Nobody should be surprised that Wall Street hit new records this week. After all, the U.S. has just witnessed the end of a sensational hostage crisis that was threatening national security and undermining economic confidence — and even more sensationally, this was the second such crisis in two months.
John Boehner was held hostage by Republican hardliners until last Thursday, when the U.S. Congress voted to continue pumping money into the U.S. government. The fiscal militants forced Boehner to endanger the U.S. economy with threats of a Treasury default. Boehner reluctantly paid this rhetorical ransom in order to preserve the appearance of party unity and therefore his own credibility as a political leader.
Now consider events a month earlier on the other side of Washington. Until September 18, when the Federal Reserve voted to continue pumping money into the U.S. bond market, Ben Bernanke was arguably held hostage by the Fed’s hardliners. The monetary militants forced Bernanke to endanger the U.S. economic recovery with threats of a premature end to quantitative easing. Bernanke reluctantly paid this rhetorical ransom in order to preserve the appearance of institutional unity and therefore his own credibility as an economic leader.
The fact that both these hostage crises were resolved without any bloodshed or major economic damage was naturally cause for financial celebration. But what happens next will depend on an interaction between Boehner, Bernanke and President Obama that has not yet been widely analyzed.
Let us begin with politics and the Boehner-Obama relationship. Both Republican and Democratic leaders now badly want to avert the next phase of automatic spending sequestration that is due to start in mid-January in the absence of a budget deal. Democrats want higher public spending as a matter of principle, while Republicans are under huge pressure from defense contractors to avert the next round of sequestration, which will bear much more heavily on defense spending than the cuts last year. Moreover, neither side has anything left to gain by threatening a budget breakdown — and both have much to lose if they are held responsible for extended gridlock.