We Can’t Handle the Truth

The truth is that the dollar’s continuing position as the global reserve currency will make it darned tough for the U. S. to “bring manufacturing back” to the United States. At the Wall Street Journal John D. Mueller remarks:

French economist Jacques Rueff described the fatal weakness of foreign-exchange reserves in a 1932 lecture. He explained that when a monetary authority accepts dollar or sterling claims for its official reserves rather than gold, purchasing power “has simply been duplicated,” so that, for example, “the American market is in a position to buy in Europe, and in the United States, at the same time.” In other words, when a foreign nation accepts repayment in U.S. dollars it increases its money supply without diminishing the U.S. money supply, allowing both countries’ central banks to lend in dollars.

This credit “duplication” is not only inflationary in the reserve-currency country and any country whose currency is tied to the reserve currency; it also necessarily causes the average price of goods to rise faster in the reserve-currency country than among its trading partners. This is why Britain’s and America’s manufacturing industries lost their competitiveness as exporters, resulting in deindustrialization.

This so-called Triffin Dilemma, though first described by Rueff, was named around 1960 for the Belgian-American economist Robert Triffin, who described the post-World War II unraveling of the Bretton Woods gold-exchange system. Under the gold standard, the world-wide increase in monetary gold equaled the world’s net exports. The problem of the Triffin Dilemma is that every additional dollar of foreign-exchange “reserves” must be matched by an equal deficit in the reserve-currency country’s net exports—that is, by net imports.

The glut of reserve currencies made the 20th century a period of intense inflation. The average price of British goods increased 72-fold from 1900 to 2000, while U.S. prices rose 18-fold over the same period. These increases far outpaced inflation in other major export countries that did not provide international reserve currencies. The prices of German, Japanese and Chinese goods all have fallen compared with U.S. exports.

Tariffs and other forms of protectionism can’t restore America’s export competitiveness. They invite retaliation, inhibit trade, and raise prices even higher. The uncompetitive U.S. price level is effectively a tariff on American goods. Thinking that another tariff will help American workers makes no more sense than believing one can heal the injuries of a pedestrian hit by a car by backing up over the victim.

The Triffin Dilemma can’t be solved without a monetary reform that ends the dollar’s use as the world’s chief reserve currency. Here’s a deal that could place Mr. Trump in Alexander Hamilton’s league: Persuade America’s sovereign creditors that the U.S. will convert every penny of foreign dollar reserves into long-term government-to-government debt, to be paid off in gold over, say, 30, 40 or 50 years. Hamilton’s plan paid off the debt from the American Revolution by the mid-1830s. The gradual repayment of all outstanding official foreign dollar reserves would reverse America’s industrial decline by restoring the price competitiveness of U.S. manufacturing.

Why hasn’t the euro become the world’s reserve currency (I hear someone ask)? There are many reasons. The Germans don’t want it to be because they’re fully aware of the Triffin Dilemma and want to continue their export-driven growth. The European Central Bank does not allow the amount of liquidity that would be required, probably for that reason. European countries have too much sovereign debt. And there are concerns about the stability of the European Union.

If the yuan were convertible, it might be a better candidate but it isn’t so it’s not. Besides, a currency that’s still under the control of a relative handful of Chinese officials who are committed to a mercantilist approach to economic growth is pretty risky.

Frankly, I doubt that Mr. Mueller notion of an effective return to the gold standard will gain much traction. The present system gives unearned benefits to too many people. It provides benefits to people who deal in dollars, it makes it less expensive for the federal government to borrow, and it allows Americans to consume (particularly to consume oil) at prices lower than would otherwise be the case.

There are some things that could be done short of a return to the gold standard. For example, the World Bank has guidelines for the volume of dollar holdings that countries may maintain. China, Germany, Japan, South Korea, and many other countries that seek to grow via exports maintain holdings in dollars that far exceed those guidelines. The World Bank could start penalizing those countries. Obviously it won’t but it could.

Still, it would be nice if more Americans and particularly American pundits and politicians understood that the dictums of classical economics about international trade presuppose the gold standard.

4 comments… add one
  • CuriousOnlooker Link

    Prettis has mentioned this multiple times; the free movement of capital is necessary for free trade (as well as the product of it).

    On that front; the expanded powers granted to CFIUS and the effective veto of all Chinese investment in sensitive areas (that is getting lengthier by the minute) maybe a sign of things to come.

    It seems like this is one area that should be tackled in trade agreements. If using fiat currencies; automatic balancing measures if imbalances in net trade and currency become too large.

  • TastyBits Link

    This is based upon the quote from the article. I have not read it because it is behind the WSJ’s paywall, and I do not feel like jumping through hoops to get to it.

    When Nixon ‘closed the gole window’ (canceled converting dollars into gold for foreign countries), there has been no reserve currency. When LBJ removing the ‘gold cover’ for dollars, foreign countries realized that the dollar’s value was quickly deflating, and they began to convert dollars to gold as fast as possible. Nixon did what he did because the US’s gold supply was quickly dwindling.

    We now have all fiat currencies, and all these fiat currencies are commodities that are only worth what somebody is willing to pay at the time of sale. The dollar is considered the reserve currency because there are so many of them on offshore accounts.

    Eurodollars, petro-dollars, or my ‘trade-deficit dollars’ are the same thing.

    When goods are exported and imported by two countries, the goods are priced in a currency. This currency could be the exporter’s currency, the importer’s currency, or a third party’s currency. It must be widely available, and it must have some value.

    Few currencies meet these criteria. China’s yuan is not available. Venezuela’s bolívar is worthless.

    If Russia buys Chinese goods, the Russians can purchase enough yuan, the Chinese can accept rubles, or they can agree on another currency. This could be Venezuela’s bolívar, but dollars are preferable.

    Most of these trade-deficit dollars (eurodollars) will never make it back to the US as non-financial capital investments. In the event that US becomes balanced or net exports, those trade-deficit dollars will continue to exist on offshore ledgers, and it would take a long time (if ever) to clear the books.

    There is no reason that the US must be a net exporter. Being trade balance neutral or slightly net importer is the goal. In any case, there is no requirement for credit-backed currencies to balance, and there is little chance that they will. US dollars are created through the financial system, and there is no natural limit to the number of credit-backed dollars.

    And, offshore ledgers can also create dollars through lending. Bretton Woods was a quasi-gold standard system, but a gold standard requires a currency be fully backed by gold not just covered. (A gold backed currency can only increase as the gold supply increases. A gold covered can increase by fiat, but the growth is slowed by the cover requirement – fractional reserve money creation.)

    The problem with his scheme is that there is no limit to the growth of trade-deficit dollars, and he will quickly run into the same problem Nixon encountered. The domestic creation of dollars would need to be constrained. Otherwise, these dollars would migrate offshore, and they would be converted into gold. Eventually, the gold supply would be depleted.

    Also, the idea of a trade balance is a hard money concept. With an unrestrained money supply, there is a trade account, and the yearly deficits are never resolved. The ledger is an ongoing account. There is no and can be no resolution. A deficit grows and grows.

    Credit-backed dollars do not function as gold backed dollars. It is similar to the difference between Einstein’s physics and Newton’s.

  • Ben Wolf Link


    All USD except the physical kind exist on hard drives at the Federal Reserve. They’ve always been here, we’ve simply crafted laws so corporations and foreign central banks can pretend the dollars they hold are elsewhere.

    We should keep in mind that more than half our trade deficit results from American companies manufacturing elswhere and then selling the product within the United States, while using tax havens to shelter the profits.

  • TastyBits Link

    @Ben Wolf

    … at the Federal Reserve.

    I agree about the hard drives, but not all or even most dollars are on the Fed’s ledgers. This is the reason the Fed was surprised by the 2008 Financial Crisis, and why everything it tried has failed.

    They do not understand that the money supply includes dollars created through lending (‘ledger dollars’ or credit-backed dollars). In addition, they do not understand that other financial products that act like money. M3 was an attempt to capture it, but it was still short.

    If the Fed were able to account for all dollars, its balance sheet would be tens of trillions of dollars.

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