6 minTriffin, Trump, and two accounting identities
Guy Wagner Being at the heart of the world's monetary system is a major advantage for the USA. However, some observers are beginning to point out the disadvantages for the United States of having the world's reserve currency.
1. Triffin's dilemma
Robert Triffin was a Belgian-American economist, best known for his criticism of the Bretton Woods financial system. In the 1960s, he identified a problem with international reserve currencies, now known as Triffin's dilemma. This can be summarized as follows:
- For a country's currency to serve as an international reserve currency, the country that issues it must ensure that there is a sufficient amount of its currency available worldwide;
- This normally means that the country in question must run trade deficits. By importing more than it exports, it “floods” the rest of the world with its currency.
- In the long run, however, these deficits risk undermining confidence in the currency.
For the dollar as a global reserve currency, the dilemma therefore concerns the incompatibility between providing enough dollars to the rest of the world and maintaining stability and confidence in the greenback. When Triffin articulated his dilemma, the dollar was still convertible into gold. By guaranteeing the convertibility of their currency into gold, the United States was precisely trying to maintain confidence in the dollar.
Starting in the 1960s, the country had run high budget and trade deficits. These deficits led to a loss of confidence in the greenback and prompted many countries to demand that their dollars be converted into gold. As a result, US gold reserves declined rapidly. At the same time, US attempts to convince its trading partners to revalue their currencies failed. This ultimately led President Nixon to end the dollar's convertibility into gold in 1971. It is interesting to note that at the same time, Nixon announced a temporary 10% surcharge on imports to protect US industry. By unilaterally ending the convertibility of the dollar into gold, the US showed even then that it was prepared to put its national interests before those of the international order.
2. Advantages and disadvantages of the dollar as a global reserve currency
The advantages for the US of having the world reserve currency appear to outweigh the disadvantages by far. When he was Finance minister in the 1960s, future French president Valéry Giscard d'Estaing described the US's position as issuer of the global reserve currency as an “exorbitant privilege.” A few years later, his US counterpart, John Connally, said that “the dollar is our currency, and your problem,” emphasizing the United States' refusal to subordinate its domestic economic policy to global considerations.
Having the dollar as the global reserve currency gives the United States two major advantages:
- The ability to finance itself at low cost and to finance its trade deficit by issuing its own currency. Also, most commodities are denominated in dollars, so US companies and banks are not exposed to exchange rate risk;
- Control of the global financial system and the geopolitical power that comes with it, including the ability to impose economic sanctions by controlling access to the dollar banking system.
However, there has been growing concern in the US for some time about the disadvantages of the current situation. Many observers believe that it has led to the deindustrialization of the United States, which could jeopardize US military supremacy. Several reports by the Department of Defense thus highlight the erosion of the industrial base as a major risk to national security, citing the fact that the United States is becoming increasingly dependent on external sources for the supply of critical components. Other disadvantages highlighted include excessive public and private debt, over-financialization of the economy, and the risk of financial bubbles.
3. The balance of payments and savings-investment identities
The balance of payments identity indicates that the sum of the current account and the capital account equals zero. In other words, if a country has a current account deficit (or trade deficit, to simplify), it must finance it with a surplus in its capital account.
The savings (S) - investment (I) identity indicates that savings minus investment equals net exports (NX):
S – I = NX
In other words, if a country's savings are lower than its investment, it must import foreign savings.
Since the mid-1970s, the United States has recorded an almost continuous trade deficit. Based on the identities presented above, this means that the United States consumes/invests more than it saves and that the country regularly has a capital account surplus, i.e., it imports capital. Many economists have therefore established a cause-and-effect relationship, taking the low savings rate in the United States as the starting point and the country's trade deficit as the result, arguing that “the United States is living beyond its means.”
However, this reasoning is increasingly being questioned by other economists who argue that it is, on the contrary, the country's capital account surplus that is causing its insufficient savings and trade deficit. This capital account surplus is the result of:
- The role of the dollar as a global currency. The rest of the world wants to hold dollar assets. The United States therefore acts as a global importer of capital and must maintain trade deficits;
- The mercantilist policies pursued by other countries aimed at favoring their exports at the expense of domestic consumption, notably through wage moderation and the maintenance of an undervalued currency. Germany, Japan, and China are often cited as examples of countries pursuing such a strategy.
Donald Trump does not like trade deficits, free trade agreements, or the way global trade is currently organized, which he considers unfair to the United States. He also wants to reindustrialize the United States. At the same time, he is aware of the advantages for the United States of having the global reserve currency. It is therefore logical to assume that he will focus his efforts on the second point by putting pressure on certain countries to reduce their trade surplus with the USA. If he believes that it is the capital surplus that is driving the trade deficit, he could even impose restrictions on capital movements to the US.
4. Is the US's outperformance coming to an end?
As mentioned above, the mirror image of the US trade deficit is the US capital account surplus. A decline in one will lead to a decline in the other. If, as Donald Trump says, the organization of world trade has been unfavorable to the US manufacturing sector, it has been very favorable to the US financial sector and stock market. A reduction or even elimination of the US trade deficit would lead to a reduction in demand for US financial assets and put an end to the outperformance of the US stock market.
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