Fed & ECB - A Study In Contrast

This week is jam-packed with events that will keep markets on their toes, but the two to focus on are the testimony to the Joint Economic Committee by Fed Chairman Ben Bernanke on Tuesday and the European Central Bank meeting on Thursday (the bank stress tests will be released on Thursday after the markets close. But given all the leaks, there might not be much left to release come the time.). Bernanke and Trichet will be far more interesting, highlighting the difference in approach to the crisis resolution - and reminding us at the same time of the limitations of central banks.

Bernanke will with no little pride be able to point to some hopeful developments, the slowdown in orders, including export orders, abating in the manufacturing sector - still a weathervane for the broader economy despite the service sector's weight - consumer confidence picking up, even house prices, while still falling, no longer setting record declines. Plus, there have been more signs of healing in the financial markets - risk gauges like Libor/OIS are narrowing - 3-month Libor is headed below 1% - and one Fed facility, at least - the one that supports commercial paper- is seeing less usage (though that's in part a reflection of the lower demand for corporate borrowing due to the recession). Sure, he'll be crossing his fingers behind his back as he speaks, given testing times ahead in the auto industry and the continued worsening in the jobless rate (a 9% unemployment rate for April is not out of the question). He will do his utmost to calm any fears that the Fed is in over its head with its ballooning balance sheet by outlining the exit strategies, the groundwork for which was laid in the March joint statement by the Fed and Treasury. And he will have soothing words for those worried about record debt levels. Demand? No sign it's waning massively, plus never underestimate the power of a determined central bank. Inflation? Conscious of the danger, believes the Fed has it under control. And the administration, he will note, is determined to reduce the deficit in the years ahead.

Two days later, listen to Jean-Claude Trichet, president of the European Central Bank. He will explain why a 1/4 percentage point cut in the euro zone's key rate to 1.0% and the extension of its refi operations from six months to possibly a year are sufficient to lay the groundwork for recovery, even as these measures pale in contrast to the Fed's actions. He has a point: Structurally, the euro zone depends on banks for lending, in contrast to the U.S., which relies heavily on debt markets - so expanding money supply is one key way of ensuring the supply of credit to the economy. Add the automatic stabilizers such as unemployment benefits, welfare payments, healthcare etc, to the special spending packages, and the euro zone and the U.S. are spending similar amounts. And he too can point to success: Euro zone market rates are in many instances lower than dollar rates, even though the Fed's key rate is much lower. But most importantly, expect Trichet to remind his audience of the stifling impact of ever-rising government deficits: consumers, fearful of higher taxes later, don't spend any additional funds, opting to save them instead; interest rates eventually end up having to be higher than desirable to attract investors; economies lack the resources to tackle the big structural issues, such as pension funding, better education, etc.

So, is the ECB free-riding on the coattails of the Fed's massive intervention? Or is the Fed being reckless, and is it the ECB that should be lauded for its adherence to fiscal discipline? It's probably a bit of both, and a lot of the difference in the approach is based on their history - the Fed and the Great Depression; the ECB and Europe's battle with hyperinflation.
But it's also a moot point in many ways. There's only so much central banks can do; they are after all merely guardians of the economy. It's time to remember that the economic challenges the euro zone and the U.S. face require political solutions. From the big exporters to the finance- and real-estate dependent economies - it's time we recognize the integral part the economy plays in society and reclaim our power to set its course.