Before analyzing the emergency plans that the global economy needs, we must remember that, as in the past, the prudence and responsibility of the civil society and businesses will help us to get out of this crisis .
In the face of an unprecedented crisis, we have to be realistic, responsible and cautious.
This is a supply shock added to a mandatory shutdown of the economy. As such, a serious response must be supply-side driven. It is ludicrous to try to stimulate demand with printed money and public spending in a forced lockdown where any extra demand will not drive supply up, even may drive it down.
A mandatory shutdown due to a supply shock is not solved with government spending or demand-side measures. Printing money and lowering rates help the already indebted and governments with already historic-low bond yields, deficits are already going to soar due to automatic stabilizers.
Governments that overspent in growth times, massively increased debt and ignored the pandemic risks only to then create a widespread lockdown cannot present themselves as the solution.
Small and medium enterprises do not need a government to incentivize demand, because this is not a demand problem, the shutdown is imposed by law due to a health epidemic that lawmakers preferred to ignore.
We cannot fall into the trap of believing that what the economy needs is more monetary easing when it fails, and if it does not work then we must try even more monetary insanity.
Monetary insanity is not the solution to monetary excess and lunacy.
It is our duty to warn of the risks of falling into irresponsible optimism, precisely so that we can get out of this crisis sooner and better.
What Recovery Will There Be?
Estimates of economic growth are plummeting at breakneck speed . The closure, albeit temporary, of economic activity, transport and trade, will mean an inevitable recession. The biggest mistake policymakers can make is to believe in a V-shaped recovery. All governments should prepare for an L-shaped recovery. If I am wrong, economies will be stronger anyway, but if I am right, massive stimulus implemented only three weeks after a market all-time high and immense deficit spending policies at the very beginning of a pandemic crisis will cripple the economy to an irreparable situation.
Leading economies have a great capacity to face a shock like this. This is not the case in Italy or Spain. Calculations for the United States indicate that unemployment will skyrocket to 6.5 percent, in the case of the United Kingdom to 7 percent and in Germany to 6 percent. In weak and highly intervened economies, the combination of already high unemployment, high debt, and high government spending can lead to a Greece-style crisis when the measures to address a forced shutdown come from more government intervention.
In the eurozone, most of the plans announced by governments are based on three important flaws: Ignore that many countries were already close to a recession in 2019, assume a low-impact parenthesis and estimate a rapid and exponential recovery that will inflict no real damage on employment or public and private accounts.
In the eurozone, Germany, France, Italy, and Spain’s fourth-quarter GDP already reflected a significant slowdown, so the European Commission, ECB and governments’ responses start from the wrong diagnosis: that the problem we are facing is one of demand and access to credit and not of sales collapse due to an imposed lockdown, with an accumulation of tax liabilities and fixed costs.
The United States must avoid making the mistakes that the eurozone nations are already starting to make.
European governments are unwillingly creating a worse long-term impact on the economy by giving citizens unrealistic small doses of negative information and extending lockdowns in fifteen days periods. This is leading to massive cash flow problems all over the economy because businesses find that the support mechanisms only last for a few days while the extension of losses destroys cash flow and balance sheets. Businesses are seeing current invoices delayed or unpaid while orders for November and December are being canceled.
The vast majority of companies do not face a problem of access to credit (there is ample liquidity and credit supply on solvent demand and at very low rates), they face complete closure and layoffs due to cessation of activity. Zero income, but fixed costs and accumulated taxes. Many businesses will find that delaying tax payments or provide loans doesn’t solve anything.
Most businesses problem is not one of loan guarantees, but of the impossibility of requesting a loan. We are not in a crisis due to lack of access to credit, but rather a crisis due to the disappearance of activity.
The Private Contribution
Governments expect banks to provide massive relief through more loans, ignoring the fact that banks in the eurozone still have billions of nonperforming loans and face a massive increase in delinquencies in Europe but also in their growth subsidiaries, mostly in Latin America and Asia.
Banks are going to face an increase in default on existing assets both in Europe and abroad. Banks can cope with this situation and they have done it well, but they are not going to be able to increase risk by tens of billions while helping their current clients to come out of the crisis Most European governments assume a balance sheet strength in private agents that is neither evident in large companies nor is it existent in SMEs (small and medium companies).
Additionally, Europe’s large companies already have high levels of indebtedness, although it has decreased admirably in recent years. Net debt to EBITDA in nonfinancial companies is already likely to soar due to the downgrades in earnings and cash flow.
Credit, liquidity and short-term aid measures are suitable for those who would have survived anyway before these new central bank and government measures. Liquidity was immense, rates were low and the banks did everything possible to lend.
The losers from this crisis will likely be those who have done their homework and live month by month, without large assets to cover a loan and without muscle to face months of zero income. And those, the ones who are going to suffer the most these months, were already drowned in taxes last year.
Governments are already going to consume all the fiscal space they have and more. The idea is that this enormous liquidity at negative real rates may be used for something effective for once, not to increase structural imbalances in current spending.
This is not asking the state to intervene, it is asking the government to stop intervening so much, stop the tax burden machine during an unprecedented business cataclysm, and unite in responsibility and austerity with those who are fighting every day to survive.
If governments and central banks decide to multiply the previous mistakes adding larger ones, like direct monetization of spending or helicopter money, they will add a monetary crisis to a mandatory supply shock. A mistake is not corrected doing the same but more aggressively.
We must ask the government to stop intervening so much, not to exploit an unprecedented business cataclysm to increase interventionism.
If governments insist on maintaining the few tax revenues they can scratch from the wreckage they will jeopardize the receipts of 2020 and those of 2021 and 2022, because of the massive increase in unemployment and closure of businesses.
Keeping the tax wedge system in a crisis of this magnitude generates a double negative. The domino of business failures and job losses will take years to recover, and with it, tax bases and receipts. Second, the potential growth is curtailed because of disproportionately high regulatory taxation, making it even more difficult to attract the little investment that could come after the recovery.
A widespread economic closure shock is not solved with demand measures or using the private sector balance sheet to add debt and accumulate risk, but with urgent supply measures that respond to the reality of businesses and, with them, of workers and families.
The US and the world will rise from this crisis. What the government has to do is allow it. The government is there to facilitate, not to pick winners and losers.
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