In the vaguely ridiculous Hollywood blockbuster Taken 2, Liam Neeson plays a former CIA operative who is kidnapped in Istanbul, where he is enjoying a vacation with his ex-wife and daughter, by a gang of vengeful (and surprisingly incompetent) Albanian criminals. In order to escape, Neeson’s character calls his daughter on a miniature phone which he managed to retain, and asks for her help.
And this is where things get truly surreal. In order to help his daughter to determine his location he gets her to retrieve some grenades he has stashed in his hotel room (!), and then asks her to run around Istanbul hurling grenades in a seemingly haphazard fashion, so that Neeson’s character can guide her to the Albanians hideout, by using the sound of the detonating grenades as a sort of explosive compass. The sublime ridiculousness of this plot was brought home by Neeson’s line, spoken to his daughter as she prepared to commence her destructive trip through downtown Istanbul: “Kim…” he urged fervently “be casual.”
What makes it so difficult for the viewer to take this plotline seriously is the incredible disregard that Neeson’s character seems to have for the potential consequences (such as his daughter blowing her arm off / killing herself / killing numerous innocent Istanbulites) of an action which would seem very unlikely to yield a successful result.
In a (admittedly peculiar) way, Neeson’s reckless CIA operative can be seen as a less cerebral version of Fed Chairman Ben Bernanke, especially in light of the Fed’s decision not to reduce its $85 billion per month bond buying programme last week, as was widely expected. Bernanke’s grenades may be financial rather than incendiary, but by continuing the Fed’s enormous and historically unprecedented money printing project at a time when the economy is demonstrating growth of about 2-3% per annum (admittedly unspectacular, but hardly indicative of a crisis) displays an egregious ability to ignore the potential consequences of an extreme action.
Just as our kidnapped CIA agent seemed either ambivalent to, or unaware of, the possibility that throwing grenades around one of the largest urban agglomerations in Europe could end in tears, so Bernanke seems willing to ignore the implications of maintaining the Fed’s utter dominance of the financial markets, even when this means printing the equivalent of South Korea’s entire GDP in freshly minted dollars on a monthly basis.
The list of possible consequences includes inflationary risks, currency market instability, volatility of international capital flows (as demonstrated in the recent emerging market crisis), and a general distortion of the market mechanism that is supposed to price risk and gauge value in the international financial markets. However, the biggest risk that the Fed may be taking is with its own credibility. During the 2008 financial crisis, one of the factors which allowed calm to be restored to the markets was the credibility of the world’s central banks, and the trust of market participants in the ability of these central banks to support the market through a temporary liquidity crunch. However, if the next financial bubble is to be found in the central bank’s balance sheets themselves (see chart), then who will the markets trust to restore calm?
The Fed’s decision last week might have at least have been understandable if its quantitative easing programme were thought to be having a meaningful impact on US economic growth. But not even the Fed itself believes that this is the case. In a study released last month by the San Francisco Fed, they admitted: “Asset purchase programs like QE2 appear to have, at best, moderate effects on economic growth and inflation.”
Just like attempting to use a series of explosions set off by a terrified high school student to triangulate a precise location in one of the world’s most densely populated cities could be considered a bit of a long shot (why not just call the police on your miniature phone instead?), the Fed’s money printing exercise does not seem likely to generate robust economic growth. What it is doing is creating massive bubbles in the stock and bond markets – and that is the real issue here. Tapering, let alone unwinding, the QE programme may not be as easy as was initially assumed.
The Fed decision last week was a very important signal to the market. Quantitative easing can no longer be considered an emergency measure; it is here to stay. The Fed has now given itself responsibility for the direct management of a much broader range of economic and financial variables, including the prices of real and financial assets, and for ensuring an unspecified level of economic growth. In practical terms, this means that the currency has now (more explicitly) become another instrument in the Fed’s toolbox, along with short term interest rates, something which will likely create a headwind for the USD going forward. The impact of this headwind will depend largely on to what extent the world’s other central banks emulate the Fed’s strategy, something which is far more likely amongst central banks of developed countries which are more politicized, including the Bank of England, the Bank of Japan and the Bank of Canada.