One of the best parts of being a journalist is having an excuse to call strangers and ask them all kinds of questions. Recently I called Benn Steil, senior fellow and director of international economics at the Council of Foreign Relations, a think tank in New York, and asked him about the possibility that the United States would enter a state of deflation.
Steil discounts the probability, while allowing for the possibility, and says the root of all the market uncertainty is the massive, global-deleveraging process that we are still going through. In short, the vicious cycle of losses inducing selling, leading to more losses and more selling.
“This clearly has some ways to run, Steil says. “It illustrates one big feature of financial globalization nobody had really appreciated before,” that being the Triffin Dilemma.
Steil told me that in 1960 Belgian economist Robert Triffin testified before Congress about the flaws he saw in the Bretton Woods system, which introduced a series of fixed exchange rates between the world’s currencies and established the U.S. dollar as the world’s reserve currency, replacing gold.
In his testimony, Triffin observed that in order to supply the world with dollars, the U.S. would have to run continuous balance of payments deficits or the world would be confronted with a lack of liquidity. At some point, those deficits would get so large that the world would lose confidence in the U.S. dollar, sparking a crisis. The battle between too much and too little liquidity became know as Triffin’s dilemma.
Until recently, Steil says, “The U.S. was clearly creating an excess of global liquidity and that had fueled the decline of the dollar against the euro, the rise of all commodities and inflation around the world.”
But the massive resulting sell off has brought about the current credit freeze and financial crisis. “Suddenly everyone needs dollars and there is a global scramble for dollars and there is too little of the stuff. This is just the sort of problem Triffin described in the 1960s,” he says. “We went from one pole of the Triffin dilemma to the other in a course of months.”
Steil also discounts fears that the Federal Reserve Bank’s massive liquidity injections will lead to a hyper inflation. Once the deleveraging has run its course and deflation no longer appears to be a threat, the Fed will begin buying securities back from Treasury to soak up excess liquidity.
“The Fed expects to reverse it,” Steil says. “Obviously this is a significant risk. The Fed’s balance sheet has ballooned to proportions we have never seen before. But if its agenda is fighting deflation, it probably has enough tools at its disposal.”
Tags: Deflation, liquidity crisis, Robert Triffin
