadow banking system.”

The Shadow Banking System Casts Its Shadow Across the World

The shadow banking system is the deeply interconnected network of banking institutions that operate outside direct control of central banks.

They include the large Wall Street banks and their offshore units.

This shadow banking system extends its shade across Europe, the Caribbean and Asia — the world over.

It first took shape in the 1950s and ’60s. That is, after Bretton Woods hoisted the dollar up to global dominance.

It expanded through the 1980s, ’90s… and beyond.

Entirely beneath notice, the shadow banking system shouldered the central banks out of the international monetary system.

“The Dollar Did Not Replace Gold in 1971. The [Shadow Banking System] Did Long Before 1971”

Snider: “The global money system moved on without central banks bothering to notice.” More:

The dollar did not replace gold in 1971. The [shadow banking system] did long before 1971…

Especially from the 1960s forward, and particularly in the 1990s forward, was that as the [shadow banking system] replaced other forms of mediation in global trade. What actually happened was it became a parallel banking system unto itself… with no backing by gold or by physical cash issued by the U.S. Treasury…

That balance clearly shifted and changed throughout the ’80s. When the pound crisis hit in 1992, central bankers were astounded by the massive offshore liquidity that easily dwarfed what they could answer with. The balance of money had shifted, dramatically, yet economists and policymakers did not shift with it…

And the shadows are so opaque, so impenetrable… they escaped regulation:

So what we’re describing here is almost an entire massive complete system… that existed offshore and wholesale, in the shadows, because there was no regulatory authority… no government authority over the conduct of this system. It was essentially a self-contained system that operated beyond the reach of everybody.

“The Real Action Transpires in the Shadows”

This shadow banking system runs on dollars — as the respiration runs on oxygen, as autos run on gasoline — as politics runs on lies.

As much as 80% of international trade is invoiced in the dollar. And this dollar participates in nearly 90% of all foreign exchange trades.

Meantime, nearly 40% of the world’s debt is issued in dollars. And offshore banks sit upon perhaps $18 trillion in dollar-denominated international liabilities.

Yes, the real action transpires in the shadows. Snider:

The world needs dollars for the purposes of a global reserve currency. It gets them from this [shadow banking] system…

You want to swap yen for U.S. Treasuries? Credit-based “dollars.” You want to swap yen for Singapore bonds? Credit-based “dollars.” A company in Brazil wants to ship China raw material? Credit-based “dollars.” A firm in Europe is trying to build capacity in Thailand? Credit-based “dollars”…

The [shadow bank’s] dollar is the world’s true reserve currency; therefore, problems in it are going to be problems shared by the whole interconnected global economy…

A Way out of Triffin’s Dilemma?

Can we conclude the shadow banking system offers the way out of Triffin’s dilemma?

After all, its thirst for dollars is seemingly infinite. And the dollar packs a wallop… despite record debts and infinitely mushroomed deficits.

So turn your focus away from the central banks, argues Snider.

Is the Russian central bank hoarding gold in conspiracy against the dollar? Is the People’s Bank of China shoveling dollars overboard? Is the Bank of Japan losing its yen for dollars?

Be not deceived.

As long as the shadow banking system runs on dollars… so does the world:

Unless and until the banking system moves away from dollars, diversifying national reserve holdings means absolutely nothing. Nothing… despite a decade’s worth of noise, fury and quite often heartache, there is simply no realistic alternative… We are stuck with this arrangement largely because the media, politicians, central bankers, etc., don’t know a thing about it.

But perhaps each American should fall upon both knees… and thank fortune for this shadow banking system.

It may be the central pillar holding the dollar up high…


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning