The Next Bretton Woods: How Cryptocurrency and Blockchain Technology Could Solve the Triffin Dilemma

The Next Bretton Woods:

How Cryptocurrency and Blockchain Technology Could Solve the Triffin Dilemma

Christian Pafford

POGO 750 DL1 Dangers of Technology: AI and Beyond

Dr. Stephen Ruth

April, 2022

Introduction

Triffin’s Dilemma describes the conflict of economic interests that arises between short-term domestic and long-term international economic objectives for any reserve currency. The dilemma states that since foreign nations want to hold the reserve currency, the country with the reserve currency must be willing to supply the world with that currency. This forces the country with the world’s reserve currency to run a twin deficit[1] in an attempt to supply the world with currency. If the country with the reserve currency stops supplying foreign nations with the reserve currency, liquidity would dry up, and the global economy would go into recession. If the country with the reserve currency continues to supply the world with its reserve currency, then the confidence of the reserve currency over time will wear down and eventually lose reserve currency status. The reserve currency country will also have its domestic economy hollowed out, causing jobless economic recoveries. Triffin’s dilemma is usually credited with outlining the problems created by the Bretton Woods conference, where the US dollar became the world’s reserve currency.

            62 years after his testimony to Congress, Triffin’s paradox is more relevant than ever. The contemporary American political environment reflects the socioeconomic struggles that have been building since the dollar became the world reserve currency. American manufacturing since the 1970s has largely disappeared. Formerly wealthy states in the Midwest have been hit the hardest, with the region being aptly named the Rust Belt due to the decline in manufacturing. This has renewed political interest in finding a solution to the Triffin Dilemma, as both rightwing and leftwing populist are using the consequences of the dilemma to gain political support.

            Robert Triffin’s solution to his dilemma was the creation of a new currency, separate from any country, that would act as a neutral reserve currency. A currency whose supply could increase to fit the needs of the global economy without strengthening or weakening any country’s own domestic currency. This would solve the problems of the current global monetary system, alleviating the pressure currently on the US Dollar, and allowing the rest of the world to grow without the need for another country’s currency.

            The format of this paper will go as follows. First, I will outline the strengths and weaknesses of a strong and weak currency. Then I will summarize how the international monetary system worked under the international gold standard, the Bretton woods system, and the current international monetary system. Lastly, I will give three potential solutions to the Triffin Dilemma utilizing cryptocurrency and blockchain technology.

Basics of a Strong vs Weak Currency

            It doesn't always make sense for a country to have a strong currency. Having a strong currency makes its country’s goods more expensive on the international market, causing less to be sold. The opposite is true when a country has a weaker currency. By having a weak currency, a country will make its exports cheaper on the international market, causing more to be sold. China has long been accused of artificially lowering the value of their currency in an attempt to stimulate their exports. The parallel to this is the United States, where the existing monetary order forces the value of the Dollar higher, making American goods less competitive globally, and leading to a decrease in manufacturing jobs.

Analysis – How the Gold Standard Worked

Everything was simpler when the international monetary system was based on the gold standard. Since all country’s exchange rates were fixed, the gold standard would automatically adjust prices in accordance with international trade. Suppose a large influx of immigrants came to the United States and brought down wages. Allowing American manufacturers to make more goods for the same amount of money. Because the supply of money (gold) essentially was fixed in the short run, U.S. prices fell, and the prices of U.S. exports then fell relative to the prices of imports.[2] This causes other countries to demand more American goods, as they are relatively cheaper than goods produced by themselves. As foreigners buy American goods, gold from these countries flow into the United States, increasing the money supply, and causing prices to rise.

            The pros of the international gold standard system was how there was no need for any centralized monetary authority to monitor the supply of money. The system also automatically got rid of global trade imbalances. One country couldn’t dominate the manufacture of goods, because the inflow of gold would eventually make goods to expensive. Opening up the ability for another country to make those goods for cheaper. The net result is a balancing act, where prices dance around an equilibrium, preventing them from being too cheap or expensive.

            There are three main disadvantages to the gold standard.[3] This includes the governments lack of ability to properly change the money supply to fit current market conditions. Which can exacerbate illiquidity problems, aka the economy doesn’t have enough money supply to adequately function. The second issue is that it becomes impossible to insulate a country from the economic shocks of another country. The best example of this is the Great Depression, where an economic shock in the United States is transmitted to the rest of the world via the gold standards automatic adjustments. Lastly, the automatic adjustments of the gold standard can take decades to actually complete, causing countries to experience decades of either economic growth or economic decline.

Analysis – Bretton Woods Pre 1971

            Within the gold standard was the incentive structure to dominate and conquer other countries, as it was the only permanent way of accessing raw materials and consumer markets.[4] Eventually this culminated into World War II, which decimated every developed country on Earth, except the United States. This gave the United States the leeway to create a new international monetary system based around the United States Dollar. The exchange rate for the United States Dollar became 1 ounce of gold for every $35 USD.[5] Countries around the world would then peg their own domestic currency to the American Dollar, with deviations of only 1% allowed.[6]

In this new system, international investment, trade, and payments were to be conducted in US Dollars, ushering in the era of the Dollar as the reserve currency of the world.[7] To help with these new institutions were set up to ease the global transitions away from the gold standard, namely the IMF and the World Bank. These institutions, as well as American fiscal and monetary authorities, made sure the supply of dollars would be enough to satisfy global demand.  Ensuring that investment, trade, and global economic growth would be high.

The new system helped relieve the world of the liquidity problem of the gold standard had. Just as in banking, as long as everyone doesn’t try and get their money out at the same time, banks can operate just fine. If everyone tries to take out all their cash out at the same time, there won’t be enough for everyone, and bank runs will occur. Similarly, in this new system, as long as all other countries do not try to cash their US dollars for physical gold, there will be enough financial resources for everyone.

Analysis – Post 1971

            Fast forward 27 years, and that’s exactly what happened. In the 1960s, European and Japanese exports became more competitive with U.S. exports. The U.S. share of world output decreased and so did the need for dollars, making converting those dollars to gold more desirable. The deteriorating U.S. balance of payments, combined with military spending and foreign aid, resulted in a large supply of dollars around the world. Meanwhile, the gold supply had increased only marginally. Eventually, there were more foreign-held dollars than the United States had gold. The country was vulnerable to a run-on gold and there was a loss of confidence in the U.S. government’s ability to meet its obligations, thereby threatening both the dollar’s position as reserve currency and the overall Bretton Woods system.

            This came to breaking point between 1968 and 1971, where the United States drastically increased the amount of dollars in circulation to appease the rapidly growing economies in Europe and Japan.[8] The result was inflation, which was transmitted to other nations in through the Bretton Woods system. It also resulted in the U.S. not having enough gold to cover the volume of dollars circulating throughout the world. This forced the US dollar to be overvalued.

            Fearing that the value of the United States dollar was going to collapse, currency traders around the world started to convert dollars into other currencies.[9] Countries began to worry the dollar would crash and they wouldn’t be able to get the same amount of gold, so they rushed to convert dollars for gold. After WW2, the United States held 75% of the world’s gold within its borders, and that percentage only increased during the Bretton Woods system.[10] Other countries attempted to get ‘their’ gold out of the United States, but knowing it would crash the entire system – like a bank run – the American government under Nixon shut the gold window. Officially ending the gold standard, and ushering in a new system based on floating exchange rates. The current system still relies on the American dollar for liquidity, as almost all international trade and investment is still conducted with dollars.[11] This current system has put immense stress on the American economy, even more so than the previous Bretton Woods system. Many economists see us nearing a breaking point. Political populists, notably former president Donald Trump, are articulating the issues of the current international monetary system, appealing to people who have been most hurt by the Triffin Dilemma.

Analysis – Future

            The solution to this problem is easy, but its implementation is going to incredibly difficult. Any replacement to the system must be able to increase the liquidity of money when needed, without being tied to any individual country. This way global economic growth will have the funds it needs to keep expanding, without harming the economy of the world reserve currency nation. The best way I think we can accomplish this is by utilizing cryptocurrency and blockchain technology. I will give three potential solutions to the current international system, and outline the advantages and disadvantages of the economic and political ramifications.  

The Bitcoin Standard

            Unfortunately, a global bitcoin standard would be plagued by the same issues the gold standard was plagued with prior to the Bretton Woods system. In fact, it would be worse than the gold standard. Roughly 2,500 to 3,000 tons of gold is added to the economy each year, and it has been like this for a very long time.[12] Although the amount of gold on Earth is finite, we know there is a lot more here; there’s also ways we could get it from outer space like on asteroids. This allows for a continual increase in the supply of gold (money) into the economy, helping to create liquidity. Bitcoin will have the problem of liquidity seizing once the 21-million-coin market cap is reached. This over time would lead to slower economic growth because there would not be enough bitcoin to supply world demand.

            In my personal view, bitcoin is largely an escape value for excess ‘dumb money’ liquidity created by global central banks. In order to prop up the contemporary international monetary order, central banks around the world – but especially the Federal Reserve – have resorted to creating tons of liquidity in markets. Most of this money goes to financial institutions, large banks, and corporations. It also manifests itself in low interest rates on things like mortgages. Some amount of this money goes to people who are very risky (wannabe millionaires) or people who don’t know what else to do with the excess money.

            The best argument for a bitcoin standard is political. Due to bitcoins proof-of-work method of verifying transactions, it is a trustless system.[13] There is no need for any entity to backstop the system because it does it on its own. A bitcoin standard would force everyone to have privacy. Privacy from government, from corporations, from each other. All other international monetary solutions open up the door to massive privacy concerns, which is avoided under bitcoin.

Fedcoin

            Fedcoin is a hypothetical Central Bank Digital Currency issued by the Federal Reserve.[14] Yale law school states “bitcoin suffers from volatility, liquidity limits, mining oligopoly, mining inefficiency, poor scalability, network latency, inability to handle micropayments, and the absence of monetary policy” as reasons to not have a bitcoin standard.[15] By the Federal Reserve issuing a direct CBDC, they would have access to greater monetary controls, allowing them to be more effective in their pursuit of economic growth and low inflation.[16] By having independent monetary policies set for each individual in society, the Federal Reserve may be able to create enough liquidity for the entire global economy. They could do this by setting differing interest rate policies on the individual level.

            The largest concern under this sort of monetary system would be the danger to everyone’s privacy. A Federal Reserve direct CBDC would allow all transaction data to be stored at the Federal Reserve and differing individual monetary policies open the door to targeted discrimination.[17] Public trust in American institutions are at an all time low, completely usurping the current system and replacing it with something that could potentially be unfavorable to privacy rights isn’t going to be popular.[18] Although a direct CBDC issued by the federal reserve could potentially solve the issues of the Triffin Dilemma, the potential harm and political chaos it would cause would make isn’t worth it.

            There is also no definitive proof that this could really solve the Triffin Dilemma. Traditionally, the solution to Triffin’s paradox is for the global reserve currency to be a neutral reserve asset, like gold. This way no country’s own domestic currency is tied to international commerce, and thus other countries cannot exert upward pressure on it. An international system based on an American CBDC would still have one core issue, even if it would help with current liquidity funding problems. The digital currency would still be tied to an individual country. An international monetary system based on Fedcoin would likely be no different then the system right now.

A Third Way –Keynes right again

            Near the end of WW2, allied officials meet in Bretton Woods, New Hampshire to discuss how they would rebuild the international monetary order. The most influential parties involved were the Americans and the British. Two plans were eventually debated. American Harry Dexter White’s plan was eventually agreed upon, in what we know as the Bretton Woods system. Keynes plan was to create a neutral reserve asset called Bancor, which would be used as a new international currency to be used in global trade.[19] The idea was shut down; however, I think a modified version could be the basis of the next monetary system.

            There is a non-digital version of this created in 1969, with the aim of boosting the reserves of member nations. It is the only global ‘currency’ and is backed by all IMF member nations. Calls for the creation of a digital SDR have been growing in recent years, with the hope that it’s reformation could lead the people embracing it as a form of global currency.[20] Both in the form of a neutral reserve asset and as a mechanism for international trade. This would work by having countries keep their own currencies and central banks while agreeing to denominate all payments in the international neutral reserve asset, in this case the digital SDR.[21]

            Unlike bitcoin and gold, the virtual SDR would be able to expand to meet the demand of the world economy. Since it would be a neutral reserve asset, it would solve the Triffin Dilemma, and its international use would not exert pressures onto one singular country. The digital SDR option is possibly the best option, since it solves the liquidity issues and the Triffin Dilemma without as much political drama as Fedcoin.

The digital SDR could likely come about without individual member countries voting whether or not it should be done. Digital SDRs will most likely come about automatically as more and more countries slowly adopt digital currencies. The hard part will be convincing the United States to go along with losing the privileges that come with being the reserve currency of the world. Currently the United States is arguing about what it’s future will look like. There are those who still see the American dollars dominance as more important then solving the Triffin Dilemma. Whereas newer, more populist politicians, see fixing the economic strain of the dollar as more important than keeping the reserve currency.

Conclusions

            Either way, the current system will not go away without a fight. In order for the order to change something has to give, and there must be some catalyst. Economists in 2008 thought the global financial crisis was going to be enough to break the system. It didn’t. Some economists though the coronavirus recession would’ve broken the system. It didn’t. Some economists are now saying that the current inflation in the United States, and the rest of the developed world, has changed the entire economic game. Everyone knows intuitively that printing money causes inflation. But how can the current system, which requires the Americans to continuously create dollar liquidity, do so without ‘printing more money? Economic research on solutions to the Triffin Dilemma and what comes after this topic is broad, but exist. Further research on this topic should deep dive into the socio-political ramifications of both the current international monetary system and future monetary systems. Specifically, more research needs to be done on the tradeoff between freedom and economic growth, and the impact economic inequality has on an individual’s tendency to prioritize cultural or economic freedom.

Bibliography

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"Explaining Blockchain — How Proof Of Work Enables Trustless Consensus". 2016. Medium. https://keepingstock.net/explaining-blockchain-how-proof-of-work-enables-trustless-consensus-2abed27f0845.

"Gold Standard - Econlib". 2022. Econlib. https://www.econlib.org/library/Enc/GoldStandard.html#:~:text=The%20gold%20standard%20was%20also,to%20gold%20were%20necessarily%20fixed.

"GOLD STANDARD AND AFTER - The Fight For Markets Was Kept At Bay By Colonialism". 2022. Telegraphindia.Com. https://www.telegraphindia.com/opinion/gold-standard-and-after-the-fight-for-markets-was-kept-at-bay-by-colonialism/cid/394608.

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[1] A twin deficit is when a country runs both a budget deficit and a trade deficit.

[2] "Gold Standard - Econlib". 2022. Econlib. https://www.econlib.org/library/Enc/GoldStandard.html#:~:text=The%20gold%20standard%20was%20also,to%20gold%20were%20necessarily%20fixed.

[3] "Nelson W. Aldrich | Biography & Facts". 2022. Encyclopedia Britannica. https://www.britannica.com/biography/Nelson-W-Aldrich.

[4] "GOLD STANDARD AND AFTER - The Fight For Markets Was Kept At Bay By Colonialism". 2022. Telegraphindia.Com. https://www.telegraphindia.com/opinion/gold-standard-and-after-the-fight-for-markets-was-kept-at-bay-by-colonialism/cid/394608.

[5] Ghizoni. 2022. "Nixon Ends Convertibility Of U.S. Dollars To Gold And Announces Wage/Price Controls | Federal Reserve History". Federalreservehistory.Org. https://www.federalreservehistory.org/essays/gold-convertibility-ends.

[6] "Bretton Woods Agreement And System: An Overview". 2022. Investopedia. https://www.investopedia.com/terms/b/brettonwoodsagreement.asp#:~:text=The%20Bretton%20Woods%20Agreement%20and%20System%20created%20a%20collective%20international,to%20the%20price%20of%20gold.

[7] Barry Eichengreen (2021) Bretton Woods After 50, Review of Political Economy, 33:4, 552-569, DOI: 10.1080/09538259.2021.1952011

[8] "The Operation And Demise Of The Bretton Woods System | VOX, CEPR Policy Portal". 2022. Voxeu.Org. https://voxeu.org/article/operation-and-demise-bretton-woods system#:~:text=A%20key%20reason%20for%20Bretton,consistent%20with%20the%20official%20peg.

[9] "Nixon Shock ". 2022. Investopedia. https://www.investopedia.com/terms/n/nixon-shock.asp#:~:text=President%20Richard%20Nixon%20closed%20the,and%20more%20dollars%20for%20gold.

[10] "What Is The Gold Standard?". 2022. Investopedia. https://www.investopedia.com/ask/answers/09/gold-standard.asp#:~:text=At%20the%20end%20of%20WWII,still%20backed%20directly%20by%20gold.

[11] Bertaut, Carol, Bastian Beschwitz, and Stephanie Curcuru. 2021. "The International Role Of The U.S. Dollar". Federalreserve.Gov. https://www.federalreserve.gov/econres/notes/feds-notes/the-international-role-of-the-u-s-dollar-20211006.htm.

[12] "When Will Gold Run Out? Global Reserve Supply Facts And Predictions". 2019. Provident Metals. https://www.providentmetals.com/knowledge-center/precious-metals-resources/global-gold-supply-predictions.html#:~:text=Between%20all%20of%20the%20gold,at%20just%20over%20190%2C000%20tons.

[13] "Explaining Blockchain — How Proof Of Work Enables Trustless Consensus". 2016. Medium. https://keepingstock.net/explaining-blockchain-how-proof-of-work-enables-trustless-consensus-2abed27f0845.

[14] 2022. Law.Yale.Edu. https://law.yale.edu/sites/default/files/area/center/global/document/411_final_paper_-_fedcoin.pdf.

[15] 2022. Law.Yale.Edu. https://law.yale.edu/sites/default/files/area/center/global/document/411_final_paper_-_fedcoin.pdf.

[16] 2022. Federalreserve.Gov. https://www.federalreserve.gov/publications/files/money-and-payments-20220120.pdf.

[17] 2022. European Data protection Supervisor. https://edps.europa.eu/press-publications/publications/techsonar/central-bank-digital-currency_en

[18] "Public Trust In Government: 1958-2021". 2021. Pew Research Center - U.S. Politics & Policy. https://www.pewresearch.org/politics/2021/05/17/public-trust-in-government-1958-2021/.

[19] “Creation of the Bretton Woods System.” 2022. Federal Reserve History. https://www.federalreservehistory.org/essays/bretton-woods-created

[20] “The SDR’s Time has Come.” 2019. The International Monetary Fund. https://www.imf.org/external/pubs/ft/fandd/2019/12/future-of-the-IMF-special-drawing-right-SDR-Ocampo.htm

[21] "Yanis Varoufakis: Imagining A New Keynesian Bretton Woods". 2022. World Economic Forum. https://www.weforum.org/agenda/2016/05/yanis-varoufakis-imagining-a-new-keynesian-bretton-woods.