By John Cassidy
January 24, 2012

A fragile recovery in the U.S. could get derailed by a European meltdown. ECB chairman Mario Draghi can keep things on track.

By John Cassidy, contributor

FORTUNE — Who will be the most important person in economics in 2012? President Obama? Mitt Romney? Ben Bernanke? My candidate is Mario Draghi (a.k.a. “Super Mario”), who took over as chairman of the European Central Bank. Though virtually unknown to Americans, the dapper Italian technocrat could emerge as a savior of the world financial system or as its unwitting assassin.

As unemployment falls and confidence returns, one thing that could derail the U.S. recovery is a blowup in Europe that ensnares Wall Street banks and sends markets reeling. Draghi will be key to preventing such a calamity. Like Bernanke in the subprime crisis of 2008-09, his job is to prop up the system, providing it with enough liquidity to prevent a self-fulfilling “run” on vulnerable entities, and giving Angela Merkel, the German Chancellor and de facto leader of Europe, more time to tackle the debt problem. “Can the euro be saved without more active engagement from the ECB?” David Riley, sovereign ratings chief at Fitch, warned last week. “We think no.”

In announcing last month that it would provide Europe’s stricken banks with unlimited loans of up to three years’ duration, Draghi has already defused the funding crisis that many financial institutions were facing. Together, the banks took out more than 500 billion euros in loans; many are now sitting on more liquidity than they know what to do with. The ECB also relaxed the terms on which it accepts financial assets as collateral. That allows heavily exposed institutions, such as Commerzbank and Société Générale, to park some of their junkier assets, including the debts of vulnerable sovereigns, on the balance sheet of the central bank, getting cash in return.

The ECB is doing its job as the lender of last resort to the European financial system. But will Draghi provide a similar backstop for embattled European governments, such as those in Madrid and Rome? His official position is he won’t, but my advice is this: Watch what he does, not what he says.

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In the summer of 2008, about a month before Lehman Brothers went down, I saw Draghi, then the head of the Italian central bank, speak at a Fed conference, and I was impressed. He demonstrated a command of economics, financial markets, and the importance of prompt central-bank action. He is also an astute political operator, who spent six years at the World Bank and 10 years at the Italian Treasury. Right now he is playing a game of chicken with the big European governments, the French especially, over who will pick up the tab for further sovereign debt restructurings, which are practically inevitable.

European politicians would like the ECB to bear some of the cost, thereby disguising it from an angry public — and that would happen if the central bank purchased bonds that were subsequently restructured. Draghi and his colleagues on the ECB board would prefer to pass the buck to a new bailout fund, the European Stability Mechanism, which the politicians will control. The problem is that the fund isn’t big enough — its borrowing power has been capped at 500 billion euros — and it doesn’t go into operation until the summer.

Can a compromise be found that reassures markets? Part is in place. Thanks to the ECB’s three-year loan auctions, banks can borrow money from Frankfurt at a very low rate and use it to buy sovereign bonds that pay higher coupons. Since the new loans were announced, yields on short-term government bonds in Italy, Spain, and even Belgium have fallen sharply. On top of indirectly funding the purchase of sovereign bonds, I think the ECB will soon purchase them directly. It officially won’t be described as a bailout. With Europe heading into a crunching recession, it will form part of a policy of quantitative easing, in which the ECB mimics the action of its counterparts in the U.S., Britain, and Japan. Having questioned the efficacy of QE, Draghi would have to explain such a turnaround. But following changes on the ECB’s board, he has some freedom of movement. And with the deepening slump affecting the mighty Germany, the good burghers of Saxony and Bavaria may temper their complaints about an Italian debasing the currency.

We in the States are merely interested observers. Anything Draghi does to prevent a repeat of 2008 would be welcome.

This article is from the February 6, 2012 issue of Fortune.


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