Triffin’s dilemma

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Neil Woodford 8 July 2016 Est. reading: 4 min read

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.

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.

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 multi-regional, 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.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address: 27 Old Gloucester Street, London, WC1N 3AX.

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