In 1929 Irving Fisher, one of the most prestigious economists in the United States, said that the crisis was temporary and that the fall of Black Monday on the Stock Exchange was a buying opportunity. In 1933 he wrote a classic article: Debt Deflation and the Theory of Great Depressions.
In the three major depressions he studied, 1825, 1875, and 1929, there was a prior problem of overindebtedness and inflation of assets and miscellaneous bubbles. The crisis triggered asset deflation and the value of credit guarantees fell, making the debt unsustainable. Then the bankruptcies began and the credit channel collapsed. That caused depression and deflation.
Prior to the pandemic, Robert Shiller, Nobel laureate in economics, with the same prestige today as Irving Fisher in 1929, said he did not see a stock market correction anytime soon. He was surprised, since according to his index, the US Stock Exchange had the same level of overvaluation as in 1929. Now he warns that there is a risk of depression. What has changed? That economists have learned from history, especially after the Great Recession of 2008, and we have better indicators than in 1929.
Central banks have reacted very quickly and with the strongest force in history to stop asset deflation and credit contraction. The Federal Reserve, in addition to giving banks unlimited access to liquidity and buying public debt, has entered the corporate credit market en masse to avoid collapse. In the US, most of the credit is financed in the capital market and this increases the complexity of managing the crisis, as was demonstrated in 2008.
To avoid bankruptcies, companies must have income to pay them. The confinement has caused a collapse in sales and governments have activated guarantees to avoid a chain of chain debt defaults. The central bank fills the reservoirs and the guarantees prevent the pipes from collapsing so that the credit reaches the companies, wages can be paid and consumers can buy. With these sales, companies can pay their debts and prevent the credit channel from collapsing. And for those who lose their jobs, there is unemployment insurance, which was created in 1937 in the USA, after the serious social crisis caused by the Great Depression. What I have just described is the circular flow of income that the French physiocrats taught us 250 years ago.
The problem is that the recession, as the IMF warns, is already inevitable, it will be very intense and the recovery will be slow. Therefore, many companies will not be able to resist and many debts cannot be paid. Debt in the US is 20 trillion dollars higher than that of 2007. Debt on mortgages is the same, public debt has increased 13 trillion, corporate debt 4 trillion, half in junk bonds, and consumer credit 2 billion families, almost double that of 2007. China in 2007 was a country with little debt. Today it has more debt to GDP than the United States. Their companies have twice the debt on GDP than in 2007.
Spain was one of the most indebted countries in the world in 2007, most of it debt of companies and families, and it is the one that has reduced the debt the most since then. Spanish banks again have more deposits than loans and are not dependent on capital markets and have unlimited access to the ECB’s liquidity. Business debt is lower, especially in construction and housing development. Now the problem will be in the tourism sector and in the industrial sector of value chains most affected.
The problem in Spain now is public debt, which, according to the IMF, will increase to 115% of GDP this year. And the deficit will return to 10% of GDP as it did in 2009. That represents a very significant increase in debt issues this year and next. In the short term, the priority is to reduce the pressure on our health system to reduce the number of deaths. Then approve a public investment plan to lower the unemployment rate. If you are a European better, but Spain will have the highest unemployment rate in the OECD and cannot wait for Europe.
At the same time, we must maintain the confidence of international investors to finance our public debt. If the government does not achieve this objective, there will be no money to pay for the equipment to protect health personnel, ERTEs and company guarantees, or to finance the deficit in our public pension system. Today the ECB buys public debt en masse, something we did not have in 2008. But only the ECB will not be able to finance all the debt that we need to issue. And the eurobonds will come, but not in the short term.
The Government is in the minority. That is why it is urgent that he present a credible public debt reduction plan in the next five years that has sufficient support to be approved in Congress. The alternative is a rescue of the Mede and we should have learned in 2012 that it is better to take the measures ourselves than to have to negotiate them with the rejection of international investors. Countries that do not learn from its history are condemned to repeat it.
José Carlos Díez He is Professor of Economics at the University of Alcalá