Thinking 2020
Written by Pablo González and Pedro Nonay trying to understand Covid 19’s consequences.
Entry 3 – Covid 19
11 April 2020
Before continuing with the “story” that I had in mind, I would like to make some comments on opinions that I have received from some of my friends about the 2 previous entries. Opinions that I appreciate, and I ask you, because they help me to focus ideas, and can make this little exercise a little more useful for everyone.
Comments on feedback received:
Corruption.
A friend of mine tells me that we must put an end to it, because it is a great scourge. He is not lying, but we must understand that corruption, like drugs or whores, is something impossible to eliminate. It has existed since the beginning of time, and it will exist until the end.
What we can do (and this is something that all civilizations have done, with greater or lesser success) is to try to minimize its effects.
A country in which the corrupt control all the institutions is not the same as one in which there is some corruption, but it is harassed by the institutions.
It would be very nice to eliminate it, but perfection in this is not possible.
It should also be clear that, although corruption has always been a problem, it is by no means the main cause of Covid 19 or of the economic and social crisis we are facing.
Black money.
I am also told that the whole current situation is likely to increase the displacement of many people into the underground economy.
This can occur to avoid taxes, under the justification that tax money is spent by governments on profound stupidities (they are not wrong). Or, it can also happen to make the “war” economy more viable, as would be the case of paying salaries in black and avoiding social security expenses (the employer spends less, and the worker earns more).
The risk is certain. And it will generate a lot of tensions. The parties involved will look for ways to do it. And governments will look for ways to avoid it (with their traditional ineffectiveness).
Historically, black money has moved around 20% of the economy (a little more or a little less, depending on the country and the moment). Which is not only not little, but rather a lot. But I don’t see that changing. I say that because there are human factors at play here (greed versus risk-taking), and these human attitudes have nothing to do with the crisis, but are eternal.
Surely the need will encourage more than one to take a risk they would not take without it. But governments also have more tools today than ever before (precisely after the Internet) to monitor this.
I think the game will be a “draw”. And things will remain more or less the same.
Debt forgiveness.
I am also told that the only way out is a debt “reset” (in its many variants).
I am not saying that they are not trying and studying it, in all versions. In fact, I think they are doing it, or is it not something like that what was done in Spain with the SAREB?
But, in order to do something like this on a large scale, it must be taken into account that a forgiven debt means that someone does not get paid. Of course, the “forgiven” person improves his balance sheet, but the “forgiving” person ruins it.
The question is: do banks and states have room to take massive losses on forgiven debts? I think the answer is no.
Someone (rather many) can ask that banks write off, with state aid to assume those losses (even being previously nationalized). And that the governments take the money for these aids out of “the banknote printing machine”. It sounds nice, in fact, they are going to do it as far as they can. But those things have a limit that we are going to exceed. Then there is hyperinflation, loss of world confidence in that country, …..
What can happen is something similar to what happens in company mergers. When a company merges with another company with which it has a debt, when the creditor and the debtor remain on the same balance sheet, the debt disappears (as if by magic). However, when such things happen, it is usually the creditor who takes control of the new company, with all its assets. That is to say, it ends up being something similar to a dation in payment (I give you what I have left, and with that I no longer owe you anything).
Thus, the concept of “merger of countries” may appear (isn’t that what is being discussed in Europe under the name of “mutualization of debt”?) In this case, the country that stops collecting is the one in charge (it is its payment).
Or, there is another way for countries to “forgive” their debt, which is direct payment in kind. This would be the case of handing over public assets to whoever puts up the necessary money. An exaggerated but descriptive example would be for Spain to hand over ownership of the Prado Museum, or the Royal Palace, or its many other properties to whoever gives it the money it needs. And, if someone says that this is stupid, I remind him that the Marshall Plan in Spain (little, as Berlanga made clear in the film), cost us to hand over the sovereignty of the American bases to the USA (and it seemed to them an acceptable consideration at the time).
Summary: Yes, there will be some of that, but it is not so easy. Those of Pablo Iglesias simplify it in “we will take it away from the rich” and, it may be ideologically viable, but it is not at all clear to apply, because there are workers who have their savings in that place to which they want to charge the costs.
I am more inclined to a “merger of countries”, or a dation in payment, than to a direct cancellation of debts.
Obsolete charts of accounts.
Another interesting comment received says that, in the modern world, nothing is amortized in 10 years, that times have accelerated, and that this makes balance sheets more false (by obligation of the law).
It is completely true. But that is not the cause of today, nor of the internet (a little bit yes, specifically the part that everything has been accelerated). The cause is that bureaucrats always want to use the same rules (accounting plan, for example) for very different things. And, just as you can’t use a screwdriver to turn a nut (a wrench is better for that), you can’t use the same chart of accounts for very different activities.
The clear example is that, if a company works with products with a production cycle of 15 days (those that sell lettuce, for example), its balance sheet should not be annual, but biweekly, which is the production cycle. And if a company works with products with a production cycle of several years (real estate development, for example), the annual balance sheet does not provide any useful information (a ten-year balance sheet would provide much more information).
In short, it is true that the official accounting information is little more than garbage. But that does not come from this crisis, but from always.
A different thing is that there are experts in taking advantage of these stupidities of obligation by Law. If someone knows that, although the official balance sheets are ugly, in that company there are assets that have not been disclosed, and the company has difficulties due to accounting law, it is time to “attack” it.
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I continue now with the “story”, although not much, because I have been extended with the previous comments.
Covid 19 and “stop the bike”.
Our society already had some previous problems, with an ultimate cause (Internet), and with some weaknesses that I have already mentioned.
Covid 19 is doing a real stress test to the system. And it will most likely give us the heart attack (of the system, not of the health of each one, although someone will also get the other one).
We have half of the world’s population “confined” (another buzzword). I know that those who do not comply are many more than what the media say (the fools, the smart people, the thieves, the drug dealers, …). But billions of people stopping their activity for months is something never seen before (and all at the same time). One thing is a strike in a sector, or in a country, for a few days, and another thing is this.
The fact is that we are not consuming (or much less); we are not producing; we will not generate profits, which means that we will not pay taxes next month (the case of the self-employed is more bleeding); …
We have stopped the bicycle. And we all know that, if you don’t pedal, and you don’t put your legs on, the consequence is to fall off. It is a silly example, but very descriptive, and it is what is going to happen (with little remedy).
A slightly more serious example than that of the bicycle is that of blast furnaces. If you stop the furnace with the vats full of liquid steel and let it cool, the steel solidifies. In that case it is not at all easy to “open store” the next day. The vat has been rendered unusable, and a new facility has to be built (with a large investment). Moreover, if that happens, and if there is the money for the new facilities (which will not be the case), it is time to rethink if the old facilities were the most adequate for the current demand, or if something different has to be built again. I think that is the situation we find ourselves in.
The world has stopped (that old joke saying: “stop the world and I’ll get off” has come true, and … it’s not so funny). The machines have broken down. Not just the social elevator, but almost all the machines. Getting it up and running again involves a lot of investments (with money we don’t have), and decisions about what new machines we need now.
Downtime costs.
The stoppage in economic activity will generate two types of costs. The direct ones, which are those of unpaid wages, unmade sales, and ungenerated taxes. And the indirect ones, which are those of future investments in “fixing the machine”.
I don’t think almost anyone can accurately estimate these costs today (data is lacking). But it is easy to make some big numbers to get an idea of the order of magnitude. And, since that is what matters (the order of magnitude), it does not affect at all to have errors of 20-30 %. That’s why I’m going to make those fat numbers with data almost from memory, since looking for exact data in Google is easy, but it would consume unnecessary time.
- If Spain’s GDP is a little over one trillion, and if public activity is something like 35% of GDP, then private activity is about 650 billion. That implies about 55 billion per month.
It is not easy to know what percentage of the private activity has stopped in the confinement. But it seems logical to think that it could be in the range of 60 – 70 %. I mention here that there are many companies that are not officially closed, but their sales have fallen a lot, which has the effect of “no income”, which is what matters (not the official closure).
Assuming that 60% of the private economy has been stopped (which I believe the reality is higher), that would imply a “non-produced” GDP of about 33 billion euros per month.
- Thinking from the point of view of individuals, there will be many who have savings. For them, “down” time means depleting savings in an unexpected way. But, at least they can do it. Those who have a clear source of income after the hiatus will do better.
But there are many others who have no savings, no source of income for later. It is difficult to estimate this, but some assumptions can be made:
- First, I will assume that the unemployed prior to the “shutdown” were already considered in the budgets, so no “new money” will be needed (which is already a lot to assume).
- I will also assume that the new unemployed will be something like 1.5 million people. Here I consider as unemployed also those of the ERTES, because that cost will have to be taken out of “new money”, even though it will be paid by the company that will receive subsidies for it.
I have not put 1.5 million by eye. I did it because a news item on April 2 said that there were about 600,000 people in ERTEs, and about 300,000 new unemployed. And I think these figures will go up. In fact, 1.5 million seems to me to be a low figure. - Those people (the newly unemployed) are very likely to be, for the most part, from the weaker strata of society. I do not think that more than 10% of them have savings to cope with the lack of income.
- 1,000 per month each (part of that 1,000 euros may come to them indirectly, in the form of assistance to the landlord to keep the rent down, but that changes the recipient, not the total need for funds).
- If we think of 90% of 1.5 million people receiving 1,000 euros per month, that gives us about 1.3 billion euros per month.
- In addition, we have to think about the self-employed and small businessmen (retail, hotel business and similar). These people do not appear as unemployed, nor as part of ERTEs, but many of them will not be able to survive. It seems that there are 3.2 million people in the self-employed regime, to which must be added small entrepreneurs who are not in that regime. We can think of about 4 million people in these conditions. Of these, it is easy that a quarter of them cannot guarantee their subsistence with savings. There would be another million people who would need that €1,000 per month. So another 1,000 million euros per month.
- First, I will assume that the unemployed prior to the “shutdown” were already considered in the budgets, so no “new money” will be needed (which is already a lot to assume).
- So, just for the basic survival of people with no savings, about 2.3 billion euros per month would be needed (which is most likely a low estimate).
- Now let’s think from the point of view of the companies. In recent years, few companies have achieved profit margins of more than 10% of sales. So, if they do not modify their costs (if they do not make layoffs, basically), and if we think that the 2 months “stop” will have made them lower their sales by more than 10% of the annual total, it is normal that almost all of them will end up in losses this year (with the exception of Mercadona and a few others privileged by covid 19).
There will be a percentage of these companies that will be able to assume the losses with their current balance sheets. But others will not be able to, and will need: either to go to insolvency proceedings, or injections of new capital (let’s see who will provide it).
In addition to balance sheet problems, there are cash flow problems. A company may be able to sustain losses, but does it have, in liquidity, enough money to pay two months of expenses without revenues? Very few companies will have that liquidity. Their options are: to seek financing (to see if they can get it), which will be an unforeseen additional cost, or to hastily sell off an asset (which further spoils the balance sheet).
In short, many companies will go bankrupt (with the generation of additional future unemployment). Others will enter the financial UVI. And others are going to change owners, with the old one leaving and the one who puts up the “new money” (or the guarantee capacity) entering. In view of the latter, the government’s decision to prohibit the takeover of strategic companies by foreign capital looks very nice, but who is putting up the money?
- It is also necessary to look at things from the point of view of: reduced government revenues.
We have already said that it is necessary to think that almost no company is going to make a profit this year. Let us assume that 80% of them will not. As corporate tax collection in Spain has been 5% of GDP (approx.), that is about 50,000 million. So, if 80% less is collected, about 40,000 million less will be collected for IS.
As for VAT, collection in Spain was around 6.5% of GDP, which is about 65 billion. It is clear that the confinement has lowered the sales of many products subject to VAT. Quantifying it is difficult, but it does not sound strange to think that it may have been something like half. So, if for two months half of the things subject to VAT are sold, in the year 10% less has been sold. That gives us a lower annual VAT revenue of about 6.5 billion euros.
The collections from other concepts (personal income tax, …) will also fall, but the above is enough to know that the State’s revenue will fall by more than 46,000 million euros.
In short, the State will have much less revenue than expected, and much more expenditure than expected (aid to individuals and companies, in addition to the financial ones). More than 50 billion may be missing if the “standstill” lasts two months. Moreover, even if the total standstill is two months, the reactivation will not be 100% from one day to the next. There will be many months of low activity, which will mean the need for more money.
To this must be added the costs of “fixing the machine”, which will be new investments, or the hackneyed “Marshall Plan”. This will have to be higher than the previous one.
Where is Spain going to get that money from? If someone leaves it to them, they will impose their rules. And if they can’t find it, the way out is starvation.
For now they are going to dissimulate, and to put patches. For example, the pacts of two days ago with Europe say that 400,000 million will be activated for the whole of Europe. If they are distributed proportionally to the population, Spain will get 10%, which is about 40,000 million. And, … we have already seen that this figure is not enough for the immediate costs.
Here I am reminded of a sentence I read recently. It went something like this: “the result of the geopolitical war between the USA and China, which has accelerated with Covid 19, is that the spoils for the winner will be Europe”.
Another way of looking at the issue is that similar numbers can be made for all countries. The result will be the same: bankruptcy of almost all of them. This could lead us to think of something similar to the fall of the Roman Empire.
I will continue, … . But not everything is so pessimistic. There may be solutions by creating a New Order.