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Triffin's dilemma
Neil Woodford, 8 July 2016, 16:36
Given recent political events, it feels
strange to be writing about anything other
than Britain’s relationship with Europe. I
have been clear throughout the EU
Referendum campaign, however, that
there are many more important influences
on the long-term outlook for the UK
economy than the outcome of the
Referendum and I continue to stand by
that view, now that the outcome is known.
Globally, I see several interlinked challenges that are combining to exert
downward pressure on global economic growth rates and look likely to
continue to do so for some considerable time. The eurozone economy
epitomises some of these issues with its sluggish growth, stagnant
productivity, ideological conflicts, troubling debt dynamics and poor
demographics.
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Flaws in its monetary union have exacerbated some of these problems for
Europe but the region does not have a monopoly on them – wherever we
look around the world, we see them. Additionally, with liquidity problems in
emerging markets, a dangerous credit bubble in China and the continued
threat of a prolonged period of deflation, it is clear that investors have a lot
to worry about.
One of the rare economic bright spots in recent years has been the US.
Last December, the Federal Reserve (Fed) raised interest rates for the first
time in almost a decade in a valedictory move to declare victory over the
stagnation that had afflicted its economy ever since the financial crisis. With
relatively robust domestic growth and a job market deemed to be
approaching full employment, the Fed judged a rate hike to be an
appropriate move in monetary policy for the US economy. But it certainly
wasn’t what the rest of the world needed.
This isn’t a new phenomenon. In 1960, the Belgian American economist
Robert Triffin argued that the Fed could “either run policy that was right for
the US or it could run policy appropriate for the rest of the world”. In benign
economic times, he argued that one policy might suit all for a period but, in
times of trouble, the US dollar’s dominant role in the Bretton Woods fixed
exchange rate system would result in serious economic imbalances around
the world. He was right – ‘Triffin’s dilemma’ had identified a dynamic that
would ultimately lead to the collapse of that system in the early 1970s.
The Bretton Woods agreement had originally come into force in the
aftermath of World War II, when delegates from the 44 Allied nations
gathered at the Mount Washington Hotel in Bretton Woods, New
Hampshire to find a common and co-ordinated path towards global
economic recovery. The result was a fixed exchange rate system in which
each country’s currency was pegged to the value of gold, thereby
preventing individual states from attempting to gain an economic
advantage through competitive devaluation.
The US dollar’s pivotal role in this system was its ultimate undoing and,
although we now live in a world of floating rather than fixed exchange rates,
the US dollar’s status as ‘reserve currency’ can continue to cause problems.
When the dollar is strong, it effectively means that global liquidity conditions
become tighter. In turn, this causes problems in particular for emerging
markets which are reliant on the flow of dollars to sustain their economic
growth. ‘Triffin’s dilemma’ is alive and well in modern financial markets.
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Ironically, I believe it is a Bretton Woods style accord that is required to
enable the global economy to move on from the current period of
stagnation. The policy outcomes would likely be somewhat different but it
would be the concept of co-operation that would matter. These are multiregional, global problems and their solution requires co-ordinated global
policy action.
The prospect of such co-ordinated policy remains pretty remote but the
longer economies remain mired in stagnation, the more plausible it
becomes. Perhaps the voting behaviour of the British public recently could
be seen as a wake-up call for policymakers which hastens such an
outcome?
In the meantime, the global economy is slowing and the US economy
doesn’t look as robust as it did. This is already having an impact on global
earnings and, in my opinion, that is likely to continue. Not all companies are
affected by the global economic challenges to the same extent, however,
and this is why my investment strategy continues to favour businesses that
are largely in control over their own destinies. That leaves me feeling
optimistic about what my funds can deliver over the long-term, despite the
unprecedented global challenges.
This article first appeared in Money Marketing on 7 July 2016.
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