Immediately after the Second World War, the Scottish mandarin Donald MacDougall had expounded the proposition that the world faced a dollar shortage, which was likely to be endemic and semi permanent.

His popular theme was that America had a surplus of goods and commodities that the rest of the world needed and there was nothing in return that the Americans needed.

Trade would therefore become a one-way flow from America to the rest of the world with nothing going back to pay for it. The basic economic problem was therefore to manage a dollar shortage.

Now an opposite theme is developing; the world has a surplus of goods that America is willing to consume and claims to need very little that the Americans produce; this has led to a glut of dollars, which can only be accommodated by an accumulation of dollar surpluses.

As the Nobel laureate Merton Miller once teasingly wrote, Americans pay for goods by providing dollars for which they can have an unlimited surplus as they have only to print paper in return for commodities.

So long as the rest of the world is willing to hold the bulk of their exchange reserves in dollars, there is no obvious reason for Americans not to exchange their monopolistic capacity to produce dollars for goods. Once again trade becomes a one-way flow.

The Americans are however obviously agitated by this simple logic. They are now seeking to put pressure on the surplus producing countries like China, and Japan to revalue their currencies so that Americans have to pay more for importing goods from abroad.

For conventional reasons Americans are unwilling to achieve the same economic effect by producing so many more dollars that they can easily flood the world with a glut of their currency.

The obvious reason must be that they do not want American prices to rise; but then there lies a contradiction; for if other countries revalue the exchange rate, their goods will be more expensive for the American importer; thus what they are seeking to do is to make foreign goods more expensive for Americans without effecting the price of domestic goods.

But that in a free market cannot happen; if foreign goods compete with American produced goods, an increase in prices through a revaluation must surely lead to an increase in price for American goods; if, on the other hand, foreign goods do not compete with American goods, that is if in some way, foreign goods are unique, then an increase in prices will only lead to more dollars accumulating to foreigners, thereby increasing the dollar glut.

Prima facie, the economics of persuading other countries to re-value is surely logically equivalent to devaluing one's own currency. Now every country has the modus to devalue its own currency quite simply by increasing its supply of domestic currency on the production of which it has a monopoly.

If Americans wish to increase the value in dollar terms of the Japanese yen or the Chinese yuan it could achieve that simply by printing more dollars that is by reducing the value of the dollar. Managers of over valued currencies have often been told that they should devalue their currency.

This is almost the sine qua non of that sensible package that the IMF and the World Bank hand out to every country. Why should that not apply to the dollar?

The answer is of course obvious; the only way the main reserve currency can devalue is indirectly by increasing its production of money. That is not part of the standard solution offered by convention. The Fund would not, for example, tell the Indian finance ministry to devalue the rupee by printing more.

On the contrary, they would generally argue that devaluation has become a necessity because they have printed or spent too many rupees. To advise Americans to devalue their currency by printing more goes against the grain.

Yet there may be a good case for increasing American money supply on a global basis. It is possible that as part of globalisation, productivity in countries that are trying to catch up may have increased more spectacularly than statistics reveal.

An increase in the supply of monetised dollar debt could have a world-wide expansionist effect which the revaluation of a few currencies will not have, indeed to the contrary it could have a deflationary impact.

But the notion that the Americans have the power to follow the policy that Merton Miller jokingly hinted at should also act as a cautionary warning to managers of reserves in countries like Japan, China and India.

A substantive change from pre 1914 days, a period which *T N Srinivasan sometimes cites in his trade lectures, is that in earlier times, private investors had effective control on foreign exchange. Now this control has moved to official authorities.

In former times no one would accumulate reserves for a rainy day, but today we act as if it will rain forever. It is therefore necessary for us to be aware of the implicit veracity of Miller's comment.

It is no doubt sensible to accumulate reserves, diversify our portfolio etcetera, but there is also a case for using them for changing paper to goods, otherwise, we may face the risk of accumulating paper that may earn nothing.

The Reserve Bank has gone far to increase the group of goods and services for which foreign exchange is readily available. Yet, partly because the authorities have a monopoly on rupee supply -- which they can increase at will -- there is always a tendency to over-value foreign exchange.

No one is confident, not just of the value of the rupee but also of the value of the dollar.  Economists therefore always welcome a freely determined market rate.

The best way to achieve that is not by experiment as is done today but by an undertaking that the Reserve Bank will only intervene when the exchange rate crosses arbitrarily decided pre-announced levels, both upwards and downwards.  The Bank should be free to announce another set of levels but only after it has intervened at the pre-announced rate.

Such a policy is not necessary but it is useful; if the Central bank openly admits its own ignorance and explores finding a temporary equilibrium, that very process adds to the confidence of the prevailing exchange rate.

And if the prevailing exchange rate is considered market determined, economists are able to conduct their analysis of related issues with greater clarity and assurance.

This however is a minor digression to the main theme that the world needs to be aware of the dangers of the dollar glut. The obvious point is that the American debt expressed in dollars is redeemable in paper currency; that it has value in terms of goods depends on the value of goods that can be purchased and that the American authorities have just as much ability to inflate the value away as authorities of other countries have to inflate their domestic debts away.

No country, no borrower does that simply out of whim. Yet the present glut of foreign currencies held by Asian Central banks represents a potential systemic instability, which could prove more dangerous than we are willing to believe.

*Chairman and professor, Economic Growth Centre, Yale University, USA

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