Fernando Fernández. Professor. IE Business School
14 October 2011
Those who favor a reduction in interest rates and expansion policies as a solution to the crisis are wrong. The only way out is to recognize losses, even if means being poor, and to start from scratch.
We are so preoccupied with the Spanish economy that we are scarcely aware of the fact that world growth has stalled in the second half of this year. Concern about Spain has naturally grown after the press conference offered by the deputy prime minister in which she proved that (i) the targets for growth and controlling the deficit are unattainable, (ii) the State has no means of imposing fiscal discipline on the autonomous regions and (iii) the government doesn’t know what to do and is agonising between spending adjustments which could impact electoral results (but not that much as far as I’m concerned), and raising taxes, which could bring in votes but will not help meet this year’s target. None of the above is new. However, the intensity of the global slowdown is a new development as reflected in the reports of the OECD, IMF and the ECB. We should consider that in all probability all the major industrialised economies will have negative growth in the last quarter.
The situation is so desperate that the economic debate of 2008 has arisen once again. The world will stop at nothing to avoid a new chapter in global recession: more monetary expansion (the so-called QE3), drops in nominal interest rates - even down to zero (which is what is requested of the ECB), and more fiscal expansion (€350,000 more investment and lower taxes in the nth Obama programme.) Nobody has tried to rationalise this as well as Martin Wolf in the Financial Times who said we need to combine more borrowing at very low rates today with credible limits on spending tomorrow. This is exactly what was tried out three years ago – there was a short spurt of growth in 2010 which has led us to the current situation. It is like trying to make a circle square, or like real socialism.
Borrowing at extremely low rates is only feasible for two or three countries- the United States, Germany, Switzerland, where 10-year bonds are below 2% because they act like a free port in a perfect storm, and because in times of recession people try to preserve capital. But that luxury is not available to other industrialised countries, nor to the majority of private investors or the interbank where liquidity constraints are very high again. Perhaps it would be more accurate to think that risk aversion is so extreme that there are only three central banks in the world that are solid, and for very different reasons. The United States because it is the Empire and the reserve currency, Germany because it is the orthodoxy, and Switzerland because it is a tax and regulatory haven. These interest rates are not the cost of credit, but rather the meagre returns on savings in recession.
To make flexible spending credible, i.e. today it grows, tomorrow it contracts, is like asking investors to forget about the history of finance, to throw away their databases, their temporary series and believe in the new man. This means asking Spaniards to forget that the PSOE ridiculed the budget balance saying it was a neoconservative obsession on the part of the more reactionary Spanish right wing. All this with an aggravating factor - we requested it in 2009 and it didn’t work out. Once more and then no more. Today there is no room for expansionary policy. Debt levels and public spending are already negative, and the central bank balance sheets have expanded like never before. There is no ammunition left in the arsenal of the economic authorities. To be precise there is only one weapon left, namely if China re-valued the renminbi dramatically, stopped exporting, and started consuming like crazy. The other major saver is Germany which I won’t mention for obvious reasons.
Many economists, who insist on adding fuel the fire, use the same argument as bad debtors when they renegotiate debt restructuring: "It will be worse for you if you do not renew your credit because you will have a bad debt". Good bankers are saying that we have reached this point: I assume the loss, shrink the balance and start working from scratch. If we had more of them, and more demanding inspections on the part of the Bank of Spain, the Spanish financial crisis would be history and growth would have returned long ago. Good political managers are able to acknowledge the fact the public debt is now excessive and that any additional capacity to take on private debt is nonexistent. All you can do is start with a clean slate, recognize the loss, shrink GDP, lower real wages, accept impoverishment and begin to grow. When the choice lies between passing on no cost at all to the taxpayer, and blood, sweat and tears all round, the no-cost option may be more popular now, but it will end in tears for sure.