Research Highlights Podcast
July 2, 2026
Views on the dollar shortage controversy
Harris Dellas and George Tavlas discuss the postwar dollar shortage debate between Charles Kindleberger and Milton Friedman.
Source: Usconsulate, Public domain
In the fifteen years following the end of World War II, Western Europe's capital account surpluses were not sufficient to finance its trade deficit with the United States. Charles Kindleberger of MIT, who helped assemble the Marshall Plan, defined this gap as the "dollar shortage" and argued that it was a structural problem rooted in Europe's lagging productivity, one that could only be fixed by sustained US lending. Milton Friedman disagreed, treating the shortage as a simple consequence of overvalued fixed exchange rates that floating currencies would correct. The argument continued through scores of books and articles written by many other economists into the late 1950s, until Europe's productivity caught up, and the debate faded.
In a paper in the Journal of Economic Perspectives, authors Harris Dellas and George S. Tavlas revisit the controversy and explain why it still matters. They find that Kindleberger anticipated much of what is now called the intertemporal approach to the current account, and they trace how two recent episodes of dollar shortages echo and depart from the original.
Dellas and Tavlas recently spoke with Tyler Smith about the paper.
The edited highlights of that conversation are below, and the full interview can be heard using the podcast player.
Tyler Smith: What was the postwar dollar shortage?
George Tavlas: The dollar shortage that Harris and I have written about took place in the 1940s and 1950s. It concerned the economic relationships at that time between the United States and Europe. The war destroyed Europe's productive capacity and left the United States as the world's major undamaged economy. Europe desperately needed US goods in order to improve its living standards and to rebuild its depleted capital stock. Its dependence on US exports was persistent because, at the end of the war, there weren't any good substitutes for US exportables. In order to pay for its imports of US goods, Europe had to do one of three things: export its own goods to the United States to earn dollars or gold, which was the other major reserve; borrow dollars from the United States; or use its existing stock of dollar and gold reserves. The destruction caused by World War II left Europe unable to produce many goods for export. It was unable to borrow, and its stocks of both gold and dollars were essentially nonexistent. So, the dollar shortage dominated discussions on international monetary policy during the 15 years following World War II. Because the shortage stood in the way of Europe's reconstruction, it had negative impacts on global trade, and that provided a justification for protectionism on goods and on capital.
Smith: It seems like this debate has been settled for over 60 years. Why revisit it today?
Harris Dellas: Dollar shortage debates have resurfaced in the last ten years or so in two different contexts. One is actually quite similar to the old context of the '40s and '50s, and it concerns less developed countries. In many cases, those countries have fixed-exchange-rate regimes and capital controls, and they often run into balance-of-payments problems—that is, situations where their holdings of foreign reserves are not sufficient to finance their current account deficits. So, this is very similar to the experience of the '40s. But there is one fundamental difference. The old dollar shortage actually had very little to do with the dollar. It came down to the fact that the United States simply was the country those economies were trading with. They needed American goods, and they had to pay with dollars. But it could have been a dollar shortage even if the US dollar had not been the international reserve currency at the time. The modern dollar shortages, by contrast, arise exclusively because the dollar is the international reserve currency. If you're an African country and you want to import goods from Vietnam, you need dollars. There are similarities in the sense that in both cases it is the inability of countries to borrow in order to finance imports. But the difference is that back then they could have borrowed in anything—it didn't matter, the international reserve function was not important. Now they have to use dollars. That's one context in which the dollar shortage has reappeared.
The other one, which is interesting, concerns not less developed countries but developed countries, and it concerns financial transactions. The dollar shortage became a very prominent concept again about ten years ago—during the financial crisis and afterward. It concerned transactions in the financial markets of advanced countries in particular situations where, say, Japanese banks had borrowed in dollars and would have to repay those dollars at some point in the future. There was uncertainty about whether they would be able to obtain those dollars. And the uncertainty did not concern the existence of collateral or anything like that—these were financially sound enterprises. It was simply the fact that there might not be enough dollars available to them. This dollar shortage had to do with the fact that those commercial banks throughout the developed world, which use dollars in their financial transactions, do not have access to the Federal Reserve.
Smith: At the heart of your paper is a clash between two economic camps, represented by Charles Kindleberger on one side and Milton Friedman on the other. First, what was Kindleberger's diagnosis of the dollar shortage problem?
Tavlas: In his work on the dollar shortage, Kindleberger argued that Europe's dependence on US exports would be persistent because there were no good substitutes for US goods at the time. So, Europe would have to rely on US goods for many years into the future. To deal with the situation—because he recognized that Europe needed US goods to rebuild its economy—he focused on the capital account. His solution to the dollar shortage was for the US to lend to Europe. And this, by the way, was the focus of the Marshall Plan, which provided funds to Europe to purchase US goods. By borrowing from the United States, Kindleberger believed, Europe would be able to purchase the goods it needed to rebuild its economy. Europe would be able to increase its productivity—and this was the essential problem pinpointed by Kindleberger—so that it could compete with the United States and become less reliant on US exportables. Kindleberger was also of the opinion that the exchange-rate adjustment mechanism, which was emphasized by people like Friedman, would not work. That is, it wouldn't eliminate the current account imbalance because of low trade elasticities. There simply wasn't any competition for US goods, so it didn't matter what the price was—Europeans needed those goods and had a demand for them. In other words, since there were no good substitutes for US products, trade elasticities were low, which meant it would be very difficult to achieve current account balance through the exchange-rate mechanism. Even if balance could be achieved, what good would it do if it meant Europe could not import enough to rebuild its economy? So, that was his diagnosis. Europe needed to be able to borrow dollars in order to purchase dollar-denominated goods, rebuild its economy, and increase its productivity so that it could become competitive with the United States.
In contrast to Kindleberger's emphasis on the capital account, Friedman was part of a group of economists who focused on the mechanics of restoring Europe's current account to balance. He believed that the key to resolving the dollar shortage was to allow exchange rates to adjust.
George Tavlas
Smith: What did Friedman think was causing the dollar shortage?
Tavlas: In contrast to Kindleberger's emphasis on the capital account, Friedman was part of a group of economists who focused on the mechanics of restoring Europe's current account to balance. He believed that the key to resolving the dollar shortage was to allow exchange rates to adjust—to move to floating exchange rates. More specifically, he thought the dollar was undervalued vis-à-vis European currencies. He argued that the key to ending the dollar shortage was to let currencies float so that the dollar would appreciate against European currencies, which would in turn depreciate, reducing European imports and bringing Europe's current account into balance. Friedman didn't pay attention to the implications of using the exchange rate to achieve current account balance. As a result, his solution could have been very detrimental to Europe because if Europe had reduced its imports of goods from the United States, it would not have been able to rebuild its infrastructure and compete with the United States. The United States was the only country producing the goods that were of value to Europe in rebuilding its economy. So, by shutting off imports through the exchange-rate mechanism, Friedman's solution would not have provided a long-term solution to the dollar shortage for Europe.
Smith: Can you describe what was missing from the frameworks that Kindleberger and Friedman were using?
Dellas: What was missing from Kindleberger was just the formal framework. He had all the ingredients of the intertemporal approach to current account and balance-of-payments determination. What is the essence of this theory? The main idea is that, rather than looking at the current account from the point of view of the trade balance—imports and exports, it's more useful to look at it from the point of view of saving and investment. It's equivalent, but from a modeling perspective, and also from an empirical perspective, it is much more powerful. What does this mean? Let's look at Europe and the United States at the time. The United States is rich; Europe is poor. The intertemporal approach to the current account says that poor countries—like less developed countries—should borrow, and use the borrowed funds to smooth consumption and to finance productive investment so that they can grow and eventually repay. So, the intertemporal approach suggests that poor countries should run large current account deficits if the gap from the rich countries is very large. This borrowing will improve the poorer country's productivity in the long term, and it can use the borrowing to bring some of those future gains into the present, to finance current consumption. That's the essence of the intertemporal approach, and this is exactly what Kindleberger said.
Friedman was, of course, very familiar with intertemporal considerations. He's the man who founded the permanent income hypothesis, which is exactly about how saving and consumption respond to changes in income over time. The permanent income hypothesis says that if your income is low now relative to your future income, you should borrow—that is, in the open economy context, run a current account deficit. But Friedman did not apply that at all to the analysis of the current account in the dollar shortage. So, both of them were perfectly familiar with the intertemporal approach, but only Kindleberger actually applied it to the dollar shortage. Friedman completely ignored it and focused on monetary considerations.
Smith: How did the great dollar shortage actually get resolved?
Tavlas: A couple of factors helped resolve the dollar shortage—some transitory and one more permanent. The transitory factors were mainly two. One was the Marshall Plan, which started in 1948 and channeled about $13 billion, mostly in the form of grants, to European countries to rebuild their economies. As I recall, that was about 3 percent of national income at the time. The other was a series of exchange-rate devaluations in 1949, beginning with the British pound, which devalued by around 30 percent—and most other European currencies followed. So, those were the temporary factors. The structural factor was the closing of the technological gap between the United States and Europe. Throughout the 1950s, European productivity growth outstripped productivity growth in the United States and made European currencies more competitive. So, in the 1950s Europe began running current account surpluses with the United States, and the United States began running current account deficits. The closing of the technological gap was made possible by the United States lending to Europe. The Marshall Plan worked, and later private capital inflows began coming into Europe—and that proved that Kindleberger was right in this debate.
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“Retrospectives: The Great Dollar-Shortage Debate” appears in the Spring 2026 issue of the Journal of Economic Perspectives. Music in the audio is by Sound of Picture.