Across the Curve

Beckner on the Federal Reserve and the Greenback

Stephen Beckner is a long time observer of the Federal Reserve and currently works for Market News International, a well respected and widely followed news service. He writes frequently and cogently about the Federal Reserve and as a reader  he seemed to have some trustworthy sources at that August institution. Several readers forwarded a copy of a piece which he wrote yesterday for Market News and I reproduce it here.

EXPECT TO HEAR MORE DOLLAR-SUPPORTIVE COMMENTS FROM THE FED

By Steven K. Beckner
Monday, October 26, 2009

It was no accident that Federal Reserve Chairman Ben Bernanke went
out of his way last week to talk about the need to maintain confidence
in the U.S. dollar, I am reliably informed.
We can expect to hear more hints of Fed concern about the
depreciation of the U.S. dollar.

That does not mean, however, that the Fed is getting ready to
tighten monetary policy to bolster the dollar, I’m told.

The Fed chairman seldom talks about the dollar. He usually leaves
that subject to Treasury Secretary Timothy Geithner — the senior
partner in Group of Seven exchange rate discussions and the leader on
U.S. dollar policy.

But with the greenback falling against other currencies, with the
price of gold soaring and with foreign investors and governments
expressing mounting concern about the security of their U.S. debt
holdings, Bernanke broached the subject — without being asked — last
Monday.

Following a speech at a San Francisco Federal Reserve Bank
conference in Santa Barbara, Bernanke was asked about the Group of 20’s
call for a rebalancing of world growth.

“In the case of the United States, we have a difficult fiscal
situation,” he began his reply. “I think it is important … (and)
policymakers need to recognize that we need to develop a fiscal exit
strategy which will involve a trajectory for fiscal sustainability.”

“That’s clearly important to maintain confidence in our economy and
confidence in our currency and so on,” Bernanke continued, adding that
“that is well understood in Washington.”
Monday.

Following a speech at a San Francisco Federal Reserve Bank
conference in Santa Barbara, Bernanke was asked about the Group of 20’s
call for a rebalancing of world growth.

“In the case of the United States, we have a difficult fiscal
situation,” he began his reply. “I think it is important … (and)
policymakers need to recognize that we need to develop a fiscal exit
strategy which will involve a trajectory for fiscal sustainability.”

“That’s clearly important to maintain confidence in our economy and
confidence in our currency and so on,” Bernanke continued, adding that
“that is well understood in Washington”                                                I do not mean to imply in any way that the Fed is at odds with the
Treasury over dollar policy. On the contrary, they seem very much in
synch. After Bernanke and Geithner met with their Group of Seven
counterparts in Istanbul on Oct. 3, the Treasury Secretary vowed, “We
are going to do everything we can do to sustain confidence” in the
dollar, including running a sound monetary policy and bringing the
federal budget “back into balance as soon as possible as we get out of
the crisis.”

But what was striking, to me at least, was that Bernanke felt the
need to inject the dollar into his response last week without having
been directly  asked about it. I was later told that its inclusion was
purposeful. Now, don’t get the wrong idea. The fact is that neither the
Fed nor the Treasury are greatly concerned about recent movements in the
dollar. The greenback’s recent slide is seen as largely a retracement of
the run-up experienced earlier in the financial crisis when risk averse
investors fled into dollars as a “safe haven.”

And the mere fact of that previous flight into the dollar makes
officials feel confident that the dollar retains much of its cachet as
the world’s premier reserve and transactions currency.

What’s more, if truth be told, the dollar is one of the most
effective channels through which monetary policy is working right now.
With banks doing little lending and with securitization markets
remaining feeble, credit flows remain weak despite very low interest
rates.

Consumer and business spending has shown only tentatives only
tentative signs of recovery. But a weaker dollar, by making U.S. goods
and services more competitive in world markets, is helping net exports
and providing a source of economic growth.

Nor is the dollar’s weakness seen as an immediate source of
inflation pressure at a time of what the Federal Open Market Committee
has called “substantial resource slack.”

And so, for all these reasons, the value of the dollar is not
about to become a significant factor influencing monetary policy in the
foreseeable future, knowledgeable sources say. That would only occur if
dollar depreciation became “disorderly” and/or there was some
combination of stronger growth and higher inflation.

But while the Fed is not concerned enough about the weakness of the
dollar to want to tighten monetary policy to protect it, policymakers do
have concerns about longer term market perceptions and inflation
expectations.

Because of the risk of deteriorating inflation expectations, which
could greatly complicate the Fed’s task of assuring economic recovery
while maintaining price stability, I have been told to expect to hear
more expressions of support for a strong dollar — and not simply
repetitions of the Treasury boilerplate about a “strong dollar” being in
the U.S. interest.

Look for the Fed to continue to send periodic signals of the Fed’s
long-term determination to maintain the purchasing power of the American
currency. But do not take these comments as a signal that the Fed is
getting ready to take action to push the dollar higher.
. 212-273-7530 (C) 203-550-1196 all assets were not created equally

Frequent Fed assurances about its ability and willingness to use
“tools” at its disposable to “exit” its ultra-accommodative credit
stance when the time comes can also be seen as dollar-supportive.

Already, there has been a flurry of explicit comments about the
dollar.

The day after Bernanke spoke, San Francisco Federal Reserve Bank
President Janet Yellen told me and other reporters covering her Bank’s
conference in Santa Barbara that the dollar’s strength will depend on
the ability of the United States and its major trading partners to
reduce global imbalances. Asked about the weakness of the dollar, Yellen
said the G-20 and G7 call for more “balanced” global growth will entail
the United States reducing its budget deficit and Asia “moving to
greater reliance on domestic demand.”