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Friday, January 30, 2009

Gold and the Dollar Crisis

I have to admit that I get some kind of a bizarre (sadomasochistic?) joy out of these intellectually challenging economics books. But then I like to read for Faulkner for fun and devote a significant chunk of time to the upkeep of a blog whose number of hits (aka readers) is, well, not overly impressive, maybe I simply am bizarre when it comes down to it. In any case, Robert Triffin's Gold and the Dollar Crisis - The Future of Convertibility was fun, even if I only read the first half (the second half deals with his proposed changes to the Bretton Woods system finally truly in place in 1958 - analyzing never enacted reforms to a system not in place anymore felt a little bit too hardcore).

Triffin of course is the source of the famous (maybe my perception has become a little bit skewed here) Triffin dilemma, which states that a continued American capital deficit is necessary in order to provide the liquidity needed in an economically expanding world, while it will at the same time undermine the dollar's credibility as the global reserve currency because of the increasing gap between American gold reserves and greenbacks circulating (metaphorically speaking).

In his own words:
'The gold exchange standard may but does not necessarily, help in relieving a shortage of world monetary reserves. It does so only to the extent that the key currency countries are willing to let their net reserve position decline through increases in their short-term monetary liabilities unmatched by corresponding increases in their own gross reserves. If they allow this to happen, however, and to continue indefinitely they tend to bring about a collapse of the system itself through the gradual weakening of foreigners’ confidence in the key currencies.'

Very similar to Eichengreen's analysis at times, he argues that up to 1914 the gold standard worked and provided stability (to major Western countries in any case) because of cushioning, private financial flows (because of the expectancy that problems would be solved and currencies not depreciated) as well as 'higher endurance of macroeconomic suffering' (unemployment namely) feasible due to very restrictive voting rights (and in turn a lack of democratic accountability). He differs from Eichengreen in the sense that these explanations do not suffice in his opinion. He thus adds the 'widespread acceptance of long-term deficits' and the fact that major imbalances were prevented ex ante before its impacts on employment or growth could be felt. Finally, 'financing of expenditures over production did not exist in any dangerous manner.'

All of this changed after WWI. Especially private financial flows became accentuating rather than cushioning of the impact of current account imbalances simply because the belief that currencies would not depreciate had evaporated (here his and Eichengreen's analyses are congruent again). Basically the same situation developed around the Dollar (not the Pound Sterling of the interwar years) after WWII.

Triffin's dilemma of course perfectly summed up the situation and his definition quoted above describes perfectly what 'happened to the UK in 1931' and (unbeknownst to him in 1960 of course) to the USA in 1971 and 1973. Ironic in retrospective is that Triffin shows himself convinced that this situation would not arise again. 'Only an incredible complacency on our part could [...] force us to suspend or modify the legal gold cover requirements of the Federal Reserve System.' His main concern lies with the deflationary consequences of an adjustment to the American balance of payments deficit instead.

His suggestion to solve this problem lies with an international lender of last resort, more powerful and better financed than the current (or historic) IMF since 'the basic absurdity of the gold exchange standard is that it makes the international monetary system highly dependent on individual countries’ decisions about the continued use of one or a few national currencies as monetary reserves.'

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