— Other Liabilities

Penicillin and interest rate resistance

Walter Ehrlich, remembered his experience [in the second world war] after he had been badly wounded in northern France and taken back into the hospital. He described a nurse going from patient to patient with her ‘large syringe’, injecting a penicillin as she went without bothering the to change needles. ‘I was told changing the needle was not necessary because penicillin prevents infections.’

Robert Bud – Penicillin: Triumph and Tragedy

The message delivered to the markets with the Quantitative Easing program aftermath the 2008 crisis was the necessary lessons from the Great Depression of 1929 was learned and authorities were willing and capable to act. So in a way US public and global economy were lucky to experience this crisis at this part of history, since the cure was already available for the disease.

The aim of the QE program was to increase monetary base with FED buying government bonds from investors with money it created from thin air and hoping that investors with an excess amount of cash would invigorate the economy by making investments instead of parking their assets to safe havens. And afterwards the economy has recovered re-normalization process would have begun.

Well, let’s have a look at today’s financial agenda. The interest rate debate is still on and does not look likely to be over in a short time-frame.

Last week ex-FED president Ben Bernanke has published an article in his Brookings Institute page.

In his article Bernanke mentions the need for a safety cushion in case of another financial emergency; given the situation does not allow FED to increase rates.

And he contends Fed has only two viable options for this case, either following ECB’s and BOJ’s footsteps and moving to the negative interest rate zone or increasing its 2pc inflation target.

However it should not be forgotten that the argument “because we cannot pull interest rates under 0pc” was the rationale of choosing QE over negative rates in the first place at the time of crisis.

Caution against negative rates derived from the presumption that negative interest rates would give incentive to public to hoard cash; hence the policy would not have the desired effect.

It seems that the relative success of NIR policies undertaken by ECB and BOJ have caused Bernanke to favour negative rates over a higher inflation target.

He dismisses possibility of another round of QE in the grounds of hardships of explaining this monetary tool to public and inherent uncertainties embedded within this tool.

Divergence among economists on the cause of financial crises is well known. Since it is not possible to know what exactly causes a financial crisis; usually they are diagnosed with symptoms (turmoil in the markets and the economy) and cured with a shotgun therapy methods which does not aim for any specific treatment but rather to invigorate any (but any!) sort of economic activity.

Since we’re in this desperate times; can any sort of desperate means be justified? Shotgun therapy might provide a new breath to the economy in the short term, however this might cause side effects such as credit boom. Or even worse to admit, we actually don’t have any idea about other uncertainties they might trigger in the long term.

Antibiotic Resistance

Our generation was lucky enough to miss out the antibiotic age. Thanks to the antibiotic miracle bacterial infections and surgical operations have ceased to be deadly risks for humankind. Discovery of penicillin was an substantial event.

At the time biggest obstacle standing in front of the medicine was the scarcity of it. Therefore drug companies and science world literally raced to cover this shortage.

However sometimes advantage becomes the disadvantage. As the bacteria started to gain resistance against the drug due to the over-use and carelessness about hygiene; it was clear that there has never been a victory. And the risks concerning penicillin started to reveal themselves.

Bacteria such as ‘staphyloccus aeureus’; which were immune to the antibiotics demonstrated that overuse of antibiotics was a danger bigger than bacteria is. And now the medical approach has transformed from antibiotic for everything to caution against the drug. World Health organisation suggests using antibiotics only when necessary as the top precaution against antibiotic resistance.

Human nature is the sole explanation for this case.

The biggest premise of modern society was to free human from mechanical work and limitations of its body; remember? If immunity from all disease is only one pill away, why would you care to protect yourself from the bacteria?

Thus, sudden and radical treatment takes command over cautionary approach which only works in the long run. But we don’t know if it’s just our ‘natural’ human nature or the human nature altered by the modernism.

And when we face an economic crisis we are faced with more monetary easing as the only option. Which is the equivalent of hoping to control hypertension with pills instead of good nutrition.

Which indication for the negative rates?

Negative rates mean central banks charge commercial banks for their excess reserves held in their accounts. Which is the exact opposite of general practice, banks getting a return for their excess balance.

Monetary easing policies which including negative rates aims to direct these excess balances to real economy. In cases of QE central bank increase the price of securities and therefore make them less favourable investment options. In case of negative rates banks are encouraged to increase lending, since they are taking a hit in every dollar landing in their central bank account if they choose not to make loans to their customers.

This conditions give rise to economic activity, yet unprofitable business models in normal times also become profitable in these atmosphere since costs of borrowing is low.

However, as these businesses keep on operating in the eased condition the elephant in the room, credit risk is waiting patiently in the corner. As the rates rise these businesses will face the trouble of increasing borrowing costs, or failure to roll-over their loans which implies the increasing risk of bankruptcy.

If monetary easing policies prove themselves to be successful banks will increase their lending and therefore the amount of money supply in the economy will also increase. In the meantime supply for goods and services will stay intact.

Which means savings will decrease and consumption and investments will increase. Unfortunately, in the background we have no solid projection about what could be the cost of these uncertainties might be.

The term interest creates a medium between ones who need the money and ones who have it by defining the time cost of money.

But there is a problem with this definition, as mentioned by David Howden; the choice of time is always sooner or later, never more or less.
If the whole economy is shaped around the assumption that this easing will last forever, an expected side effect will be some sectors going extinct and some overgrow.

Besides the other uncertainties monetary easing will cause, countries running trade deficits will also be more prone to the shocks stemming from capital flights and market conditions.

The real problem with central banking nowadays is, the medicine itself obscure the alternative path of prevention.

As we look at the financial agenda, the main discussion topic today is which monetary tool would be more suitable for the problems faced by economy. Monetary easing is inevitable, therefore the discussion should only focus on which path to choose.

Well, what about monetary easing policies which cause low interest resistance?

This article originally appeared on diken.com.tr on 20/09/2016