The Triffin dilemma and the exorbitant privilege

Apr 1, 2025

Fiscal deficits and trade deficits are not the same. The U.S. government has run a fiscal deficit for most of the last 50 years, with the national debt exceeding $36 trillion as of March 2025. This debt is financed through the issuance of government debts, which are purchased by both domestic and foreign investors. The U.S. dollar’s status as the world’s primary reserve currency allows the U.S. to run persistent trade deficits without immediate consequences, as foreign countries are willing to hold dollar-denominated assets.

Tariffs account for a mere 2% of U.S. federal revenue. In the short term, they may provide a temporary boost to government revenue, but they are not a sustainable solution to the long-term fiscal challenges facing the U.S. economy. The trade deficits we observe are both a consequence and a prerequisite of the U.S. dollar’s global reserve currency status. Research provides no support for claims that tariffs would ameliorate budget deficits. Instead, economic evidence indicates tariffs typically accelerate inflation and hamper economic growth. Furthermore, the government subsidies often paired with protectionist policies tend to expand federal expenditures rather than reduce them.

The “exorbitant privilege” is supposed to protect the U.S. from the consequences of its trade deficits. It also allows the U.S. to finance its fiscal deficits by issuing dollar-denominated debt and collects seigniorage on a global scale. What gives?

Exorbitant privilege works best when the U.S. provides safe, scarce, stable assets — not when it floods the world with politicized, inflation-risky debt. When the U.S. government runs deficits, it funds them by issuing Treasury bonds. These must be bought by someone—domestic investors, foreigners, or the Fed. U.S. Treasury auctions are getting softer — higher bid-to-cover ratios, weaker foreign participation. To keep yields from spiking, the Fed steps in and buys Treasuries, especially during crises. The world accepts U.S. debt because it’s considered safe and stable. If it starts to look like emerging-market-style monetization, investors reprice risk and demand higher yields.

War spending and geopolitical weaponization of the dollar (e.g., Russia sanctions, Iran SWIFT bans) has undermined the voluntary trust in the dollar. Central banks are diversifying reserves and the call for an alternative bancor is growing.

Problem

The U.S. Treasury faces an exceptional refinancing burden in 2025. Approximately $9.2 trillion of government debt will mature in 2025, about 25% of total U.S. debt (>$36 trillion) and roughly 31% of GDP. This surge stems from heavy borrowing during the pandemic-era near-zero interest rate period, much of it in short-term Treasury bills and notes. Now, as those low-coupon debts mature, they must be rolled over at today’s much higher rates – the average Treasury yield is around 3.2%, the highest since 2010.

U.S. Treasury debt distribution by maturity.

In practical terms, over half of all U.S. publicly-held debt will need to be refinanced in just the next three years, implying hundreds of billions in added interest costs as old debt issued near 0% is replaced with debt at 4–5% yields. The Treasury’s current strategy is to lean heavily on short-term issuance (T-bills and other maturities under 1 year) to manage this wave, taking advantage of strong demand for short-term Treasuries and expectations of future rate cuts. This “front-loaded” approach means a large share of new issuance in 2025 will be in short-term instruments, continuing a trend since 2020 that has pushed the bill share of total debt to ~21–22%, up from ~10–15% pre-pandemic​.

Monetizattion of the debt is a concern.

Foreign holders of U.S. debt are dwinding.

Moreover, if interest rates don’t fall as quickly as hoped – or worse, if inflation stays elevated – short-term financing could backfire. The strategy of issuing very short maturities banks on the Fed cutting rates (and thus lower-cost rollovers) in 2025. However, should the economy enter a “new normal” of persistent inflation or if the Fed is forced to keep rates high, Treasury would repeatedly refinance at high yields, locking in much higher interest costs.

US inflation rate.

The increase in T-bill issuance since 2020 has been driven by the need for rapid funding during the pandemic, the flexibility and cost advantages of short-term debt, strong investor demand for short-term, high-quality assets from money market funds (MMFs), and strategic debt management recommendations from the Treasury Borrowing Advisory Committee (TBAC).

As of April 2025, the U.S. Treasury is scheduled to refinance approximately $9.2 trillion in debt over the course of the year. The Treasury employs a strategy known as “active duration management,” which involves issuing a significant volume of short-term debt to maintain flexibility and manage interest costs. However, this approach also increases the volume of debt that must be refinanced frequently.

As of Mar 2025, the total U.S. federal debt stands at $36.2 trillion, which translates to >$100k pp in the U.S.

TTM debt change. The sharp increase in the U.S. national debt in 2020 was primarily driven by the economic and fiscal response to the COVID-19 pandemic.

A significant concern related to the growing debt is the increasing cost of servicing it. The U.S. government generates revenue from customs duties, but the amounts are relatively small compared to total federal revenue. In 2023, customs duties brought in $80 billion, with projections of $96 billion by 2034. Recent tariff increases have temporarily boosted customs revenue; for example, March 2025 saw $8.75 billion in customs duties, the highest since September 2022. However, tariffs historically account for a minor share of federal revenue. Government revenue and spending TTM ($bn). Government Net Spending on RHS.

But is this really a problem?

Debt as % of GDP.

Despite a debt-to-GDP ratio above 250%, Japan has so far avoided the kind of debt crisis that hit other high-debt countries. Domestic Investor Base: Nearly all Japanese government bonds (JGBs) are held domestically, so there is little pressure from external creditors to demand higher yields or panic-sell, similar to the U.S. dollar’s status as the world’s reserve currency. The Bank of Japan’s aggressive monetary easing has been a game-changer—In effect, the central bank has been monetizing debt, keeping borrowing costs ultra-low. Traditional economic theory might predict that a country with debt ~250% of GDP would eventually inflate away some of that burden or face high inflation due to monetization. Yet Japan famously experienced the opposite: chronic low inflation or deflation, even as debt ballooned.

U.S. federal debt has risen to roughly 120% of GDP (gross) in recent years​, the highest since WWII for the U.S. While high, it is only about half of Japan’s debt load. The IMF and analysts often compare the two countries, noting that if one only looks at net debt and low yields, Japan and the U.S. are in a similar ballpark of indebtedness​. The big takeaway is that Japan shows a country can sustain very high debt with the right conditions (domestic financing, central bank support, etc.), but the U.S. cannot automatically assume it could do the same because its context differs.

History

Under the classical gold standard, currencies were pegged to gold at fixed rates. The gold standard failed during World War I as countries abandoned gold convertibility to finance military expenditures. This led to inflation and economic instability. Attempts to return to pre-war gold parities in the 1920s caused deflation and economic hardship, particularly in countries like the UK, which overvalued its currency when rejoining the gold standard in 1925. The global economic collapse during the Great Depression exposed the weaknesses of fixed exchange rate systems. Many countries abandoned the gold standard entirely during this period, leading to chaotic floating exchange rates and protectionist policies that further deepened economic woes. The Bretton Woods system, established in 1944, was a response to the failures of earlier monetary systems and sought to establish a stable framework for postwar economic recovery and international cooperation.

The Triffin dilemma was identified in the 1960s by Belgian-American economist Robert Triffin. Triffin argued that a country whose currency serves as the global reserve currency faces an inevitable dilemma. To maintain its currency’s role as the global reserve, a country must supply sufficient quantities of it to meet international demand. Reserve status elevates the currency’s value, making the issuer’s exports more expensive and imports cheaper, reinforcing trade deficits.

Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries’ demand for reserve currencies. On the one hand, the monetary authorities cannot simply focus on domestic goals without carrying out their international responsibilities; on the other hand, they cannot pursue different domestic and international objectives at the same time. They may either fail to adequately meet the demand of a growing global economy for liquidity as they try to ease inflation pressures at home, or create excess liquidity in the global markets by overly stimulating domestic demand. The Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world, still exists.Zhou Xiaochuan, “Reform the International Monetary System” People’s Bank of China, 23 March 2009

If the U.S. continues to run persistent deficits, foreign dollar claims will eventually exceed gold reserves. To avert a run on gold, several measures must be taken. First, interest rate hikes become necessary: The Federal Reserve must tighten monetary policy, raising rates to attract foreign capital and stabilize the dollar. These higher rates suppress domestic demand, ultimately triggering deflation. Second, global spillover effects occur: U.S. economic contraction exports deflation, especially to commodity-exporting nations. As seen in Triffin’s analysis of Latin America, price declines in primary goods (which have inelastic demand) cascade into wage cuts and reduced consumption throughout these economies. Triffin analogized competitive devaluations to oligopolistic price wars: Countries devalue to boost exports, but if demand is inelastic, revenues stagnate. Falling export incomes force domestic wage cuts, further depressing demand and price.

The collapse of Bretton Woods in 1971–1973 seems to confirm Triffin. Chronic deficits increased foreign dollar holdings beyond U.S. gold reserves, creating a credibility gap. By 1971, foreign central banks held $47 billion in dollar reserves against U.S. gold reserves valued at just $10.5 billion. This imbalance made a run on gold inevitable. While Triffin anticipated a deflationary collapse, the actual breakdown coincided with stagflation (high inflation and unemployment). This divergence occurred because the U.S. abandoned gold convertibility in 1971 rather than contracting liquidity,.During the Great Depression (1930s), a similar liquidity contraction occurred under the gold standard when countries hoarded gold instead of expanding credit. This led to severe deflation and economic stagnation globally. allowing unchecked dollar printing. However, Triffin’s core insight—that the system’s structural flaws made collapse inevitable—was validated. Triffin noted that the U.S., as the issuer of the global reserve currency, could finance its deficits by issuing dollar-denominated debt rather than undergoing economic adjustments. However, this privilege came with risks, as excessive reliance on debt undermined long-term stability.Michael D. Bordo and Robert N. McCauley, “Triffin: dilemma or myth?” Bank for International Settlements, BIS Working Papers No 684, Monetary and Economic Department, December 2017.

By 1973, most major currencies adopted floating exchange rates, allowing market forces to determine their value relative to others. Floating exchange rates facilitated deeper integration of global financial markets but also amplified risks like speculative attacks and asset bubble. The global economy shifted permanently to fiat-based currencies. This allowed central banks greater flexibility in monetary policy but also increased risks of inflation and currency instability. The absence of a coordinated international monetary system allowed countries to finance deficits through borrowing without immediate consequences. Since the 1970s, global credit expansion has consistently outpaced real economic growth. Credit now grows at roughly twice the rate of GDP, creating a system heavily reliant on borrowing.Òscar Jordà, Moritz Schularick, and Alan M. Taylor, “When Credit Bites Back: Leverage, Business Cycles, and Crises” Federal Reserve Bank of San Francisco, Working Paper Series, 2011.

Since the fall of Bretton Woods, a profound change has occurred: the international economy has entered the era of a “debt-driven” economy. Credit expansion has outpaced potential growth. Before the demise of Bretton Woods, credit and economic growth moved more or less at the same pace. However, since the end of the 1970s, credit expansion has reached twice the average rate of economic growth. This has led to the oversizing and predominance of financial markets (“financialization”). The share of the US financial industry has doubled in real terms since the end of the 1970s, growing from approximately 4% to more than 8% of US GDP.Jacques de Larosière, “The Demise of the Bretton-Woods System Explains Much of Our Current Financial Vulnerabilities,” Speech delivered at the Eurofi High Level Seminar, April 2012.

Historical debt management strategies

1970s: During the high-inflation period, Treasury’s debt profile was heavily weighted toward short-term instruments, with Treasury bills comprising 40-45% of total U.S. debt. This coincided with the Federal Reserve’s aggressive rate hikes to combat inflation, resulting in interest costs consuming an increasing portion of the federal budget. While high inflation eroded the real value of outstanding debt, and earlier financial repression (through Fed rate caps) helped manage refinancing burdens, the experience taught mixed lessons: short-term borrowing can be sustained partly by inflating away debt, but at significant economic cost. This episode prompted Treasury to pursue a more balanced maturity structure in subsequent years.

1980s to 1990s: Though U.S. debt was relatively modest as a percentage of GDP in the early 1980s, double-digit interest rates caused net interest outlays to reach record levels (exceeding 15% of federal spending). This fiscal pressure eventually led Congress and the White House to implement deficit-reduction measures through the late 1980s and early 1990s, including the 1990 Budget Enforcement Act and the 1993 budget deal. Combined with robust economic growth, these efforts reduced both the debt-to-GDP ratio and interest burden throughout the 1990s. This period demonstrates that when interest costs become excessive, the U.S. has historically responded with policy adjustments—spending cuts and tax increases—to restore confidence and reduce future refinancing needs, albeit often after significant delay.

Post-2008 Global Financial Crisis: Treasury adopted a strategy opposite to today’s approach. With historically low interest rates and strong investor demand for longer-term assets, the U.S. significantly extended the average maturity of its debt. By 2016, Treasury bills represented only about 9% of outstanding debt (an all-time low), as the government issued more 10-year notes and 30-year bonds to secure low rates. The Treasury Borrowing Advisory Committee (TBAC) explicitly recommended minimizing bill issuance in favor of longer maturities. This strategy reduced rollover risk by ensuring a large portion of debt would remain financed at low rates even if market conditions changed. The average maturity of U.S. marketable debt increased to approximately 6+ years by the late 2010s, providing a buffer entering the 2020s. This approach proved beneficial when massive deficits emerged in 2020, as much of the existing debt remained cheaply financed.

2020 COVID Crisis: The pandemic prompted an explosion of short-term borrowing. Facing urgent liquidity needs in the trillions, Treasury flooded the market with T-bills as the fastest way to raise cash. Bills outstanding surged to approximately 25% of the debt stock by mid-2020. This was understood as a temporary measure; as TBAC noted, it “made no sense to issue 30-year bonds for a one-year problem.” Once the immediate crisis subsided, Treasury gradually shifted back toward longer-term issuance. From late 2020 through 2021, it increased auction sizes for notes and bonds while allowing the bill share to decline toward 15-20%. By early 2022, bills comprised about 18% of debt, down from their peak. This experience demonstrated Treasury’s flexibility in temporarily relying on bills before rebalancing to extend maturities when conditions permitted—a strategy similar to what they may attempt around 2025-26. The 2023 debt ceiling impasse complicated matters, forcing Treasury to draw down cash reserves and pause net new borrowing for months. During this period, no new bills could be issued, and outstanding bills actually decreased, reducing the bill share to approximately 18% by mid-2023. After the debt limit was raised, Treasury had to “catch up” with a surge of bill issuance to rebuild cash buffers and address postponed financing needs, leading to the above-normal bill share entering 2024.

Rise of protectionism

And it wasn’t just Keynes whose ideas seemed to have been forgotten. As Brad DeLong of the University of California, Berkeley, has pointed out in his laments about the Chicago school’s “intellectual collapse,” the school’s current stance amounts to a wholesale rejection of Milton Friedman’s ideas, as well. Friedman believed that Fed policy rather than changes in government spending should be used to stabilize the economy, but he never asserted that an increase in government spending cannot, under any circumstances, increase employment. In fact, rereading Friedman’s 1970 summary of his ideas, “A Theoretical Framework for Monetary Analysis,” what’s striking is how Keynesian it seems.

And Friedman certainly never bought into the idea that mass unemployment represents a voluntary reduction in work effort or the idea that recessions are actually good for the economy. Yet the current generation of freshwater economists has been making both arguments. Thus Chicago’s Casey Mulligan suggests that unemployment is so high because many workers are choosing not to take jobs: “Employees face financial incentives that encourage them not to work . . . decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire).” Mulligan has suggested, in particular, that workers are choosing to remain unemployed because that improves their odds of receiving mortgage relief. And Cochrane declares that high unemployment is actually good: “We should have a recession. People who spend their lives pounding nails in Nevada need something else to do.”

Personally, I think this is crazy. Why should it take mass unemployment across the whole nation to get carpenters to move out of Nevada? Can anyone seriously claim that we’ve lost 6.7 million jobs because fewer Americans want to work? But it was inevitable that freshwater economists would find themselves trapped in this cul-de-sac: if you start from the assumption that people are perfectly rational and markets are perfectly efficient, you have to conclude that unemployment is voluntary and recessions are desirable.

Yet if the crisis has pushed freshwater economists into absurdity, it has also created a lot of soul-searching among saltwater economists. Their framework, unlike that of the Chicago School, both allows for the possibility of involuntary unemployment and considers it a bad thing. But the New Keynesian models that have come to dominate teaching and research assume that people are perfectly rational and financial markets are perfectly efficient. To get anything like the current slump into their models, New Keynesians are forced to introduce some kind of fudge factor that for reasons unspecified temporarily depresses private spending. (I’ve done exactly that in some of my own work.) And if the analysis of where we are now rests on this fudge factor, how much confidence can we have in the models’ predictions about where we are going?Paul Krugman, “How Did Economists Get It So Wrong?” The New York Times, September 6, 2009.

Recent resurgence of protectionism and the departure from the Chicago School’s free-market consensus reflect broader shifts in global economic and political dynamics. These policies represent a shift from free-trade principles that dominated global economics for decades, signaling a preference for economic sovereignty over multilateral agreements. Paul Krugman and Brad DeLong’s critiques of the Chicago School’s “intellectual collapse” and contribution to a “Dark Age” in economics center on its abandonment of Keynesian insights, overreliance on idealized market models, and failure to address real-world complexities revealed by the 2008 financial crisis. This decline appears to have happened gradually and through internal contradictions. As economist John Cassidy explained, the 2008-2009 recession exposed weaknesses in Friedman’s ideas. One explanation for this decline is what one scholar describes as a lack of “strong instinct of memetic self-preservation”. More fundamentally, the Chicago School may have undermined itself by embracing rational expectations theory without sufficient empirical testing. This position created a paradox: “If people have rational expectations, how can the free market be ‘under-rated’? And if the free market is not under-rated, then what reason is there to second-guess democratically-chosen policies?”

The decline of the Chicago School’s influence and the rise of protectionism are not isolated phenomena but reflect a broader reevaluation of economic orthodoxy. The 2008 financial crisis and subsequent recession challenged many core assumptions of Chicago School economics, particularly regarding the self-regulating nature of markets. This disillusionment created space for alternative economic approaches, including more protectionist policies. The political dynamics have shifted as well. The Chicago School’s influence peaked during a period when faith in markets was high. As economic insecurity has grown, political actors are more willing to embrace protectionist policies that promise to protect domestic industries and workers. Historical evidence suggests that protectionist tendencies often emerge in response to economic shocks. According to economic historians Douglas Irwin and Kevin O’Rourke, “shocks that emanate from brief financial crises tend to be transitory and have little long-run effect on trade policy, whereas those that play out over longer periods may give rise to protectionism that is difficult to reverse”.

Back to basics

A “fallacy seldom contradicted is that exports are good, imports are bad. The truth is very different. We cannot eat, wear or enjoy the goods we send abroad. We eat bananas from Central America, wear Italian shoes, drive German automobiles, and enjoy programs we see on our Japanese TV sets. Our gain from foreign trade is what we import. Exports are the price we pay to get imports. (Free to choose, Milton Friedman, 1980.)

Let’s suppose, to begin with, that the rate of exchange between the dollar and the yen was, as it was for a long time, 360 yen to the dollar or one dollar would buy 360 yen. Then these people who had all these dollars that were useless to them would say, “If you’ll sell me some yen, I’ll give you a dollar for 300 yen.” “No,” says the owner of the yen, “even at 300 yen to the dollar American goods are too expensive. They’re not worth it.” “Okay, I’ll give you a dollar for 200 yen.” And you can see what would happen. The price of the yen would be bid up until what? Well, the fewer yen you get for a dollar, the more expensive Japanese goods are to Americans. The more dollars you get for a yen, the cheaper American goods are to Japanese. So the effect would be that the yen would rise in price until it was no longer true that all U.S. goods were more expensive than all Japanese goods. As the yen became more expensive, Japanese goods would become more expensive to U.S. citizens in dollars and American goods would become cheaper to Japanese in yen. That would continue until on the average the dollar value of the goods that the Japanese would buy in the United States would be roughly equal to the dollar value of the goods that the U.S. would sell. At that point, the price of the yen in terms of the dollar would be at an appropriate level.

I have simplified the story because over and above these bilateral transactions between the United States and Japan, of course, these flows of trade will take roundabout directions. The Japanese will spend some of their dollars in Brazil and the Brazilians in turn will spend their dollars in the U.S. and the dollars may flow in very roundabout circles. But the principle is the same. People want dollars not in order to have pieces of paper but in order to have U.S. or other goods. And again, the actual situation is complicated by the fact that, in addition to the flows of goods and services, there are also capital flows, also investments abroad. The United States throughout the nineteenth century, throughout the period when we were building up and getting to be the economically most developed country in the world, had a balance of payments trade deficit every single year almost. Why? Because the U.S. was a country in which foreigners wanted to invest capital. The British were producing goods and sending them over to us in return for pieces of paper, not those green pieces of paper but different pieces of paper, bonds, promising to pay back a sum of money at a later time plus interest on it. The British regarded that as a good investment and they regarded it therefore worth their while to send us goods in order to get those pieces of paper.

There was nothing wrong with that. On the contrary, we benefited by having foreign investment here that enabled us to develop more rapidly and the British benefited by getting a higher yield on their savings than they could have gotten any other way. In the twentieth century that was reversed. We had what was called a favorable balance of trade because the U.S. citizens were finding that they could get a higher return for their money by investing abroad than they could at home, and as a result we were sending goods abroad in return for those pieces of paper. Again, in the post-World War II world under American foreign aid and Marshall Plan programs we were making gifts abroad. We were sending goods and services abroad as an expression of our belief that that was a contribution to a peaceful world.

So the situation is more complicated, but the fundamental point is the same. So long as you have a free exchange rate which is free to determine in the market the price of the dollar in terms of the yen, there is no balance of payments problem. There is no sense in which American industry is in danger of being undercut by foreign industries and destroyed. (Free Trade: Producer Versus Consumer, 1978)

The argument in favor of tariffs that has the greatest emotional appeal to the public at large is the alleged need to protect the high standard of living of American workers from the “unfair” competition of workers in Japan or Korea or Hong Kong who are willing to work for a much lower wage. What is wrong with this argument? Don’t we want to protect the high standard of living of our people?

The fallacy in this argument is the loose use of the terms “high” wage and “low” wage. What do high and low wages mean? American workers are paid in dollars; Japanese workers are paid in yen. How do we compare wages in dollars with wages in yen? How many yen equal a dollar? What determines the exchange rate?

Consider an extreme case. Suppose that, to begin with, 360 yen equal a dollar. At this exchange rate, the actual rate of exchange for many years, suppose that the Japanese can produce and sell everything for fewer dollars than we can in the United States–TV sets, automobiles, steel, and even soybeans, wheat, milk, and ice cream. If we had free international trade, we would try to buy all our goods from Japan. This would seem to be the extreme horror story of the kind depicted by the defenders of tariffs–we would be flooded with Japanese goods and could sell them nothing.

Before throwing up your hands in horror, carry the analysis one step further. How would we pay the Japanese? We would offer them dollar bills. What would they do with the dollar bills? We have assumed that at 360 yen to the dollar everything is cheaper in Japan, so there is nothing in the U.S. market that they would want to buy. If the Japanese exporters were willing to burn or bury the dollar bills, that would be wonderful for us. We would get all kinds of goods for green pieces of paper that we can produce in great abundance and very cheaply. We would have the most marvelous export industry conceivable. (The Case for Free Trade, 1997)