Image: Euro © Royalty-Free, Corbis

Keep the promise alive. Give me decisive non-action.

That's my hope for central bank decisions in September.

Frankly, it's an attitude founded not so much on optimism that the global financial and economic crisis is about to fix itself as on a cynical calculation that the world's leaders won't do much before the end of the year. And I think the best strategy for getting to that point in the year without the current crisis getting significantly worse is lots of central bank promises coupled with very little action.

That way the Federal Reserve and the European Central Bank keep the hope of powerful central bank intervention alive -- which bolsters the prices of financial assets and optimism about the economy.

So far, so good; for all the attention the market gave the ECB's announcement Thursday, it was only a promise with contingencies. There was no action.

And all promises with no actions doesn't reveal the depressing truth: that central banks have used their powder, emptied their toolbox, burned all their fuel -- and the likelihood that anything they can do will significantly add to economic growth is just about nil.

The bad alternatives

I can think of two possible outcomes if the Federal Reserve and the ECB summon up the last ounces of policy mojo that they have -- and neither is good.

image: Jim Jubak

Jim Jubak

First, at a minimum and in the short term, if the central banks act instead of just promising to act, all those shorts and bears who had moved out of the financial markets in August to avoid getting crushed if the Fed and the ECB did move would now be free to go negative again. That includes not only traders who might short equities but also bears who might want to bet against the bonds of Spain and Italy.

And that freedom to go negative could produce a repeat of the worst of the Spanish and Italian bond crises in relatively short order.

Second, more serious and in the slightly longer term, if the central banks act and demonstrate that they can't fix the European debt crisis or the global economic slowdown with a wave of their balance sheets, then we've taken away an important psychological support for the belief that the crisis and associated slowdown are going to get better soon.

After all, if the Fed does implement a new program of bond buying under the rubric of QE3 and it doesn't work (say, for example, unemployment stays stuck at July's 8.3%), then how do we get out of this slough of slow growth in the United States? If the ECB does start a program of unlimited buying of three-year and shorter Spanish and Italian bonds, and the effort doesn't reduce interest rates enough to get those economies moving again, then tell me why a 35-year-old unemployed Italian or Spaniard should think things will get better soon?

It would be up to global political leaders to act -- and I don't see a window for that until near the end of the year.

Keeping hope alive

Better the illusion of hope than no hope at all? You bet. The hope that the central banks could yet throw out a rescue line would buy governments and the global economy time to eliminate debt, time to regain confidence and time to put policies in place that might actually address issues such as productivity and unemployment. (I'll explain how this might work at the end of this column.)

But first, let's look at the odds for constructive non-action.

So far, the odds are high.

On Aug. 31, at the Kansas City Federal Reserve's Jackson Hole conference, Fed Chairman Ben Bernanke laid out what the Fed could do and the circumstances under which the Fed might act -- but did nothing.

On Wednesday, the day before the meeting of the ECB's board of governors, details of the bank's plan leaked to Bloomberg News. That was in itself brilliant (and I suspect deliberate), because it created the impression that the bank was preparing to act. ECB chief Mario Draghi's news conference after the meeting furthered that impression. He laid out such a clear and reassuring plan for action -- the bank would buy relatively short-term Spanish and Italian debt, it would renounce any claims to seniority for its own bond holdings, and it would take on new regulatory powers -- that no one called out that this plan was nothing but a more detailed version of promises made earlier this summer.

The plan didn't just avoid mentioning concrete actions to put those promises into motion. It also included an absolute barrier to action.

  • Yes, the central bank would buy unlimited quantities of Spanish and Italian government bonds, but only after the governments of those countries formally asked for such a rescue. Those governments haven't done that, and have instead made statements ranging from "we see no need to do that" to "we see no need for that at this moment." Both Mariano Rajoy's government in Spain and Mario Monti's government in Italy suspect, rightly I think, that asking for a bond rescue with conditions that smell even faintly of the conditions imposed on Greece would be political suicide.
  • Yes, the central bank would buy unlimited quantities of those bonds after the European Financial Stability Facility and the European Stability Mechanism had acted. But the first is supposed to be going out of business, and the second isn't yet in place. In fact, the European Stability Mechanism is in limbo until the German constitutional court rules on Sept. 12 on the constitutionality of the fund. Until then, the Bundestag can't even vote to approve the European Stability Mechanism, and, without the Germans, this fund is going nowhere.