Noah denkt™ - The Power of Balanced Reasoning
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At what point does Money Printing go toxic?
Dialogue with the Alter Ego on the dilemma of Quantitative Easing, first drafted on April 15, published on April
16, 2014
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    We believe that the Fed should not shrink its balance sheet all the way back to a size that would have been
    considered normal prior to the global financial crisis but should instead leave a larger amount of liquidity in the
    financial system on a permanent basis. (...) by keeping the balance sheet more elevated than otherwise, the Fed
    would be providing a greater amount of liquidity to the financial system, allowing it to potentially operate with better
    efficiency and reduced risks. In our view, this proposal would improve the transmission of monetary policy to the
    overall economy and would provide the Fed with flexibility to respond to future crises with its balance sheet as it
    sees appropriate.

    Joseph Gagnon, Brian Sack: Monetary Policy with abundant liquidity; published by the  Petersen Institute, January
    2014


Question by Alter of Ego of Noah denkt™ (AE): In our previous dialogue on the systemic risk posed by the
super high US public debt, Noah denkt™ argued that the danger of bond markets flipping over this debt level
isn’t as imminent as some would have us think. In particular, you said that governments at this time do not
deserve to be severely punished by financial markets since most of their money printing rescue efforts isn’t
being motivated by a reckless pursuit of personal gains but rather by a serious concern for the stability of the
financial system. [
“... the money printing that is going on in the US and elsewhere isn't being done for personal gains or out of recklessness.
Much rather is it being pursued because those responsible shy away from submitting their people to the severe hardship that an honest correction
would entail. That may be a big analytical mistake, but it certainly isn't a morale failure of Biblical proportions. “
] If we, however, look closely
at previous systemic risks created by first world governments [
see, for instance, the fatal housing policy decisions of successive
US administrations that turned the GSEs into a seemingly guaranteed secondary market for securitized mortgages
], we will very rarely find
that these government programs are inspired by populist recklessness. Instead, it tends to be the genuine,
perhaps sometime naive desire of these governments to improve the livelihoods of their most vulnerable
citizens that drives these fatal initiatives. So the question is: At what point do inadequate government actions
cross the line and become a serious systemic risk that inevitably will be punished by financial markets?
Answer by Noah denkt™ (Nd): Well, it’s hard to generalize about that. But certainly the amount of naivety, the
degree in which circumspection, courage and due diligence are lacking in these decisions, and the measure at
which populist considerations drive them have something to do with the eventual damage they cause in the
market. Ultimately, it is probably the particular spread between populist calculations, naivety and lack of
circumspection on one side and genuine conviction on the other that determines the potential damage inherent
in these decisions.

AE: It is a personal call though to determine that spread, isn’t it?
Nd: In a way, yes. But don´t forget that government activity tends to be covered by public debate. And that
debate should in deed provide a general reference point for determining the populist-conviction-spread at the
time.

AE: There wasn’t too much public opposition though to the Community Reinvestment Act and/or the burgeoning
role of Fannie Mae and Freddy Mac in the run-up to the 2008 crisis, was there?
Nd: Well, there was some objection to the GSEs albeit not necessarily on the front burner. It should have been
clear to political and economic insiders though  that you can’t twist market logic for ever.  

AE: Obviously, it’s easy to say that with 20/20 hindsight. Let’s, therefore, look into the future instead. Is it
possible, from our vantage point, to determine a threshold where an originally well intentioned money
printing/quantitative easing policy would turn into an unacceptable, toxic risk?
Nd: We think so. In fact, we believe that the now emerging argument according to which central banks should
not shrink their balance-sheets to “normal”, i.e. pre-crisis levels but leave larger amounts of liquidity in the
system for stability’s sake would in deed turn what once was a legitimate policy requirement into a very
damaging morale hazard.
(see also: The Economist, Buttonwood Column, April 5, 2014)

AE: Why is that?
Nd: Because the initial need to avoid serious market mayhem which drove the introduction of quantitative
easing in the first place, would now be giving way to an argument of convenience that prefers maintaining a feel-
good sensation over the need to return to an open market that allows for enough constructive destruction. After
all, it cannot be denied that even the banking sector does need its fair share of shake-out to stay healthy. The
Petersen Institute proposal, however, would hamper just that by shoring up support for the established players
while severely disadvantaging those that operate on the fringes (i.e. the long-term unemployed, self-made
entrepreneurs, maverick start-up businesses).

AE: Nevertheless, it is also true that any serious tapering would seriously put in danger the still fragile recovery
we are witnessing at this time.
Nd: Of course. But the danger that sustained tapering creates is nowhere near the previous “falling off a cliff”-
risk that originally sparked the introduction of quantitative easing. No, no, the more we get used to operating in
a market whose fundamentals are distorted by big brother protection the less we will be able to grow out of that
regressive need for additional pampering and patronizing. Just look at the market as it presents itself now: Is it
not true that the competitive space is highly tilted in favor of the established players? Is it not true that legions
of university graduates, no name pioneers and Linked-in members are eternally scrambling to get just a
minimum of attention and credibility while those who have made it into the big format talk shows luxuriously busk
in their glory? And is it not true that search engine algorithms heavily favor those who have already been
covered in mainstream media while those who blog away in their self-made austerity live by the bread crumbs
falling off the table of the famed and prosperous?

AE: True. But it isn’t the job of central banks to make marketing easier!
Nd: Well, it is the government’s job to create a viable framework for a competitive and dynamic economy.
Safeguarding the status quo doesn’t do that.
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Keywords:

shrinking central bank balance sheets, central bank policy, crossing the line in quantitative easing, crossing the
line in money printing, the systemic risk of monetization, the systemic risk of money printing, when does money
printing become dangerous, limited central bank tapering
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