- - Tuesday, July 31, 2012

Two of the most powerful men in the world, supposedly, are Ben S. Bernanke and Mario Draghi, the respective chairmen of the Federal Reserve and the European Central Bank (ECB). Central banks, and therefore central bankers, are supposed to be powerful; today, not so much. As they meet this week to discuss next moves, all they have left to support employment is the most exceptional monetary-policy tool of all: the bluff.

Mr. Bernanke is a respected, mild-mannered former academic and, conveniently, an expert on monetary policy during the Great Depression. Mr. Draghi is an Italian member of long standing in Europe’s ruling elite, i.e., the monetary union engineers responsible for Europe’s sorry plight. Both men can make markets swoon or dive with a word or a phrase.

But influencing their respective economies for the better is beyond their means. Mr. Bernanke and Mr. Draghi matter today primarily because they bluff that they do and markets desperately believe them.

The central banks’ near irrelevance for economic recovery is new. Normally, central banks can pressure interest rates upward or downward to slow inflation or support employment as needed. Today’s high unemployment and already ultralow interest rates mean the Fed and ECB have shot their policy bolts.

Not that they haven’t tried using nontraditional means. For example, the Fed is attempting a $267 billion interest-rate twist, repeating a policy first tried in late 2011. The idea is to push down long-term interest rates while pushing up short-term rates, hence twisting the maturity spread.

Sounds plausible until one realizes that even $267 billion is a drop in the global money bucket. Worse, long-term interest rates already are incredibly low, with little apparent consequence for the recovery. This once was called “pushing on a string.”

Students of monetary policy will find in the Fed’s twist a discouraging parallel. In the 1960s, the Kennedy administration tried its own twist, defending the disintegrating Bretton Woods fixed-exchange-rate system. The goal was to influence capital flows in and out of the U.S. by raising short-term interest rates while holding down long-term rates.

Despite paper-thin markets relative to those in operation today, the Kennedy Twist has been regarded universally as an interesting but failed experiment never to be tried again — until now.

To be sure, the Fed still may play its vital lender-of-last-resort role in the event of a full-blown financial crisis. In that case, the Fed can ensure that financially sound market participants have ready access to financial life-sustaining liquidity until some normalcy is restored. Until then, Mr. Bernanke can only bluff and thank his lucky stars he’s not in Mr. Draghi’s fine-leather shoes.

Whereas the U.S. economy apparently has stalled, the European economy is shrinking. The eurozone monetary union is coming apart at all the seams. Not only is Mr. Draghi bereft of tools to help stabilize employment, there’s little the ECB can do to ward off the euro’s collapse because the problems are not monetary, but fiscal and, even more, raw economic.

The fiscal issue is obvious — way too much debt in all the wrong places. But the economic problem is worse. Some countries, such as Germany and the Netherlands, can compete well in the global economy; many, such as Greece and Italy, cannot. This is only an issue if the strong are linked to the weak — through a monetary union, for example. Countries that cannot compete cannot export enough. If they cannot export enough, they cannot earn the monies needed to pay off foreign creditors.

Normally, exchange rates adjust to resolve unsustainable competitiveness problems. But the weak are stuck in the euro, so the only option is a “domestic devaluation,” eurocode for collapsing wages and prices via economic depression, as we already see unfolding in Greece and Spain.

Humorously, the International Monetary Fund (IMF) recently warned of the unfolding depression and domestic devaluation. The humor, of course, was not the great suffering this implies, but that the IMF pretended domestic devaluation was just a consequence, rather than the true policy now in place. Nobody told the Greeks or the Spanish, but the rising street protests suggest they are figuring it out.

To buy more time, many of Europe’s leaders are pressuring Mr. Draghi to use the ECB to buy up government debt and so keep a lid on government interest rates. But time for what? To adopt new economic policies that at best would take years to bear fruit? Perhaps policies such as those of France’s new government under Francois Hollande, policies such as earlier retirement, a higher minimum wage and higher taxes on companies? What is the word for “crackpot” in French, anyway?

Europe is looking desperately for a savior. Through no fault of his own, Mr. Draghi isn’t him. Fortunately, he appears to know it, and the Germans are quick to remind him if he succumbs to delusions of grandeur.

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