Bernanke’s comments yesterday have caused some controversy regarding the notion that central bankers should stick to monetary policy, leaving fiscal policy to the politicians. There are two main reasons why he broke ranks. Firstly, the lines between fiscal and monetary policy have become far more blurred over the past two and a half years since the onset of quantitative easing. When the Fed owns some $1.4trln of Treasuries, then it’s far more difficult to sit by. Secondly, Bernanke is right to be concerned about the way politicians are behaving, some even suggesting that a default may not be a bad thing. The US gains considerable benefit from the dollar continuing to be the global reserve currency and still accounting for over 60% of global FX reserves of known holdings. This bestows certain benefits, such as creating a structural demand for dollars that is fairly immune to the goings on in the economy and on Capitol Hill. However, politicians are playing a risky game this time around, in terms of pushing negotiations to the wire and wringing out concessions in the process. Given the change in other risk parameters we’ve seen so far this month it could be argued that the dollar should be higher. The debt issue probably does account for some of the dollar’s reluctance to appreciate, but if this one goes to the 11th hour in the same way as the budget agreement earlier in the year, then international investors may not be so forgiving.
