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The Debate Over De-Dollarization
Recent headlines about “de-dollarization” have sparked concerns over the future of the U.S. dollar as the global reserve currency. Critics argue that chronic U.S. deficits have created an unsustainable system, with some warning the dollar’s dominance may be nearing its end.
Yet, this debate often overlooks a deeper paradox: the burdens of being a reserve currency issuer, famously captured by "Triffin’s Dilemma".
Let’s break down this dilemma and see how it's shaped the global economy and why no country - not even China or Russia—seems eager to replace the dollar.
What Is Triffin’s Dilemma? A Quick Primer
Now, this is a brief look back in history, but it’s very important to go over. So, bear with me.
Triffin’s Dilemma – named after economist Robert Triffin – is a term showing the paradox between having a global reserve currency and domestic deficits/surpluses.
See, Triffin’s original issue was with Bretton Woods1 (aka the post-World War Two dollar-gold monetary system) and how it exposed a fundamental flaw in the international monetary system.
In summary: Triffin testified2 to Congress in 1960 that the U.S. was stuck in a ‘Catch-22’ (aka a problem for which the solution is denied because of another problem).
Put simply – if the U.S. stopped running budget deficits – then the global economy would lose its main source of liquidity (aka U.S. dollars; the reserve currency). And this shortage of liquidity would increase global fragility and sink growth.
Remember: since the U.S. dollar was the reserve currency backed by gold, foreign nations needed first to gain dollars to build up their own reserves. Then later exchanged for gold if they wished. Thus the U.S. must constantly run deficits, buying more than it sells, to provide dollars globally and drive growth for foreign countries (since the U.S. was buying more of their goods).
It’s a relatively simple point that Triffin showed – but here’s where it gets interesting. . .
On the other hand – if the U.S. continued running deficits (buying more than it sells) to supply the world with dollars and thus economic growth, it would erode the confidence in the dollar. Which would lead to a run-on the U.S. gold supply (since ever-more dollars outstanding are claims on the ever-finite amounts of gold). Thus – the dollar’s value as a reserve currency would diminish, leading to further fragility, inflation, and disorder.
See the problem? It’s a “damned if do; damned if don’t” situation that Triffin noted.
Put simply. . .in the 1960s, Triffin explained this “Catch-22” to Congress:
- If the U.S. runs deficits: It provides the global liquidity needed for trade and growth but risks eroding confidence in the dollar.
- If the U.S. reduces deficits: It strengthens domestic economic stability but creates global liquidity shortages, stifling growth.
Well, the U.S. government tried to fight this paradox for over a decade (1960-1971).
Why? Because it was enjoying the benefits of freely spending money. Thus, exporting inflation globally through huge deficits.
For example: President Johnson’s ‘Guns and Butter’3 policy for funding both the domestic ‘war on poverty’ and Vietnam were wildly expensive.
Until eventually – it was too late. . .
Thus in 1971 – eleven years after Triffin testified – President Nixon suspended the dollar-to-gold window (effectively ending Bretton Woods) to prevent further gold outflows as inflation roared.
So, in the end – Robert Triffin’s monetary ‘dilemma’ proved accurate.
“But why does that matter today?”
Good point, since we’re not on a gold standard anymore. But Triffin’s Dilemma still holds true.
Why Triffin’s Dilemma Still Applies Today
Now – while Triffin’s-Dilemma was originally based on the dollar-gold fixed exchange system (Bretton Woods). I believe it still holds true today.
Why?
Because even in a fiat-based monetary system (aka money not backed with convertibility) – the U.S. dollar acts as paper ‘gold’.
Foreign nations still require dollars to build up their own reserves. And they do so in droves - whether it’s to buy goods from other nations or lend out the dollars.
· Most countries settle trade using dollars because they each can all accept and settle liabilities with it. They also can use dollars to maintain their own currency exchange rates, etc.
To put this into perspective, the U.S. dollar’s share of global currency reserves – according to the International Monetary Fund (IMF)4 is at roughly 60%.
Meanwhile, U.S. federal debt held by foreigners and international investors sits at over $7.6 trillion as of Q3-2023.
One thing to point out is after the 1997 ‘Asian-Contagion’ crisis – when financial fragility spread globally throughout emerging markets in Asia – foreign nations began buying huge amounts of dollar-assets. It’s likely because these foreign nations wanted a chest of dollar reserves to prevent another insolvency and currency crisis like 1997.
And don’t forget that the “Clinton surpluses” – when the U.S. ran surpluses between 1998 and 2001 – preceded the Asian Contagion crisis and the 2001 recession.
Meanwhile, the dollar (the DXY) continues rising in value relative to foreign currencies - sitting around 20-year highs5 – due to continued global demand.
So – it appears that the U.S. dollar is still regarded as the safest and most liquid asset for global reserve holdings.
Just as gold was pre-1970s.
Ever notice how every time the U.S. Federal Reserve raises interest rates, other countries also do? Or vice versa? That’s because of how important the U.S. dollar is in global markets.
And this is why Triffin’s-Dilemma is still very relevant. . .
Because even without gold, when the U.S. curbs dollar outflows through lower deficits or increasing surpluses – there’s a drain on global liquidity that also weighs down growth. (And vice-versa).
This dynamic starves the world of the liquidity required for growth and debt repayment (such as dollar-denominated loans in foreign countries, how else will they get the dollars then?)
See, when the U.S. runs a deficit, it’s buying more than it sells, thus fueling growth to whoever exports it to the U.S. (such as China or Japan or etc).
And secondly, the U.S. treasury is the only entity able to create physical dollars. Thus, if foreign countries take out dollar-denominated loans, they will depend on dollar inflows (from exports) to even get the dollars to repay them.
Thus, it appears how the U.S. sets its own budget (influencing deficits or surpluses) directly impacts the world economy.
But this chronic deficit also comes with downsides – such as diminishing U.S. manufacturing base, heavy amounts of debt, and potential inflation.
The Exorbitant Burden of the Reserve Currency
The “exorbitant privilege” of the dollar comes with significant downsides, including:
- Erosion of U.S. Manufacturing: Continuous trade deficits have weakened the U.S. industrial base, with domestic production crowded out by imports.
- Global Currency Manipulation: Countries like China keep their currencies artificially weak against the dollar to boost exports, exacerbating U.S. trade imbalances.
- Debt Dependence: Deficits require debt. And foreign investors already hold over $7.6 trillion in U.S. federal debt. This creates vulnerabilities, as confidence in the dollar could falter if deficits spiral out of control.
And despite these challenges, no country - whether China, Russia, or another contender - seems eager to replace the dollar. The structural sacrifices required to be a reserve currency issuer, including running persistent deficits, conflict with their domestic economic goals.
Conclusion: A Paradox That Endures
Triffin’s Dilemma remains a powerful lens for understanding the global economy.
The U.S. faces a perennial choice:
- Run larger deficits to fuel global liquidity and growth, at the cost of domestic vulnerabilities.
- Reduce deficits, risking a liquidity crisis and slower global growth.
This paradox is why the “exorbitant privilege” of the dollar also doubles as an exorbitant burden.
The next time you hear about de-dollarization, ask: Is any nation truly ready to embrace these challenges?
But – for now – it’s some food for thought.
Sources:
1. https://en.wikipedia.org/wiki/Bretton_Woods_system
3. https://www.investopedia.com/ask/answers/08/guns-butter.asp
4. https://www.reuters.com/markets/currencies/us-dollar-share-global-fx-reserves
5. https://www.marketwatch.com/investing/index/dxy
Disclosure:
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