Triffin’s world
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The US and Russia finally sat down for the first round of peace talks in Riyadh last week. This high-level engagement ably hosted by Saudi Arabia was organized to find an end to the kinetic conflict that erupted between Ukraine and Russia three years ago. In a sense, the former Cold War adversaries have not only begun talking about ending conflict, but are also bringing down the curtain on the post-second world war order.
The post-second world war order was inspired by the modernization theory that posited a causal link between economic growth and political development. The theory argued that as nations became wealthier, their political institutions would evolve to resemble Western-style liberal democracies.
The Soviet Union’s end was taken as evidence supporting the modernization theory as the lack of economic growth was seen as the prime reason behind its collapse.
The theory gained prominence in the post-Soviet era, especially with the Washington Consensus advocating free markets, privatization, and trade liberalization. Modernization theory also influenced China’s 2001 WTO entry, aiming to transform it into a Western-style democracy through economic growth.
Contrary to predictions, China’s economic rise did not yield the expected outcome. Instead, China bolstered its geopolitical influence by advancing technology and military capabilities.
This “China shock” has upended established thinking and forced a reassessment of US economic policies. As a result, the US has moved on from advocating free trade under the Washington Consensus to adopting more strategic trade policies, such as tariffs and state support, something unthinkable in the halcyon days after the Soviet implosion.
The pressures described by Triffin will certainly increase on the US dollar as countries like China, India, Pakistan and Saudi Arabia take off economically.
Dr. Aqdas Afzal
Where some countries like China have been quick in imposing retaliatory tariffs on the US, others like Pakistan remain woefully behind in their understanding of the new rules of the game. In the case of Pakistan, policymakers would have to move on from free trade, while channeling state support for developing a competitive edge for exports through an innovation and industrial policy.
Though some economists have criticized US tariffs, there is evidence to suggest that tariffs can be welfare-enhancing up to a point — indicating an “optimal” US tariff rate of 20%. Tariffs can also assist in countering some of the pre-existing “distortions” that come about due to other nation’s trade policies like use of state subsidies for exports, intellectual property theft and corporate sabotage.
As the debate rages on about the actual impact of tariffs, a dilemma connected to the US dollar being the international reserve currency, first described by Robert Triffin, a Belgian economist, may have been overlooked.
The Triffin dilemma points out that the status of US dollar as the international reserve currency despite its benefits, keeps the dollar permanently overvalued. This overvaluation ends up preventing corrective depreciation that could help in reducing the US current account deficit and create more demand, higher exports and additional jobs.
Initially, when the reserve currency country, the US in this case, is large relative to the rest of the world, there are no significant issues as the distance between the Triffin equilibrium and trade equilibrium is small.
Eventually, as growth slows down in the reserve currency country, a large gap opens up and reserve currency overvaluation and deficits increase further. This situation can become untenable leading to a Triffin “tipping point” that can induce credit risk leading the reserve currency to lose its special status ushering a new wave of global instability.
At the moment, the US dollar is far from a tipping point as there are no meaningful alternatives since a reserve currency must be convertible and provide a stable store of value that is governed by reliable rule of law. While some nations certainly aspire to have international reserve currencies, they do not satisfy most of the mentioned criteria.
Still, US share of global GDP has been declining steadily going from 40% in 1960 to around 26% presently. Moreover, the pressures described by Triffin will certainly increase on the US dollar as countries like China, India, Pakistan and Saudi Arabia take off economically. Perhaps, one potential solution to the Triffin dilemma could be found in a multilateral currency summit, where all major countries mutually agree to let the US dollar depreciate, something that was achieved through the Plaza Accord in 1985.
Peace talks in Riyadh signal the coming end of the Russia-Ukraine conflict as well as of the post-second world war order. Nevertheless, we are still very much in Triffin’s world and given its inherent dilemma, nations must find ways to cooperate in order to prevent global instability.
— The writer completed his doctorate in economics on a Fulbright scholarship. X: @AqdasAfzal
