Either Modern Monetary Theory or another Great Depression.
Juan Laborda teaches Financial Economics at the University of Carlos III and Money and Banking, Syracuse University (Madrid)
Originally published in Spanish at vozpopuli
Translated and edited by BRAVE NEW EUROPE
Allow me to be somewhat assertive. During the difficult situation that we are currently experiencing, the best thing is, without a doubt, the exemplary behaviour of the immense majority of the Spanish people. The poet Antonio Machado once wrote, “In Spain the best thing is the people. In hard times the ruling class invoke the nation and sell it; the people do not make a fuss, they buy it with their blood and save it”. What we must not allow ourselves as a society, neither economically, socially, nor morally, is to make the high costs of the COVID19 fall once again on the shoulders of Spain’s citizens, on the people. That is why I am very struck by a double amoral behaviour in some of the comments made by certain economic and political elites, both ours and those outside of Spain.
The economic environment prior to the impact of the coronavirus was one of enormous global financial fragility, so that the supply and demand shocks derived fro COVID19, if the dominant paradigm is not changed, will generate insolvency problems that cannot be resolved with credit lines because it is not a liquidity problem. Certain comments remind me of those made at the beginning of the Great Recession. Neither is it nor will it be acceptable to transfer the costs of the COVID-19 to pensioners and workers, via wage devaluation and delayed minimum wage increases. Such cuts would place the financial burden on the weakest shoulders free of charge and commit us to another destructive cycle of austerity in the future. I have already explained in previous articles my proposal: either Modern Monetary Theory or chaos. There is no other possibility. But let us return to the scenario prior to the COVID19 because in the analyses I have been reading the vast majority forget about it, so that you do not rule out economic policy errors that make those perpetrated during the Great Recession pale into insignificance.
Dusting off Hyman Minsky’s financial instability hypothesis
The pandemic is significant, not only because of its direct impact on supply and demand, but also because of the effect of the COVID19 shock on the ability of economic agents – households and businesses – to finance a sustained level of production, expenditure, and employment. We cannot understand the economic consequences of the shock, and the challenges facing the Spanish and world economies, without referring to two Hyman Minsky processes that have been unfolding in recent years. On the one hand, the Covid19 has coincided with the peak of a secular trend, the inability of producer prices to validate share prices. On the other hand, the increasing fragility of corporate balance sheets has made the economy particularly vulnerable to even brief falls in sales and declines in share prices.
If we address the situation using the framework of Hyman Minsky’s Financial Instability Hypothesis, it is easy to understand why the current economic weakness can be perpetuated through the feedback effects between demand and supply flows and their impacts on the balance sheets of companies and households. From the supply side, a supplier (think of a car factory, for example) that has contracts and commitments to pay for the labour and inputs purchased, but cannot sell its product because of disruption of integrated supply chains, will have no income and will therefore have to borrow to meet its commitments. This is true throughout the supply chain. On the demand side, the seller (a car dealer, for example) has stock that he expects to sell to cover the cost of the goods. If demand decreases, the accumulated stock must be financed. Thus, both the supply and the demand side require the financing of stock commitments, which would normally be met through integrated production and sales.
Demand for short-term financing more than doubles, while the creditworthiness of producers and sellers decreases, reducing the willingness of banks and capital markets to finance unsold stocks on both the supply and demand sides. However, this short-term liquidity problem could quickly lead to insolvency, as companies are unable to pay off debt with unsold goods. In fact, the deeper and more prolonged the original shock, the more likely this transition from a preference for liquidity to pyramid financing. In turn, this transition has a second-round effect on aggregate demand and employment, putting further pressure on liquidity and destabilizing balance sheets. In the current context, moreover, an important aspect of the problem is the global dimension of the crisis. As things stand at present, it seems that no major economy – developed or developing – will remain untouched.
Based on this scenario, which many economists have forgotten about, the only possibility of avoiding a Great Depression is to change the current dominant paradigm. Just as Franklin Delano Roosevelt’s New Deal and Keynes’ triumph brought an end to the Great Depression, Modern Monetary Theory, which I have detailed extensively in a number of previous articles, is the only alternative to orthodoxy and the dominant system of governance (Neoliberalism). Either Modern Monetary Theory or another Great Depression. Let us hope that the Spanish people will not be disappointed and betrayed for the thousandth time.