Economic and Financial Scenarios and Prospects after the Great Epidemic

Javier Díaz Giménez and Daniel Lacalle

On 21 April 2020, the Rafael del Pino Foundation organised the live dialogue through entitled "Economic and financial scenarios and prospects after the Great Epidemic. Debt, public deficit, financial system and growth" in which Javier Díaz Giménez and Daniel Lacalle participated.

Javier Díaz-Giménez is Professor of Economics at IESE Business School. Prof. Díaz-Giménez has devoted most of his professional life to research and teaching in the field of macroeconomics. In his most recent work he analyses the macroeconomic consequences of fiscal policy and pension reforms. He has published the results of his research in some of the leading professional journals such as the Journal of Political Economy and the Journal of Monetary Economics. He is also the author of the university textbook Macroeconomics: First Concepts. Díaz-Giménez has been an advisor to the Spanish Ministry of Industry and, albeit for a short time, also an advisor to the Economic Office of the President.

Daniel Lacalle is an economist, international advisor and Chief Economist at Tressis. He holds a PhD in Economics, a degree in Business Studies from the University of Madrid, a CIIA (Certified International Investment Analyst), a postgraduate degree from IESE (University of Navarra) and a Master's degree in Economic Research. His career in portfolio management and investment began at the hedge fund Citadel, in the United States and London, and continued at Ecofin Limited, covering equities, fixed income, private equity and commodities, and later at PIMCO. He has been voted for five consecutive years in the Top 3 best managers in the Extel Survey, the Thomson Reuters ranking, in the general, oil and power categories. Prior to his time as a manager, he worked as a financial analyst at ABN Amro (now RBS), and held various responsibilities at Repsol and Enagas, where he received the award for best IPO (IR Awards 2002). Daniel Lacalle writes regularly for El Español and is a regular contributor to La Sexta, CNBC, CNN, Epoch Times, Hedgeye, Mises, The Commentator and The Wall Street Journal. He is also a lecturer at the Instituto de Empresa, UNED, OMMA, IEB and the London School of Economics and Political Science. He has also written the books Nosotros, los mercados, Viaje a la libertad económica, La madre de todas las batallas, Acabemos con el paro, La Pizarra de Daniel Lacalle and La Gran Trampa, all of them published by Deusto and bestsellers both in their original Spanish edition and in their translations into English and Portuguese.


On 21 April 2020, the Rafael del Pino Foundation organised the online dialogue on "Economic and Financial Scenarios and Prospects after the Great Epidemic", with the participation of Javier Díaz Jiménez, Professor of Economics at IESE, and Daniel Lacalle, Chief Economist at Tressis. For Javier Díaz, this crisis is different from other economic crises. It is much more special than any of them because the causes are exceptional. This crisis is due to a forced halt in economic activity, to a brutal change in the context in which it occurs. It is, moreover, a crisis of unknown proportions and without any planning to deal with it. The consequences, however, will be similar to those of other crises. There will be unemployment, company bankruptcies, reconfiguration of productive sectors. However, the companies that are going to go bankrupt already had problems with their business model before. What the crisis is doing is accelerating this change. These companies are going to be badly affected. The question is how we manage the transition to this new world, because Spain sells proximity. And this type of activity is going to be highly penalised as long as there is no vaccine. The key, therefore, lies in when we are going to have an effective therapy. As long as it does not exist, the context will be very complicated. Daniel Lacalle agrees that this crisis is very different and adds that it is the first generalised crisis in practically all sectors of the economy. This is because the decision to combat the pandemic by shutting down the economy by decree has a greater and longer-term effect. We are used to crises being crises of consumer demand, of credit demand. But this is not the case. The big problem lies in the design of the fight against the crisis. Faced with the health risk, which collapses the health chain, it is decided to force the economy to shut down. And the measures taken are intended to stimulate a demand that does not exist and is not accompanied by a supply-side response because the economy is closed. The big problem is also the ex-post effect. First of all, there will be a radical change in the form of consumption. In recent years we have been ignoring the signals from the economy and have relied on monetary policy and fiscal policy. While we saw the bailed-out sectors contracting, services kept the economy artificially doped. Decisions have therefore been taken based on the wrong diagnosis: that the economy is strong when it is not. The second problem lies in considering that the forced closure is like a holiday and that everything will return to normal afterwards. But this will not be the case because the change in consumption and investment decisions will be dramatic and the recovery will not be generated by leverage. The third mistake is to believe that demand policies will strengthen the economy going forward. What they are doing is bailing out troubled sectors. Therefore, the misallocation of capital by government decision is going to be even more aggressive than in 2008. Moreover, in 2008 there were a number of mechanisms that allowed high-productivity sectors to be financed through different mechanisms. Now, resources will be reallocated to sectors that generated low productivity and low growth and caused the economy to underperform. With regard to the European scenario, Javier Díaz recalled that what dominated in December was Brexit and the EU's response to it. This issue has now become trivial. The EU had a very serious problem: that it was not an optimal currency area. It also had to clarify what the EU is about, whether it is a single market or whether it is more of a political union. The current crisis and the way it is being handled by Italy and Spain will brutally exacerbate these contradictions. Europe's response to the crisis has been every man for himself. Europe is still a single market, but it lacks leadership and a well-defined political project. In this scenario, Italy will fare worse than Spain and could even consider leaving the EU. The single market, therefore, is more threatened than ever, as there is no capacity to manage a bankruptcy of Italy or Spain as the treaties are currently configured. It is going to be very difficult to contain this situation without a change in the treaties. The question is who is going to go bankrupt, how we are going to organise the bankruptcies and who decides who goes bankrupt. If we do something, we are going to favour some sectors and countries and disadvantage others. We can try to spread the costs and we will have to do it in a context where countries do not have national central banks that can issue currency. If Spain had its own central bank, the policy mix would be different and we would already have a basic income today, because it is now that we need it. Now Spain is going to tell Europe that the ECB is its bank and that it does not have to agree anything with it because it is also its bank, and if it is not allowed to issue money, it may have to leave the issuing bank. If the impact of this crisis is different in Germany than in Spain, why does Spain have to agree with Germany on what the ECB has to do? Continuing on this theme, Daniel Lacalle commented that the story that the EU is trying to sell is that we are being stifled by the ECB and by an EU that does not support us, and that we would be better off in a different way. The ECB's balance sheet is 42% of the EU's GDP, much higher than that of the US Federal Reserve. We have negative interest rates and purchase programmes that keep bankrupt countries with incredibly low interest rates. This has been the case since the creation of the bank. Since then, the ECB's balance sheet has done nothing but expand to bail out low productivity sectors and fiscally penalise high productivity sectors. The problem is when it is said in the EU that something must be done. But remember that if Spain and Italy had their own central bank, we would have no market to finance ourselves, no basic income, no nothing. There are several mistakes being made in all this. The first is to forget that the euro is not the world's reserve currency and that its level of use in international transactions has been declining for ten years. The monetary stimulus capacity is already a failure because it does not prevent the collapse of the economy. Issuing currency to pay the debt is what Argentina has been doing for twenty years and that is how it is. Thanks to the euro, the level of inflation is much lower than in an environment of its own monetary policy and public spending is at a level that, in other circumstances, we could not afford because there is no demand for Italian or Spanish domestic sovereign currency. The problem is not a lack of unity, but too much of it in the wrong model. We are also being told that without fiscal union there is no monetary union and this does not work. This is false, as shown by the case of the United States, where there is monetary union while each state manages its own budget and Michigan does not have to bail out Illinois. In the EU, a system has been created in which those who do well are penalised. Greece has handled the pandemic admirably, so we can't talk about a north-south divide either. There should be no leadership in the EU. The EU is a miracle and a success and the euro even more so. This is because the EU is learning from its mistakes as it makes them. On the other hand, if we were to apply French dirigisme to the whole EU, then we would have the risk of countries leaving. Italy would leave. The mechanisms that bind the EU together are so extensive that the EU under a unified and mutualised dirigiste system would not have the capacity to act that it has, nor would the ECB have the balance sheet that it has, nor would there be the capacity of the financing mechanisms because the idea of mutualising risk is false. And the fact is that those who do it better are worse off than those who do it worse. Moreover, citizens know that we would be worse off outside the euro. Therefore, we cannot maintain a policy of passing on problems to those who do better. If there is no responsibility and conditionality together with solidarity, the European Union will die and the euro will go behind. With regard to the monetary helicopter, Javier Díaz believes that, as there has been no inflation in the eurozone, the ECB's balance sheet is reasonable. Before, it was said that the interest rate that anchored expectations was 4%; now it is much lower. Monetary policy, it is true, does not generate growth. But the problem now is not that, but to avoid suffering. That is what monetary policy should do. As soon as there is therapy, this is over and growth will return. The coronavirus crisis is a natural catastrophe for which no one is responsible. That is why the state must help those affected with the helicopter, giving money to the people, not to the companies. This can be done because there will be no inflation, with oil prices going negative. The way out is that when there is a vaccine, the balance sheets of the companies will be as little affected as possible, and for that we have to avoid bankruptcy by giving money to the people. In this way, companies do not have to pay salaries. Daniel Lacalle disagreed. He said that we have hyperinflation in financial assets, because of the money that has gone to support bankrupt states. We have hyperinflation in sovereign bonds. Countries that have liquidity for six months are financing themselves with negative rates. In addition, we have hyperinflation in non-replicable assets, whose prices are rising more than real wages. What the helicopter money is going to generate is deflation. If you put a thousand euros in everyone's account, 25% will go to buy food and essential goods, so capacity in those sectors does not change. Another 25% pays current spending bills, so there is no increase in supply either. Another part is used for lavish spending, such as books, movies or Netflix. The rest is saved. So the helicopter idea does not work. Moreover, it is said that this measure is only in place for some time, but then it becomes perennial, like the bond-buying programmes because countries cannot bear the market risk premium. What it generates is even worse. Monetary policy has never prevented suffering anywhere. It never has because the helicopter idea is never neutral. It always benefits the first recipients and harms the last ones, which are the wage earners, savers and the lower classes. If monetary policy prevented suffering, Argentina and Venezuela would be the richest countries in the world. The state has destroyed the economy. The forced closure has meant the destruction of the productive fabric, making this crisis worse than the last one. What needs to be done is to open up the economy so that there is enough capital to recapitalise companies. The state ignores the risk of the pandemic, mismanages it, closes the economy and decides who to bail out. This acts as a disincentive to recovery. The solution does not lie in repeating monetary policy mistakes and multiplying them. What we have to do right now is to open up all economic and financial efforts to enter the economy as soon as the economy reopens. The problem with aid is that we would give the money to the sectors that make the most noise and we would generate disincentives in all the high productivity sectors that can improve the economy on the way out. Javier Díez clarified that he would not give the money to any company. He would give it to people. That would decrease as activity returns. There is going to be a different economy because as long as there is no therapy, businesses based on proximity are not going to open. We haven't had anything like this since 1918. This crisis is a natural catastrophe that requires exceptional measures that have had a brutal economic cost. It would do nothing to any sector. There may be a gradual horizon of withdrawal of these actions. People need to be helped with a helicopter. If it has to be six months, let it be six months. Daniel Lacalle objected because that policy would not go on for a while. The very dynamic of the helicopter causes all sectors to go into a tailspin. The helicopter already exists because you have a state, Spain, which only has six months of liquidity with an expenditure of 400 billion that it could not have without the help of the ECB, which is going to have an additional expenditure that it could not have, while the government is launching measure after measure without an economic memory. In any case, the reality of the helicopter leads to such a collapse in productivity that the ability for those citizens to find jobs again and for the economy to recover is diminishing. The EU spends 1% of GDP on income support and active policies. The narrative is that states have to spend as much as necessary because they will save later. Instead of closing down, the authorities should have given protocols, as in South Korea, because other things could be done. There are countries all over the world that have not had to shut down the economy. Fiscal and monetary policy does not guarantee stability. So the reality is that governments now spend and then don't save. And whoever they have to manage next year will be blamed for the cuts. The real final problem is monetary. The EU and the euro are not the world's reserve currency. That is the unique privilege of the United States. And what the US always does is to look at the demand for dollars and it always issues much less than the demand, because it cannot pervert that equation. Closing the economy by decree has disproportionate and different effects from what governments expect. That is why governments should be the last ones to have the capacity to manage the economy. The discourse that the pandemic could not be foreseen, that everyone has done the same and that the state has to solve it is not true. Countries such as Austria, Switzerland, the Netherlands, Luxembourg, Denmark, Sweden and Finland are proof of this. Finally, with regard to possible government intervention in companies, Javier Díez was against it. All this talk of strategic sectors, or that companies should be public, are absurdities of the past. The state does not have to buy or regulate anything it was not doing before. It only has to guarantee public health. If there are no masks, it's the state's fault; if the elderly are dying in old people's homes, it's the state's fault because it has been entrusted to take care of that. We must also ask the state to allow us to go back to work. It doesn't have to buy gold shares or anything else. Let it break what it has to break. For Daniel Lacalle, in turn, the concept of strategic companies is stupid because they have shareholders from all over the world. In the story of the pandemic, the state arrogates to itself the power to preserve the past and decide the future. On the one hand, they are going to rescue and take control of sectors that were already losing profitability and market share and, at the same time, they are going to launch themselves into deciding the future, under the name of green. The only sectors in which there is not perfect competition is because this has been encouraged by the state. The first danger to freedom of information and privacy comes from giving more power to the state.

The Rafael del Pino Foundation is not responsible for the comments, opinions or statements made by the people who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their sole responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio González, are the result of the debates held at the meeting held for this purpose at the Foundation and are the responsibility of the authors.

The Rafael del Pino Foundation is not responsible for any comments, opinions or statements made by third parties. In this respect, the FRP is not obliged to monitor the views expressed by such third parties who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their own responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio J. González, are the result of the discussions that took place during the conference organised for this purpose at the Foundation and are the sole responsibility of its authors.