Thursday, April 14, 2011

Have Things Changed in the United States Budget Debate?

Last week, April 7, 2011 to be exact, things started to change. Jean-Claude Trichet, President of the European Central Bank, guided the ECB to an increase in its policy interest rate, moving from 1.00 percent to 1.25 percent. (See

The night before the announcement, Portugal declared that it would seek a bailout from the European Union.

Last Friday evening, President Obama, the United States Senate and the United States House of Representatives reached an eleventh-hour agreement on the 2011 fiscal budget.

Yesterday, President Obama gave a speech laying out his ideas about improving the fiscal position of the United States government in the upcoming future.

Has Trichet and the ECB provided the turning point?

It is not altogether clear that the financial markets believe that the real attitudes in the United States have changed. Since the Trichet announcement, and through the political maneuvering in the United States over the past week, the Euro rose from about $1.42 per Euro to about $1.46 per Euro. Op-ed pieces in the Financial Times have argued that the Americans are really not serious about getting the budget under control. Seems as if people are not convinced yet that there is anyone in the American government that is intent upon really doing something about the situation. They are just posturing.

And, there is one person I have not mentioned that plays a vital role in this scenario: Ben Bernanke.

Bernanke in now on the opposite side of the picture from Trichet. (

Trichet has turned the corner and raised interest rates.

Bernanke continues to promote QE2.

The Europeans cannot fault the Americans for messy governance. Since the sovereign financial cookie began to crumble in Europe in January 2010, the governments in Europe have fallen all over themselves trying to avoid any real fiscal action that would restore order to the national problems of the continent.

This has allowed countries to delay taking real actions that might resolve the European situation.

Then Trichet stepped up. Because of the pending ECB movement, Portugal had to move, they had to show some activity before the rate increase was announced.

Now, other European nations are on notice. Trichet has indicated that the recent move was not necessarily a part of multiple moves in the interest rate. But, I don’t think that any European nation doubts that Trichet and the ECB will continue to raise rates if the troubled nations don’t seriously attack their problems.

As I said, Bernanke is on the opposite side of the picture.

The Bernanke record? Before the Jackson Hole speech in late August (, a Euro could be purchased for about $1.27. By early November, the price of a Euro had climbed to about $1.42. Into January, as the governments of the European Union messed around, this price dropped to around $1.30. Trichet started making noises that maybe the ECB needed to start raising interest rates and this resulted in value of the Euro rising again to around $1.40. And, Bernanke continued to defend the Fed’s quantitative easing!

What is Bernanke holding out for? What does he know about the economy or the banking system we don’t?

Of course, Bernanke has always been late to the dance. He was still promoting excessively low interest rates in the early 2000s when the housing bubble and the stock market bubble were accelerating. He was still fighting inflation in August 2007 as the regime of the Quants broke. He was still worried about inflation in August of 2008 until he wasn’t worried about inflation in September 2010. (See

Any bets that Bernanke will be late to the party once again?

But, when it comes to the lack of confidence in the will of the United States to support the value of the dollar, Bernanke is not alone. With two exceptions, the United States government has followed a policy of credit inflation for the last fifty years that has resulted in a decline in the value of the dollar against major trading partners of around 35 percent. The value of the dollar has declined against other, non-major trading partners, by even more than 35 percent over this time period.

The two exceptions came when the monetary policy of the United States was led by Paul Volcker, 1979-1987, and the fiscal policy was led by Robert Rubin, 1995-1999. During these periods the value of the United States dollar rose strongly. Yet, overall, the value of the dollar still declined by 35 percent.

And, the United States dollar is the reserve currency of the world. We should be really proud of having this responsibility. And, in carrying out this responsibility the economic policy of the United States government has caused other sovereign nations to lose part of their wealth due to the fact that the United States was inflating their currency and causing a decline in the value of the currency reserves these nations were holding.

For the near term, Bernanke is going to “stay with the fight”. That is quantitative easing is going to be continued through June. Between now and then the “debt ceiling” fight is going to heat up along with the competition now being billed as the “budget debate.”

And, the value of the United States dollar will continue to decline (baring other shocks to the world).

The value of the United States dollar will continue to decline over time as long as the rest of the world believes that we will not get our fiscal house in order and also believes that our central bank will continue to inflate the globe!

How will we know if the rest of the world begins to take our fiscal and monetary responsibilities seriously?
We will know that attitudes have shifted once we begin to see the value of the dollar firm up and even begin to rise on information about growing discipline over the budget and monetary policy. (I have written an Instablog on this: see “What is Needed to Reduce the Federal Deficit,” March 3,

For now, we hear a lot of platitudes in the budget debate but very little noise of rubber hitting the road. We have a right to remain skeptical.

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