The Federal Reserve, Interest Rates And Triffin’s Paradox

One result of the global dependence on central bank interventions is a unhealthy fixation on the slightest changes in those interventions, oops I meant policies.

Since the slightest pull-back in central bank inflation of asset bubbles could spell doom for the global economy and everyone holding those assets, the world now hangs on every pronouncement of the Federal Reserve in a state of extreme anxiety.

Why the extreme anxiety? Because any change in Fed intervention creates both winners and losers. There is no way Fed policy can be win-win-win for all participants, and to understand why we turn to Triffin’s Paradox, a.k.a. Triffin’s Dilemma.

The core of Triffin’s Paradox is that the issuer of a reserve currency must serve two quite different sets of users: the domestic economy, and the international economy.

Triffin’s Paradox has two basic parts:

1. Any nation that issues the reserve currency must run a trade deficit to supply the world with surplus currency to hold in reserve and as a result,

2. The issuing nation faces the paradox that the needs of global trading community are generally different from the needs of domestic policy makers.

The global trading community requires that the issuer of the reserve currency run trade deficits large enough to satisfy the demand for reserves, while domestic audiences want a strong export sector, i.e. a trade surplus.

You can’t have it both ways: if you want to issue a reserve currency, you have to run a trade deficit that is commensurate in size with the global demand for your currency.

Since supply and demand set price, this push-pull affects the value of the U.S. dollar: U.S. exporters want a weak dollar to spur foreign demand for their products, while foreign holders of the USD want a strong dollar that holds its value/purchasing power.

It is impossible for any nation to maintain the reserve currency and run trade surpluses. If you run trade surpluses, you cannot supply the global economy with the currency it needs for reserves, payment of debt denominated in the reserve currency and domestic credit expansion.