Quite apart from the weaker dollar, we probably are at the beginning of a long-term cycle of rising commodity prices.

One of the features of the modern, 'efficient' financial markets is that they often tend to overshoot in either direction: in the process, prices of individual assets get carried way beyond the levels justified by economic fundamentals.

The immediate provocation for the thought is the recent experience in the global exchange and bond markets.

Take the exchange rates first. With each passing day, the dollar keeps sinking lower against both the euro and the Japanese yen. The latest rates are $1.55 per euro and 101 yen per dollar.

The ostensible reason for the euro's appreciation is the fact that, even as the Federal Reserve aggressively eases money and drops interest rates, the European Central Bank has been more reticent.

Clearly, the former is giving more weight to growth and employment, while the latter's priority remains inflation. One reason for this could well be the differing objectives of the two central banks: the Fed is responsible for inflation and employment, while the ECB has a single-point agenda, namely inflation control.

One wonders whether the forthcoming presidential election in the US is also playing a role in the Fed's stance: the US President has already announced a $150 billion fiscal stimulus to the economy.

When the chips are down, Keynes once again comes back into fashion: in the present economic climate, both the Fed and the administration have kept Milton Friedman on the backburner. But this apart, at least some of the European countries are getting concerned with the deflationary impact of a strengthening euro - however, Germany, the largest European economy, seems to be immune so far to the ill-effects of currency appreciation.

As for the Japanese yen, the proximate cause for its rise seems to be the unwinding of carry trades - borrowing, or not keeping savings in, the Japanese currency and investing in high-yield currencies.

While the unwinding does not seem to be as rapid as it was a decade back, in the wake of the LTCM fiasco, the strengthening of the yen is a clear indication of its presence. The reasons could be the narrower interest differential between the yen and the dollar; drying up of credit lines to hedge funds and other high-risk players; and a general climate of risk avoidance in the wake of the crisis in the sub-prime market.

Prices of 'risky', that is non-sovereign, bonds have also been falling rapidly, and the bid offer differences have widened sharply. So of course has the risk premium, that is, the difference between government and corporate bond yields. The prices of credit default swaps on corporate bonds have also shot up during the last six months or so.

The current premium on the widely traded I-Boxx index prices in the possibility of a fifth of all the bonds in the index defaulting! Actually, the highest ever default rate has been just 2.4, and the average since 1970 as low as 0.8.

Clearly, confidence in dollar markets has sunk very low, and is getting reflected in the prices of currencies and bonds. We do seem to be witnessing another repetition of prices overshooting.

The cycle of euphoria to panic and back to euphoria is perhaps the only 'stable' feature of financial markets! Meanwhile, the US treasury has still not changed its 'strong dollar' policy, whatever it may mean in the current situation.

One fallout of the weakening dollar is the sharp increase in commodity prices. Oil has shot up to $110 per barrel, gold prices have jumped, and wheat has doubled in price in a year. This obviously has implications for global inflation - and also the inflation rate in India.

Quite apart from the weaker dollar, given the continued growth in human population, expected to stabilise only at around 9 billion and the limited reserves of minerals as well as agricultural land, we probably are at the beginning of a cycle of rising commodity prices, which may well last for the next few decades.

In this scenario, the question is what the RBI will do when it comes out with its monetary policy statement next month. It will obviously be constrained by the possibility of an election later this year -- there were enough indications of this in the Budget.

Several central banks have got over the problem by aiming at controlling the 'core' inflation - the Fed, for example, excludes food and energy prices from its definition of core inflation, accepting that these are not very susceptible to correction by monetary policy.

On the other hand, at least in our political economy, these two prices are the most politically sensitive ones. In the anxiety to be 'seen to be doing something' about inflation, the RBI may well be constrained to pursue a relatively tight, if not tighter, monetary policy.