U.S. Fiscal Policy: Undermining Dollar Confidence?

We have generally emphasized monetary factors, such as the low relative and absolute US interest rates and a global financial system awash with dollars, in understanding the dollar's weakness. At the same time we recognize the concern over the trajectory of fiscal policy.

Two recent signals from Washington may be undermining confidence in the commitment to rein in fiscal policy. First, with no cost of living adjustment for Social Security recipients in 2010, the White House has floated the idea of a one-off $250 payment instead.

Second, the Senate is considering several bills that would extend the $8,000 tax break for first time home buyers. One measure would extend the break through the middle of next year and expand it to all couples earning $300k or less. Another proposal would extend the $8,000 break through Q1 2010 and then phase it out gradually (by $2,000 a quarter) until the end of the 2010. House Speaker Pelosi is sympathetic with an extension in principle, but appears to be waiting to see what emerges from the Senate.

Moreover, the program seems rife with fraud. This is not meant to be the usual cant about government programs, but rather the Treasury's Inspector General reportedly indicated that there appear to be at least 74k fraudulent claims.

Even though the FY09 deficit was about $400 billion less than both the Obama Administration and the CBO estimated earlier this year, the $1.4 trillion shortfall is the equivalent of 10% of GDP.

In addition to these two programs -- one-time payment to Social Security recipients and extending the home buyers tax break -- with unemployment rising, there is some interest in extending benefits again.

Just like recent rhetoric by Bernanke and Geithner (and others) recognizing the importance of confidence in the US economy and the dollar, officials need to recognize the limits of fiscal policy or risk undermining precisely that confidence that they seek to defend. A fiscal parallel to the strong dollar policy may be particularly helpful in changing sentiment.

Disclosure: No positions