Theoretical Underpinnings

In Triffin world, the reserve asset producer must run persistent current account deficits as the flip side of exporting reserve assets.

USTs become exported products which fuel the global trade system.

In exporting USTs, America receives foreign currency, which is then spent, usually on imported goods.

America runs large current account deficits not because it imports too much, but it imports too much because it must export USTs to provide reserve assets and facilitate global growth.

This view has been discussed by prominent policymakers from both the United States (e.g. Feldstein and Volcker, 2013) as well as China (e.g. Zhou, 2009).

As the United States shrinks relative to global GDP, the current account or fiscal deficit it must run to fund global trade and savings pools grows larger as a share of the domestic economy.

Therefore, as the rest of the world grows, the consequences for our own export sectors—an overvalued dollar incentivizing imports—become more difficult to bear, and the pain inflicted on that portion of the economy increases.

Eventually (in theory), a Triffin “tipping point” is reached at which such deficits grow large enough to induce credit risk in the reserve asset.

The reserve country may lose reserve status, ushering in a wave of global instability, and this is referred to as the Triffin “dilemma.”

The paradox of being a reserve currency is that it leads to permanent twin deficits, which in turn lead over time to an unsustainable accumulation of public and foreign debt that eventually undermines the safety and reserve currency status of such large debtor economy.

While the United States share of global GDP halved from 40 percent of global GDP in the 1960s to 21 percent in 2012, and has recovered slightly to its present level of 26%, it is still far from such a tipping point, in part because there are no meaningful alternatives to the dollar or the UST.

A reserve currency must be convertible into other currencies, and a reserve asset must be a stable store of value governed by reliable rule of law.

While other nations like China aspire to reserve status, they satisfy neither of these criteria. And while Europe may, its bond markets are fragmented relative to the UST market, and its share of global GDP has shrunk even more than America’s.

The U.S. share of global GDP troughed around the GFC and has stabilized or improved since then, coincident with the pattern in manufacturing employment.

In this telling, our share of global GDP drives the size of the Triffin distortion in trade equilibrium, which in turn drives the state of the tradeable sector.

The backdrop for these currency developments has been a system of tariff rates defining the international trading system that are, broadly speaking, locked into a configuration designed for a different economic age.

According to the World Trade Organization, the United States effective tariff on imports is the lowest any nation in the world imposes at about 3%, while the European Union imposes about 5% and China 10%.

These numbers are averages across all imports and not reflective of bilateral tariff rates; bilateral discrepancies can be much larger, for instance the U.S. imposes only 2.5% tariffs on auto imports from the E.U., while Europe imposes a 10% duty on American auto imports.

Many developing nations apply much higher rates, and Bangladesh has the world’s highest effective rate at 155%.

These tariffs are, in large part, legacies of an era in which the United States wanted to generously open its markets to the rest of the world at advantageous terms to assist with rebuilding after World War II, or in creating alliances during the Cold War. Moreover, tariffs in 3 A critical analysis of the “current account” and “fiscal” versions of the Triffin dilemma is available in Bordo and McCauley (2017).

Their dismissal of these theories focuses more on the lack of dilemma/crisis in the near term and the inability to identify any such crossing point, rather than on an ability to discount the basic mechanism.

some cases enormously understate the unevenness of the playing field, as some nations employ material nontariff barriers, steal intellectual property, and more. In theory, prior tariff rates may not affect trade if floating currencies adjust to offset them, but they have very significant consequences for revenue and burden sharing (see the discussion below).

Economic Consequences

We are far from the economic crises that comprise the tipping point of the Triffin dilemma.

But we must nonetheless reckon with the consequences of the Triffin world.

Reserve nation status comes with 3 major consequences:

1. Cheaper Borrowing

The persistent reserve-driven demand for UST securities allows the United States to borrow at lower yields.

US economists have little variation to study as the US has been the sole reserve currency for many decades.

It is impossible to compare how big this benefit is.

Some estimates, fictional as they are, have it as large as 50-60 basis points of borrowing yield (McKinsey, 2009).

In any case, many countries borrow significantly more cheaply than the United States.

At the time of writing, all G7 members borrow more cheaply than the United States except for the UK, which borrows 1/10 of a percent more expensive.

Other peers like Switzerland and Sweden borrow more cheaply too, Switzerland by almost 4 percentage points.

Meanwhile, an erstwhile troubled debtor like Greece can borrow over a point more cheaply.

More precisely, one can create a synthetic dollar borrowing rate with currency risk hedged out, i.e. examine deviations from covered interest parity, as in Du, Im and Schreger (2018).

Such deviations are currently (and usually) close to zero6 for the United States relative to other G10 borrowers; in other words, there’s little special borrowing rate conferred on the U.S. relative to other developed countries.

G10 vs. EM, however, still contain substantial residuals, suggesting that emerging markets pay a borrowing premium relative to developed markets to borrow.

Being a reserve currency may reduce borrowing costs. But whatever benefit is gained is likely to be dwarfed by things like:

• central bank policy outlooks
• growth and inflation forecasts
• equity market performance

However, the borrowing advantage may be framed differently.

Rather than reducing the cost of borrowing, it may reduce the price sensitivity of borrowing. In other words, we don’t necessarily borrow substantially cheaper, but we can borrow more without pushing yields higher.

This is a consequence of the price inelasticity of demand for reserve assets, and the flip side that we run large external deficits to finance that reserve provision.

2. Richer Currency

The more significant macroeconomic consequence as reserve producer is a strong dollar.

• This strength is beyond what would balance international trade in the long run.

According to the IMF, there are about $12 trillion of global foreign exchange reserves in official hands.

• 60% are in dollars

In reality, dollar reserve holdings are much higher, as non-official entities hold dollar assets for reserve purposes too.

Clearly, $7 trillion of demand is enough to move the needle in any market, even currency markets.

For reference, $7 trillion is roughly 1/3 of U.S. M2 money supply.

Flows creating or unwinding these holdings will obviously have significant market consequences.

Trillions of dollars of securities are bought for the Fed’s policy and not for investment.

Such securities on the Fed’s balance sheet had no effect on financial markets.

Trillions of dollars bought for foreign central banks’ policies should also have no effect.

Nations accumulate reserves to stem appreciation pressures in their own currencies.

And so there is a contemporaneous negative correlation between the exchange value of the dollar and the level of global reserves.

Reserves tend to go up when the dollar is going down.

• This is because accumulators buy dollars to suppress their currencies.

Reserves tend to go down when the dollar is going up.

Nevertheless, other than 2 quarters in 1991, the US has run a current account deficit since 1982.

The dollar is not equilibrating international trade and income flows.

• This is because that current account cannot balance over 50 years

The interplay between reserve status and the loss of manufacturing jobs is sharpest during economic downturns.

The reserve asset is “safe.”

• This is why the dollar appreciates during recessions.

By contrast, other nations’ currencies tend to depreciate when they go through an economic downturn.

That means that when aggregate demand suffers a decline, pain in export sectors get compounded by a sharp erosion of competitiveness.

Thus, employment in manufacturing declines steeply during a recession in the United States, and then fails to recover materially afterward.

Canada -1.05 Japan -3.38 UK 0.12 France -1.19 Germany -1.94 Italy -0.66 Greece -1.03 Switzerland -3.93 Sweden -2.20

Table 1: 10-year borrowing spreads to Treasury notes. Negative numbers mean the other nation borrows more cheaply than the United States. Source: Bloomberg, HBC calculations

It may seem odd to suppose that reserve demand for Treasury securities plays:

• only a small role in delivering favorable borrowing terms
• a large role in creating currency overvaluation.

But this is consistent with outcomes in both:

• interest rate markets and
• the balance of payments.

It is also consistent with the idea that liquidity injections ultimately raise interest rates because they stimulate stronger nominal growth.*

3. Financial Extraterritoriality

The reserve asset is the lifeblood of:

• the global trade
• financial systems

Whoever controls the reserve asset and currency can exert some control trade and financial transactions.

This allows America to exert its will in foreign and security policy using financial force instead of kinetic force.

America sanctions people in a variety of ways.

In a broader sense, sanctions can also be perceived as a modern-day form of a blockade.