Wednesday, April 17, 2013

Financial Sector Balance - Updated

In previous blog posts, we have discussed aspects of Financial Sector Balance here, here and here. We are now well into a slow recovery from the economic shock brought about by the housing bubble of 2007. This post is an update on data presented earlier and a few remarks.

Recapping, we recall that the FSB is an important macroeconomic relationship showing how financial flows balance among the Public, Private, and Foreign financial sectors. It could just as well be between Blondes, Brunets, and Red Heads, but we have no data on those sectors. Fortunately, the Bureau of Economic Analysis (BEA) has the pertinent data in its National Income and Production Accounts (NIPA).

By merely observing that when money flows between sectors an account in one sector must be debited and credited in the other sector by the same amount. So the sum of debits and credits will be zero, zip, nada, and we can write.

Public (Net Surplus) + Private (Net Saving) + Foreign (Net Imports) = 0

Alternatively, we can equate two expressions for GDP or national income 

GDP = C + G + I + NX

where C = household consumption, G = government spending, I = business investment in means of production, and NX = net exports, often written as (X - M).

Because all income devolves to households, we can write another expression as

GDP = C + T + S

where C is the same, T = household taxes, and S = household saving. Equating the two expressions for GDP and collecting terms we have

(T - G) + (S - I) + (M - X) = 0.

This expression conveys the general idea, but is oversimplified as it ignores some accounting conventions. For example, household "investment" in stocks is considered to be saving. Because business taxes are costs of production, they are included under consumption. We can assume that the BEA accountants get it right.

The figure below shows a stacked bar graph of the top-level NIPA data. This presentation shows that the terms of the FSB equation do balance to zero.

There are some interesting observations that become readily apparent.
  • Net saving in the private sector requires a public deficit as long as there exist net imports.
  • In the presence of large net imports and small public deficits the private sector must reduce savings and net borrow.
  • As of the end of FY 2012 (September) private saving and public deficits are still abnormally high. Further, the rapid decline of saving and deficit has leveled out. 
Because the government has no direct control over imports and private saving desires, it follows that government has no direct control over the deficit. Evidence from around the world shows that austerity measures do not reduce deficits, but only make them worse. 

Finally, it must be clear that in the US a public deficit is a necessary for private net saving.

Revised April 18, 2013.


The piper is being paid

Previously, the Albuquerque Journal published a letter that I titled "A Nation Must Live Up to its Means." A response from one reader gave a standard conservative response that the Journal titled "Some day, the piper must be paid," but the writer never mentioned a piper. But, he did disdain the government support of Solyndra.  So, I figured that the Journal was doing its usual job of editorializing in writing titles to readers' letters and submitted the following response on April 10. To my surprise, the Journal published this letter on April 22 in the Business Outlook letters. 

The Pied Piper of Hamelin is famous for leading the children out of town after the town refused to pay him for leading the rats out. It follows, of course, that bad things will happen to our children if we don't pay the national debt.

In a letter to Business Outlook on April 8, to defend the zombie myth that federal finances must be managed just like a household, the Journal trotted out the old saw that “Some day, the piper must be payed.” 

Pied Piper - Another popular myth.
That old saw raises the questions: Who is the piper? Who will pay that piper and when? As the old saw is vague about the subject, we presume that it refers to national debt, which is an accumulation of federal deficits. Contrary to conventional wisdom, I have claimed that current federal deficits are not large enough.

Because the national debt is held by the non-government sector as assets called US Treasury securities, the piper must be the holders of the treasuries, mostly institutions and rich people, and the payer must be the federal government. The payments made are documented daily by the Treasury in its “Daily Treasury Statement.”

Looking at the statement for the last day of FY 2012 one sees that $67.4 trillion in public debt was redeemed, $68.7 trillion debt was issued, and $215 billion interest was paid over the year. This happens to the tune of over $250 billion per day. The piper gets paid every day as the public debt gets rolled over and necessarily increased. Our government can always meet its financial commitments.

Unlike a private mortgage that must be paid off, the national debt has no due date. As the nation’s economy has grown, that old debt from World War II has remained as an ever decreasing fraction of the total. Public debt is the only source of net private sector savings; it doesn’t make sense to pay it off under usual circumstances.

Rather than concern ourselves with numbers on a spread sheet, we should look at what  really matters, that is the real economy. Businesses downsized to make profits on sales to those who are employed. Demand is not sufficient for businesses, as a whole, to hire up. So, we are stuck with high unemployment and pitifully slow growth. When the private sector can’t, Government purchases from the private sector can support the demand needed for full employment.

Of course, deficits can be too large, but not until full employment is reached. Our government should make sure that all the nation’s productive resources are put to use, not cut them off as it is doing now. Then we would see GDP grow and both unemployment and deficits decline.

Rather than complaining about small, failed enterprises like Solyndra, the private sector should look to government for the high-risk R&D needed for future industry.

Daily Treasury Statements