The latest actions of the European Central Bank and the Federal Reserve in the United States exemplify this new reality that when politicians can't or won't act, the central bankers will.
Fed Chairman Ben Bernanke has announced that he will keep creating money and buying mortgage bonds until the economic recovery in the United States has progressed to the point that unemployment is down to its traditional level of around 6 percent of the workforce.
His equally bold counterpart in Europe, ECB President Mario Draghi, has put no limit on his plans to keep buying bonds of troubled countries. He seeks to drive down and eradicate the premium in interest rates that the markets were demanding for the risk of countries like Portugal, Greece, Spain and Italy being forced out of the euro.
"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough," Draghi declared in July.
This month he followed it up with the declaration, "The euro is irreversible."
There is an old saying in the markets, "Don't fight the Fed." Traditionally, that has made sense because a central bank has the unrivaled power to print money and to manipulate interest rates to impose its will. But these aren't traditional times.
Over the past four years, the central banks have pumped something close to $10 trillion into the global economy to keep the show on the road. More than $4 trillion of that has come from China's commercial banks, under orders to lend as never before.
The Fed has pumped in well more than $2 trillion and Bernanke is to buy mortgage bonds at the new rate of $40 billion a month. On top of another $40 billion monthly in existing operations, the Fed is pumping in a trillion bucks a year.
The ECB has this year flooded the market with more than $1 trillion in cheap bank loans so that Spanish and Italian banks can keep on funding their country's debt. Add in the Bank of Japan and the Bank of England and the central banks combined will surpass the $10 trillion barrier later this year, if they haven't done so already.
It wouldn't be historically correct to say we have never seen this kind of intervention before. We have -- in the course of the first and second world wars -- but wars on that scale generate intense economic and manufacturing activity, which meant full employment and boom times as the output kept gushing to the guns and shipyards and airfields. Wars have also been times of strong inflation.
We don't have the inflation yet, even with oil back at more than $100 a barrel because unemployment is still high so wages are being held down, which means consumer demand is relatively low so factories are producing way below capacity and businesses are cautious about investing. At the same time, banks are trying to build up reserves to meet new regulations designed to make them more resilient. All of these factors are suppressing or more likely delaying the inflation that is likely to follow and which will make it easier to pay down the monstrous levels of private and public debt that have accumulated in recent years.
Bernanke and Draghi have been forced to take these extraordinary measures because the political leaders in Europe and the United States (and in Japan) have shrunk from the tasks of raising taxes or cutting state benefits and curbing budget deficits. In this sense, our political problem is more serious than our economic plight; witness the prospect that the U.S. Congress drives us all over the fiscal cliff at the end of this year.
But Bernanke and Draghi don't have unlimited powers.
The important element of the decision this week of the German constitutional court, which was met with a standing ovation in the European Parliament, wasn't that it authorized Germany's $250 billion share of the $700 billion European Stability Mechanism (a fancy title for the euro's new bailout fund).
The key was in the small print, which said three things.
First, it said that any rescue of an individual country had to be approved by both houses of the German Parliament, and the upper house, the Bundesrat, is much more skeptical about the euro than the Bundestag.
Second, it said there would be no more bailout money from Germany. The court ruled that the Bundestag "is prohibited from establishing permanent mechanisms based on international treaties which are tantamount to accepting liability for decisions by free will of other states, above all if they entail consequences which are hard to calculate."
Any change would require a change in the German constitution and that would mean a referendum.
The third key result of the German court decision is that with the total bailout fund limited to $700 billion, there is enough either for Spain or for Italy, but not both. So what do the central banks do then, if and when the markets start to test their limited firepower? That is the key question.
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