International Liquidity and World Inflation

The Bretton Woods regime of fixed exchange rates, particularly in its later years, periodically suffered from the ‘Triffin Dilemma’, i.e. either too little liquidity or too little confidence. These alternating crises resulted from the fact that while dollar reserves could be created only through deficits in the US balance of payments, the cumulative effect of these deficits was to reduce the ratio of the US official gold stocks to the outstanding dollar claims on the US held by the foreign central banks. The progressive accumulation of the stock of dollar claims on the US against a declining stock of US gold posed a ‘confidence’ problem for the reserve asset (Triffin, 1960).1 The adoption of floating exchange rates by major countries since 1973 has broken the link between the US balance of payment deficits and the involuntary acquisition of dollar claims by foreign central banks. This has generally resulted in a greater flexibility of reserve supply arrangements, largely by making the process of reserve creation primarily ‘demand oriented’. This flexibility in reserve creation has also been abetted by the volatility of reserve needs under the regime of managed floating, partly due to the erratic shifts in exchange rates themselves and partly due to exogenous shocks.