Contrary to what some may claim, it is the deterioration of public health, as a result of their negligence, that ended up sinking the Spanish economy
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
At this point, the obvious, the inability of the West to deal with the covid-19 pandemic, is not lost on anyone. The false dilemma between health and economy has led to the worst case scenario. As the necessary sustained health measures to combat covid-19 have not been taken, the West is far behind the curve in its dealing with the pandemic. We have simply learnt to live with the virus, and in many cases, guided by macabre denialism – Trump, Bolsonaro, or Ayuso (the President of Madrid Region) – to live badly. In the end, the overall health of society deteriorates, the number of deaths soars and the economy collapses. Order matters a great deal and, contrary to what some people maintain, out of malice or ineptitude, it is the deterioration of public health, as a consequence of their negligence, that ends up sinking the economy. If we add to this the fact that the West is not capable of guaranteeing the income of families and small and middle sized enterprises (SMEs), the outlook is very bleak. Either the former Western democracies, which have become Inverted Totalitarian states, recover the fraternity and equality of the French Revolution, or we will end up devoured by Chinese efficiency and effectiveness, which are absolutely undeniable at present.
Among the various and simultaneous crises associated with the Covid-19, let me focus on the financial dimension of the crisis, undoubtedly the Achilles’ heel of the West. Taking Minsky’s analysis as a starting point, we can draw a distinction between financial fragility and instability (see Levy Economic Institute’s paper “The COVID-19 Crisis: A Minskyan Approach to Mapping and Managing the (Western?) Financial Turmoil”. Financial fragility is a long-lasting process and a function of the declining ratio of cash inflows to outflows (debt commitments) for every agent in the system except sovereign governments. Financial instability is a much more dangerous and short-lived process, which arises when increasing financial fragility infects the financial system, especially the banking system, or, even more alarming, when it occurs or is accelerated by financial “competitive behaviour”.
Restructuring of assets and liabilities
But a second extension to the Minsky framework can be made by introducing a third process of financial fragility, namely the process of asset-liability restructuring. This process was not central to Minsky’s writings, or to his framework of financial fragility. Rather, it falls into Richard Koo’s analysis, which we have discussed at length in this modest blog when we introduced and explained his theory of the Balance Sheet Recession, which in itself, as the economists of the Levy Economic Institute maintain, is also a ‘Minskian’ process that emerges “after or shortly before the music stops”, and especially in financial landscapes in which speculative agents and Ponzi agents are highly leveraged and heavily indebted.
These potential problems of insolvency and bankruptcy surface immediately once a financial crisis develops, but their magnitude tends to peak later in the recessionary phase. Their resolution generally lasts longer than recessions, and sometimes even recoveries. In such financially dysfunctional environments, the Schumpeterian ‘clean-up’ processes of creative (market-led) destruction do not work. Minsky’s big bank has to intervene, along with the Treasury and other government agencies, to clean up the financial mess and guide the restructuring of the balance sheet (or, more often, the bailout) of financial and non-financial corporations, especially those that acquire the status of ‘too big to fail’, and of families. By incorporating this third process into Minsky’s analytical structure, he offers a way to extend his theory.
Imminent insolvency and bankruptcy crisis
As I pointed out at the beginning of the pandemic, financial fragility was extreme before covid-19. Now, it has simply become unsustainable. So substantial private debt and the risks of insolvency are where we face the third process of financial fragility: the impending – and potentially massive – crisis of insolvency and bankruptcy that is looming. It is already clear that thousands of companies, and entire sectors, will not only encounter increased financial fragility, but will be severely affected by solvency problems and will not reopen. Before a vaccine is available and widely spread, none of these businesses or tax revenues will return to “normal”.
And the intervention of the Central Banks is no longer sufficient to deal with this situation. Federal Reserve Chairman Jerome Powell recently made an obvious but essential point: the Fed – and all well-structured central banks – have tremendous lending power but no spending power. This limitation is fundamental, as it introduces the fiscal dimension of these policy interventions and highlights the need for adjustment between central banks, public treasuries, and private finance to deal with the looming solvency crisis. Enterprise restructuring will require a financially and legally complex asset-liability restructuring effort involving central banks and public treasuries, together with private financial institutions, audit oversight, and regulatory changes. In short, the need for genuine Minsky intervention between the ‘big bank’ and the ‘big government’, together with private finance, to properly link existing loan packages to the fiscal stimulus needed to manage restructuring and turn recovery into expansion.
As the Levy Economic Institute economists point out, there are at least four dimensions in which the fiscal component is crucial to managing the financial storm: 1) restoring confidence in the economy, thus reversing expectations and creating jobs and income through both direct and induced expenditures that have a direct impact on the cash flow of households and businesses; 2) restoring local and state tax revenues, which depend on the resumption of economic activity; 3) helping restructured but indebted firms and households to repay their debts; and 4) ensuring that expansion follows recovery, so that productive capacity is in place to avoid inflationary pressures from “excessive quantitative expansion” on the one hand, and disruption of production chains on the other. If we do not do any of this, the West will fall into the abyss and Chinese superiority will not only be crushing, it will above all be overwhelming.