The US economy: hurtling towards another crisis

In a recent post, “Should the US balance its budget“, I argued that it would be a folly for the US to try to balance its budget in the near term, as this would seriously impede the economy’s recovery from the recent deep recession.

But this leaves us with some obvious questions. Is the economy going to be forever dependent on huge amounts of government spending to remain afloat? What is the way out of this mess? And what needs to happen for the US economic recovery to be sustainable?

In order to arrive at an answer to this question we are going to have to get into a few equations, but hopefully it will make the explanation easier to understand. To review, here is the sectoral balances identity that we examined in my last post.

Private Sector Balance + Government Sector Balance – Current Account Balance = 0

As you may recall, this suggests that if the private sector desires to spend less than its income in aggregate, and the country is running a trade deficit, a government deficit is inevitable.

The chart below (from Pragmatic Capitalism) shows that the massive increase in the government deficit in 2008 mirrored a huge increase in the financial balance of the private sector.

This is an interesting observation, but it obscures a lot of what was really going on. If we divide the private sector into households, and the business (or corporate) sectors, we can rewrite the equation as follows.

Household Sector Balance + Business Sector Balance + Government Sector Balance – Current Account Balance = 0

Now, one of the characteristics of the recent crisis is that (unlike Japan’s bubble economy of the 1980s, for example), it was driven not so much by corporate excesses (apart from the banks), but more by excessive borrowing in the household sector. Let’s rearrange the equation above to isolate how the household sector’s financial balance is determined.

Household Sector Balance = Current Account Balance – Business Sector Balance – Government Sector Balance

The chart below from the San Fransisco Fed (h/t again to Pragmatic Capitalism) suggests that while households have increased their savings rates and starting paying off or defaulting on their debt, this deleveraging process could still have a long way to go.

In other words, the household sector’s financial balance is likely to be positive for quite a long time. This has some pretty big implications for other sectors in the economy. As the San Fransisco Fed says:

Going forward, households may keep trying to reduce excessive debt loads by increasing their saving… higher saving rates imply correspondingly lower rates of domestic household consumption growth so that a larger share of GDP growth would need to come from business investment, net exports, or government spending.

The part in bold follows directly from the sectoral balances equation above.

Now, as I said in my last post, it is clear that we are running into some severe political constraints on the ability of deficit spending to take up the slack.

Growing Exports

I think it would be disastrous if the US tried to balance its budget in the near term.  But given the political constraints just mentioned, it seems that as soon as possible it would be desirable for the US to implement policies that promote business investment and exports.

Wynne Godley, the grandfather of the sectoral balances approach, actually came to similar conclusions in a series of very prescient papers written in the 1990s and early 2000s. Godley argued that the rapid rise in US private sector debt was unsustainable, and that if the US did not change course, its economy was headed for a disaster — from which the only way out would be a massive increase in government spending to levels that were not politically sustainable.

Here is what he said in 1999:

Given unchanged fiscal policy and accepting the consensus forecast for growth in the rest of the world, continued expansion of the U.S. economy requires that private expenditure continues to rise relative to income. Yet while anything can happen over the next year or so, it seems impossible that this source of growth can be forthcoming on a strategic time horizon. The growth in net lending to the private sector and the growth in the growth rate of the real money supply cannot continue for an extended period.

Moreover, if …the growth in net lending and the growth in money supply growth were to continue for another eight years, the implied indebtedness of the private sector would then be so extremely large that a sensational day of reckoning could then be at hand.

As we all know, that “sensational day of reckoning” came in 2008. In any case, Godley came to the conclusion that there was only one sustainable long-term solution to the “strategic predicament” of the US.

There would appear to be only one antidote to this predicament, that net export demand provides the motor for sustained growth in the future; U.S. exports must rise faster than imports by very large amounts and for a long period of time.

As you can see from the graph above, the US has run a current account deficit almost continually since the late 1970s. And now that deficit is widening again thanks to the rise in oil prices. Turning this deficit around is not going to be easy. It is probably going to take some combination of a weaker US dollar and faster growth in consumer demand in the rest of the world. The central bankers know this, which is why the Bernank has been prattling on about global rebalancing for some time now. Hardly anybody is listening.

But at the end of the day, as long as China (and many other emerging market economies) continues to peg its currency to the dollar and accumulate massive amounts of dollars, it is going to be difficult for the US to reduce its deficit. China is making the right noises about trying to switch to a more consumption-based society, which could help boost US exports. But this will take time. And what will the USA sell? Much of the manufacturing sector has shifted offshore, with a permanent loss of expertise in many industries.

Stimulating Business Investment

So what about business investment? While corporate profits have rebounded very strongly in the US since the crisis ended, for the most part, companies are not reinvesting these profits.

In a recent post at Naked Capitalism, Rob Parenteau offers an interesting take:

There is a glut of profits, and these profits are not being reinvested in tangible plant and equipment. Companies, ostensibly under the guise of maximizing shareholder value, would much rather pay their inside looters in management handsome bonuses, or pay out special dividends to their shareholders, or play casino games with all sorts of financial engineering thrown into obfuscate the nature of their financial speculation, than fulfill the traditional roles of capitalist, which is to use profits as both a signal to invest in expanding the productive capital stock, as well as a source of financing the widening and upgrading of productive plant and equipment.

What we have here, in other words, is a failure of capitalists to act as capitalists… So rather than marching to Austeria, we need to kill two birds with one stone, and set fiscal policy more explicitly to the task of incentivizing the reinvestment of profits in tangible capital equipment. A program to do so would include the following measures:

1) a prohibitive tax on retained earnings that are not reinvested with a 24 month period after they have been booked;

2) a financial asset turnover tax that raises the cost to businesses of playing casino games in various financial asset markets, rather than reinvesting profits in the productive capital stock;

3) a reinvigorated public or public/private investment program that helps speed up the shift to, and lower the costs of production of new energy technologies.

Interesting ideas. Are any of them likely to happen? Probably not. What about the export solution that we examined above? Problematic. Meanwhile, austerity mania is in the air as we head towards another Presidential election in 2012.

What does all this mean? My best guess is that we are heading for another crash sometime in the coming few years. What do you think?

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Comments

  1. Prima facie I would conclude that this means more pressure on The Bernank to go for QE’s 3 through 7. But is the political backlash you describe likely to attack the Fed too?

    • Prudent Bear on the prospect of significant inflation, QEinfinitum and raising of interest rates:

      Final paragraph:
      “[…]But it will require the Fed at its next meeting April 27 to reverse policy entirely, to admit that inflation, far from being “somewhat low” is an imminent danger to the U.S. economy, to stop buying Treasuries and to put the Federal Funds rate up to at least 2%, with a view to raising it to 6-7% by the end of the summer. It is thus not impossible. But given Bernanke’s outlook and the present composition of the FOMC, it must be regarded as extremely unlikely.”

      http://prudentbear.com/index.php/thebearslairview?art_id=10518

      • That will throw them into much deeper debt deflation.

        Which is more politically palatable? Inflation or deflation?

        I think deflation is more palatable to pollies, compared to deflation, and the largely ignorant populace will agree.

        IMHO, they won’t budge on rates for a while yet, QE-X is coming, Stagflation will ingrain itself into Western economies; Fed will raise rates will they start to feel uncomfortable about they inflation that will inevitably come (and it will probably come quicker and harder than they think!) – it’s just a question whether they come at it hard enough to get on top of it early enough, or just chase it upwards, and risk going hyper (due to loss-of-confidence issues, simultaneously…)

        my 2c

  2. Whatever your outlook, most would agree China was the saving grace for our Global Economy over the past 3 years. And according to the Dateline report on SBS, a lot of this economic stimulus in China has resulted in the building of empty cities.

    Should the US economy nosedive once again, who is going to pick up the slack next time around? Where’s the next bubble going to come from?

  3. “As you may recall, this suggests that if the private sector desires to spend more than its income in aggregate, and the country is running a trade deficit, a government deficit is inevitable.”

    This is incorrect. The Private Sector Balance in your equation is the net sum of all private financial claims on others. An increase in in the Private Sector Balance does not indicate that the private sector desired to spend more than its income in aggregate. It indicates that the private sector in aggregate desired to lend to the government, at prevailing interest rates.

    The rest of the article is fundamentally flawed as it rests on this single flawed assertion.

      • Belittlement – interesting.

        Can you explain why an increase in the Private Sector Balance necessarily indicates that the private sector desires to spend more than its income in aggregate?

      • Regarding the article by Bill Mitchell that you refer to:

        You can see where Bill’s heart lies from his model, which starts with an all-powerful state (the parents) dictating that its citizens (the children) use a fiat currency of the state’s choosing.

        By depicting the state as a parent he is implying that the state is all-knowing and all-providing. The kids are helpless and totally reliant.

        This model more closely represents a dictatorship than a democracy.

        Note how wages and prices are fixed by the government. This prevents any possibility of inflation.

        In month 4, he introduces the straw man of neoliberalism. He does not investigate what happens by month 400, or whether the interest rate on savings can be kept higher than the inflation rate.

        In a democratic version of this model, the kids would make their own food and shelter. The “parents” can get access to these through reasonable levels of taxation, and by borrowing.

        Perhaps most tellingly, the kids in his model cannot lend to one another. Most of our savings are backed by private loans, not by government debt.

        • Edit: “CPI inflation” in paragraph 5, “Money Supply Inflation Rate” in paragraph 6.

      • In Paul’s defence, there is probably issues of Economic Paradigm here, and what Axioms one knowingly or unknowingly ascribes to.

        Paul does seem to be explicitly aware of his axioms, which is a good thing; i’m not saying others are not aware of there Axioms, but I would suggest that they are not explicitly aware of them, given that it is a very common human logical failing…

        But no finger pointing meant – just a general statement 🙂

    • Hi Paul,

      Personally I think people read a little too much into what sectoral balance means, my opinion is that it is a basic fundamental accounting rule that demonstrates there are linkages between the 3 sectors of the economy. Private, Government, foreign trade. This leads on to further discussions about the functional sides of the inner workings of an economy such has how foreign trade actually works at a functional level, as I discuss here.

      http://macrobusiness.com.au/2011/02/macro-101-foreign-debt/

      However you don’t really need to care about sectoral balance for what most people use it to demonstrate. It is really a simple matter of functional money.

      However I think these topics ARE fundamental to better economic outcomes for countries and I therefore attempt to be pragmatic about these topics because it seems very obvious that no one in a position to deliver these things has even half a clue how to do it. It is therefore foolish for me to pretend that I do.

      So this is simply my understanding. I am happy to provided with evidence otherwise. In fact the reason I asked Leigh Harkness to do a guest post was because his research got me thinking that I have some gaps in my understanding of the macroeconomic system.

      By definition if a government is running a surplus budget they are taxing more than they are spending. That is the definition of a surplus. That means that in aggregate there is a net flow of financial assets to the government from the private sector. This may be offset by inflow from the trade sector, but without that the private sector will be giving up “money” to the government. Therefore in the absence of a trade surplus to maintain the same level of aggregate spending the private sector must use credit or de-save. There are obviously reverse effects under the opposite circumstances.

      That is my understanding. Do you disagree with that statement in someway ?

      Secondly you said.

      > It indicates that the private sector in aggregate desired to lend to the government

      I think that one sentence sums up the fundamental difference between the Austrian and MMT school of theory. Under MMT the government does not “lend” money from anyone, it has no need to because it is the monopolist issue of the currency. Bonds are issued as an interest rate and inflation control not as a funding mechanism.

      I seem to remember that Bill Mitchell had a post ( sorry can’t find it ) where he showed that the OZ government still issued bonds even when running a surplus budget.

      Obviously Austrians believe that the public does fund the government and that is why the government issues bonds that the public buys to fund the government.

      MMT practitioners believe this is an accounting choice and serves no real function under a FIAT currency while it is obvious that Austerians do not believe this.

      Does anyone have an opinion on these points? my interpretation of them, and/or whether they are in fact correct.

      • “Personally I think people read a little too much into what sectoral balance means, my opinion is that it is a basic fundamental accounting rule that demonstrates there are linkages between the 3 sectors of the economy.”

        Agreed.

        “However you don’t really need to care about sectoral balance for what most people use it to demonstrate.”

        People who use it to demonstrate must be careful not to use its terminology in a natural language sense, as the terms it uses mean different things outside of its limited domain.

        “However I think these topics ARE fundamental to better economic outcomes for countries”

        Which topics? Sectoral balances? If so, why?

        “I therefore attempt to be pragmatic about these topics because it seems very obvious that no one in a position to deliver these things has even half a clue how to do it.”

        Deliver what things?

        “So this is simply my understanding. I am happy to provided with evidence otherwise. In fact the reason I asked Leigh Harkness to do a guest post was because his research got me thinking that I have some gaps in my understanding of the macroeconomic system.”

        I think Leigh’s article was very good. I’ve tried to provide evidence to show that the policy prescriptions put forward by RA and others, on the basis of sectoral balances, are incorrect. A number of points that I have made have not been answered and therefore I would expect RA and others to think about their understanding of these and either provide refutations, or consider modifying their line of argument.

        “By definition if a government is running a surplus budget they are taxing more than they are spending.”

        Agreed.

        “That means that in aggregate there is a net flow of financial assets to the government from the private sector.”

        There is a net flow of a certain class of financial assets – financial claims – to the government from the private sector. There are other kinds of financial assets, such as shares. Using the term “financial assets” is ambiguous and if you want to keep using it, and at the same time communicate to a lay audience, you need to keep specifying each time exactly what you mean. If you use the term “financial claims” you may get around this difficulty.

        “This may be offset by inflow from the trade sector, but without that the private sector will be giving up “money” to the government.”

        Here we hit another definitional difficulty. You are referring to “net money”, which is all the bank deposits added together, and all the bank liabilities and other private sector liabilities subtracted. (Even that is a gross simplification). Most references to money mean M0, M1, M2, M3 etc which do *not* subtract private sector liabilities. “Net money” and “Money” are completely different things. This is the epicentre of the MMT sleight of hand.

        “Therefore…”

        Anything after the “therefore” is invalidated unless you can show that the above is incorrect.

        “Secondly you said.

        > It indicates that the private sector in aggregate desired to lend to the government

        I think that one sentence sums up the fundamental difference between the Austrian and MMT school of theory. Under MMT the government does not “lend” money from anyone, it has no need to because it is the monopolist issue of the currency. Bonds are issued as an interest rate and inflation control not as a funding mechanism.”

        No, I am merely saying that if the government runs a deficit in today’s system, (assuming no QE) it indicates that private lenders were prepared to lend their resources to the government. You say “under MMT”. But we are not “under MMT”. All government deficit spending, including QE, is recorded in the national accounts as government debt. When you say it has no need to, you are referring to the power that a sovereign has to do whatever it likes. However, sovereigns that do whatever they like tend to come to grief, so sensible sovereigns operate under a set of self-imposed constraints. Under the central banking system, the key constraint is that all government spending is recorded as debt. It is this key constraint that actually enables the government to use private resources over and above those that it appropriates through taxattion. Without this constraint there will be no private lenders of resources.

        “I seem to remember that Bill Mitchell had a post ( sorry can’t find it ) where he showed that the OZ government still issued bonds even when running a surplus budget.”

        Yes I think that is correct.

        “Obviously Austrians believe that the public does fund the government and that is why the government issues bonds that the public buys to fund the government.”

        Yes that is probably a fair statement.

        “MMT practitioners believe this is an accounting choice and serves no real function under a FIAT currency while it is obvious that Austerians do not believe this.”

        You do yourself a disservice by switching from the term “Austrians” to “Austerians”. It seems like name-calling and does not add to the debate. Yes MMT practitioners do believe this. They do not grasp, or do not want to grasp, that without this “choice” the system would not work, because private asset-holders would be unwilling to lend their resources to the government. MMTers lose sight of the fact that money is an intermediary only. Governments need real productive assets, and most of the assets are in private hands. There are four basic ways to get their hands on these assets: taxation, borrowing, coercion or trickery. I think most of us would prefer the first two and not the latter two. In my opinion MMT if implemented would fall into the last category.

        • >“However I think these topics ARE fundamental to better economic outcomes for countries”
          >Which topics? Sectoral balances? If so, why?

          No macroeconomic theory.

          >“I therefore attempt to be pragmatic about these topics because it seems very obvious that no one in a position to deliver these things has even half a clue how to do it.”
          >Deliver what things?

          Good economic ( higher employment, productivity ) and social outcomes.

          >“By definition if a government is running a surplus budget they are taxing more than they are spending.”
          >Agreed.
          >“That means that in aggregate there is a net flow of financial assets to the government from the private sector.”
          >There is a net flow of a certain class of financial assets – financial claims – to the government from the private sector. There are other kinds of financial assets, such as shares. Using the term “financial assets” is ambiguous and if you want to keep using it, and at the same time communicate to a lay audience, you need to keep specifying each time exactly what you mean. If you use the term “financial claims” you may get around this difficulty.

          I cannot find any “well known” definition of the term “financial claim”. Can you site me a reference so I can determine if it is the term I want to be using ? I am getting the feeling we need a to put together a definitions dictionary for these discussions.

          >“This may be offset by inflow from the trade sector, but without that the private sector will be giving up “money” to the government.”
          >Here we hit another definitional difficulty. You are referring to “net money”, which is all the bank deposits added together, and all the bank liabilities and other private sector liabilities subtracted. (Even that is a gross simplification). Most references to money mean M0, M1, M2, M3 etc which do *not* subtract private sector liabilities. “Net money” and “Money” are completely different things. This is the epicentre of the MMT sleight of hand.

          Actually the mechanics of taxation mean that the “money” will be high powered money (HPM) however I appreciate that once again this is a definitions problem.

          >“Therefore…”
          >Anything after the “therefore” is invalidated unless you can show that the above is incorrect.
          >“Secondly you said.
          > It indicates that the private sector in aggregate desired to lend to the government
          >I think that one sentence sums up the fundamental difference between the Austrian and MMT school of theory. Under MMT the government does not “lend” money from anyone, it has no need to because it is the monopolist issue of the currency. Bonds are issued as an interest rate and inflation control not as a funding mechanism.”
          >No, I am merely saying that if the government runs a deficit in today’s system, (assuming no QE) it indicates that private lenders were prepared to lend their resources to the government. You say “under MMT”. But we are not “under MMT”. All government deficit spending, including QE, is recorded in the national accounts as government debt. When you say it has no need to, you are referring to the power that a sovereign has to do whatever it likes. However, sovereigns that do whatever they like tend to come to grief, so sensible sovereigns operate under a set of self-imposed constraints. Under the central banking system, the key constraint is that all government spending is recorded as debt. It is this key constraint that actually enables the government to use private resources over and above those that it appropriates through taxattion.Without this constraint there will be no private lenders of resources.

          I think your use of the word “sensible” is a little strange here. How exactly do you determine this is sensible ? Is the austerity of ireland and its economic effects more or less sensible that Japan’s actions and outcomes? This is seems to be purely a opinion not something based in evidence. I am not a bigger supporter of the “Government bad, private sector good” dogma, there is corruption in all systems and it is naive to think otherwise. I am interested in finding out what works and why from a functional perspective. Bringing a political belief into this discussion is a distraction.
          I am also not 100% clear on what you are trying to say “his key constraint that actually enables the government to use private resources over and above those that it appropriates through taxation. Without this constraint there will be no private lenders of resources.”. Are you saying that if a government decided to change the way it reported government spending then the private sector would no longer provide services and resources in return for currency (or products directly and instantly transferable to currency at no cost)?

          >“MMT practitioners believe this is an accounting choice and serves no real function under a FIAT currency while it is obvious that Austerians do not believe this.”
          >You do yourself a disservice by switching from the term “Austrians” to “Austerians”. It seems like name-calling and does not add to the debate.

          I agree, It was actually a typo, and not intentional. Sorry if you were offended by it.

          >Yes MMT practitioners do believe this. They do not grasp, or do not want to grasp, that without this “choice” the system would not work, because private asset-holders would be unwilling to lend their resources to the government.
          Again you are going to have to explain why because I think this is an assumption on your part. Can you provide me with an example of this ?
          >MMTers lose sight of the fact that money is an intermediary only. Governments need real productive assets, and most of the assets are in private hands.

          I am not sure about that either. I think one of the fundamentals of MMT is that money is an intermediary as it has no value to the monopolist issuer outside of its ability to act on the private sector.

          >There are four basic ways to get their hands on these assets: taxation, borrowing, coercion or trickery. I think most of us would prefer the first two and not the latter two. In my opinion MMT if implemented would fall into the last category

          I think that makes it clear where you stand on this from a political perspective, however I am not sure that has anything to do with a conversation about economics. The question for me is which approach provides the best economic and social outcomes for a country. I could just as easily call Austrian theories “deficit terrorism” but as you said above this sort of thing adds this nothing to my argument.

          I am however very interested in your opinion as you are obviously have studied/thought about these particular points and can articulate your arguments well. So my question to you is can you explain in your own terms what happens to the private sector’s financial position when the government runs a surplus assuming a balance of trade (ie export = imports ) for the period.

        • >>>“However I think these topics ARE fundamental to better economic outcomes for countries”
          >>Which topics? Sectoral balances? If so, why?

          >No macroeconomic theory.

          Couldn’t agree more.

          >>>“I therefore attempt to be pragmatic about these topics because it seems very obvious that no one in a position to deliver these things has even half a clue how to do it.”
          >>Deliver what things?

          >Good economic ( higher employment, productivity ) and social outcomes.

          OK

          >>>“That means that in aggregate there is a net flow of financial assets to the government from the private sector.”
          >>There is a net flow of a certain class of financial assets – financial claims – to the government from the private sector. There are other kinds of financial assets, such as shares. Using the term “financial assets” is ambiguous and if you want to keep using it, and at the same time communicate to a lay audience, you need to keep specifying each time exactly what you mean. If you use the term “financial claims” you may get around this difficulty.

          >I cannot find any “well known” definition of the term “financial claim”. Can you site me a reference so I can determine if it is the term I want to be using ? I am getting the feeling we need a to put together a definitions dictionary for these discussions.

          By “financial claim” I mean one side of a credit contract. Each credit contract has a borrower and a lender. The lender’s side is a positive financial claim. The borrower’s side is a negative financial claim. I will use the term “financial claim on others” to make it completely clear that I am not talking about financial claims on assets.

          If you add all private sector “financial claims on others” together, you get the Private Sector Surplus referred to in the sectoral balances model.

          I admire your push for a glossary. If done properly I think it can make a huge difference. It will be difficult to get contributors to use it consistently but worth a go. Personally I don’t care what things are called, so long as commonly used terms aren’t hijacked to mean something different to what most people understand them to mean, and so long as new terms are clearly defined. I have made the error here myself of not explaining what I mean by “financial claims”, but hopefully that is now corrected.

          >>>“By definition if a government is running a surplus budget they are taxing more than they are spending. That is the definition of a surplus. That means that in aggregate there is a net flow of financial assets to the government from the private sector. This may be offset by inflow from the trade sector, but without that the private sector will be giving up “money” to the government. Therefore in the absence of a trade surplus to maintain the same level of aggregate spending the private sector must use credit or de-save. There are obviously reverse effects under the opposite circumstances.”
          >>Here we hit another definitional difficulty. You are referring to “net money”, which is all the bank deposits added together, and all the bank liabilities and other private sector liabilities subtracted. (Even that is a gross simplification). Most references to money mean M0, M1, M2, M3 etc which do *not* subtract private sector liabilities. “Net money” and “Money” are completely different things. This is the epicentre of the MMT sleight of hand.

          >Actually the mechanics of taxation mean that the “money” will be high powered money (HPM) however I appreciate that once again this is a definitions problem.

          To determine the validity of your statements above, we would need to define: “financial assets”, the concept of “financial assets flowing to”, “giving up”, “money”, “use credit” and “de-save”. All of them could be ambiguous. Probably key is “de-save”. Usually loans to create assets are not counted as “negative savings”, but they are counted in the way you are using “de-save” here. If you don’t count them then the sectoral balances equation does not apply.

          >> It indicates that the private sector in aggregate desired to lend to the government
          >I think that one sentence sums up the fundamental difference between the Austrian and MMT school of theory. Under MMT the government does not “lend” money from anyone, it has no need to because it is the monopolist issue of the currency. Bonds are issued as an interest rate and inflation control not as a funding mechanism.”
          >>No, I am merely saying that if the government runs a deficit in today’s system, (assuming no QE) it indicates that private lenders were prepared to lend their resources to the government. You say “under MMT”. But we are not “under MMT”. All government deficit spending, including QE, is recorded in the national accounts as government debt. When you say it has no need to, you are referring to the power that a sovereign has to do whatever it likes. However, sovereigns that do whatever they like tend to come to grief, so sensible sovereigns operate under a set of self-imposed constraints. Under the central banking system, the key constraint is that all government spending is recorded as debt. It is this key constraint that actually enables the government to use private resources over and above those that it appropriates through taxation.Without this constraint there will be no private lenders of resources.

          >I think your use of the word “sensible” is a little strange here. How exactly do you determine this is sensible ? Is the austerity of ireland and its economic effects more or less sensible that Japan’s actions and outcomes? This is seems to be purely a opinion not something based in evidence. I am not a bigger supporter of the “Government bad, private sector good” dogma, there is corruption in all systems and it is naive to think otherwise. I am interested in finding out what works and why from a functional perspective. Bringing a political belief into this discussion is a distraction. I am also not 100% clear on what you are trying to say “his key constraint that actually enables the government to use private resources over and above those that it appropriates through taxation. Without this constraint there will be no private lenders of resources.”. Are you saying that if a government decided to change the way it reported government spending then the private sector would no longer provide services and resources in return for currency (or products directly and instantly transferable to currency at no cost)?

          By sensible I mean rational. It is rational to seek to determine what constraints are appropriate, then to live by those self-imposed constraints. For instance each of us places constraints on our behaviour because we know to behave otherwise may be destructive. Sovereign nations using the central banking system have, on the whole, done so willingly for rational reasons.

          It would not be simply a matter of the government changing the way it reported spending. It would be a removal of a key constraint on spending (the requirement to pay interest).

          Personally I don’t subscribe to the dogma you mention. I do think productivity arises primarily from entrepeneurship, primarily via small business but sometimes via big business. New private initiatives usually fail, but the ones that are successful more than make up for the failures. New government initiatives tend to live on as the critiera for success are not as objective (they don’t need to make a profit). Therefore a lot more care needs to be taken when starting government initiatives. Thet doesn’t mean there shouldn’t be any, but it does mean that starting an initiative purely in order to “stimulate” is usually a bad idea.

          I think many big businesses receive favourable treatment from government and are able to outlive their usefulness, and for this reason I think big business is often a huge negative for the economy.

          >>>“MMT practitioners believe this is an accounting choice and serves no real function under a FIAT currency while it is obvious that Austerians do not believe this.”
          >>You do yourself a disservice by switching from the term “Austrians” to “Austerians”. It seems like name-calling and does not add to the debate.

          >I agree, It was actually a typo, and not intentional. Sorry if you were offended by it.

          I am not offended, I’m neither of those things in any case.

          >>Yes MMT practitioners do believe this. They do not grasp, or do not want to grasp, that without this “choice” the system would not work, because private asset-holders would be unwilling to lend their resources to the government.
          >Again you are going to have to explain why because I think this is an assumption on your part. Can you provide me with an example of this ?

          Imagine MMT is implemented. The government no longer needs to record deficit spending as debt, and does not need to pay interest. A private lender comes along and is interested in lending $100000 for 10 years, at 1% interest. The government has a choice to borrow the $100000 and pay 1% interest, or just deficit spend and pay no interest. Obviously they will just deficit spend. Even at 0%, why would they borrow from the private lender? And at 0%, why would the private party lend?

          >>MMTers lose sight of the fact that money is an intermediary only. Governments need real productive assets, and most of the assets are in private hands.

          >I am not sure about that either. I think one of the fundamentals of MMT is that money is an intermediary as it has no value to the monopolist issuer outside of its ability to act on the private sector.

          >>There are four basic ways to get their hands on these assets: taxation, borrowing, coercion or trickery. I think most of us would prefer the first two and not the latter two. In my opinion MMT if implemented would fall into the last category

          >I think that makes it clear where you stand on this from a political perspective, however I am not sure that has anything to do with a conversation about economics. The question for me is which approach provides the best economic and social outcomes for a country. I could just as easily call Austrian theories “deficit terrorism” but as you said above this sort of thing adds this nothing to my argument.

          Do you know any other ways for the government to access private assets other than the four I have listed? If the government switches from a system where it borrows from private parties, to a system where it can deficit spend without borrowing, at a time where trillions are still outstanding to the private parties, is that not a form of trickery on those private parties?

          >>I am however very interested in your opinion as you are obviously have studied/thought about these particular points and can articulate your arguments well. So my question to you is can you explain in your own terms what happens to the private sector’s financial position when the government runs a surplus assuming a balance of trade (ie export = imports ) for the period.

          What matters is the wealth of the nation, which is all of the real assets owned by the government and private parties combined. These include: knowledge, educational resources, human resources, infrastructure, farm land, other improved land, intellectual property, corporate systems, goodwill, capital equipment, plant, machinery, inventories, welfare systems, health care facilities and equipment, houses, home contents, a clean environment, etc.

          If these are increasing and improving on a per capita basis we are doing well. If they are decreasing or decaying on a per capita basis then we are not.

          If private credit is growing (and by this I mean the total net credit of all net creditors), and is being put to productive use, this can dramatically improve all of the above. This has nothing to do with whether the government runs a surplus. If the value of all of the above assets grows by $1 trillion, it doesn’t matter if the government has taxed $1 billion more than they needed to.

          Healthy private credit is merely the placement of productive assets into the hands of those best able to make use of them. This overcomes the problem that the people who happen to own assets are often not capable of using them directly and productively, and the people who can do so often cannot afford to purchase them.

          The problems we have now have come about because private credit and public credit have grown unhealthily and have been put to unproductive use. The price of credit has been manipulated lower by monetarists, leading to malinvestment and unsustainable growth. The level of government debt has grown steadily through the symbiosis of Keynesianism and Monetarism.

          • Paul – One question. I don’t claim to have all the answers on this, so am genuinely interested in hearing what you think.

            You are making a big distinction between “financial claims on others” and “financial claims on real assets.” But as I pointed out in my other comment, all the financial claims on real assets should net out to zero when you aggregate the private sector balance.

            This is the case whether you are talking about a share, a corporate bond, or any kind of derivative. It is always an asset on the balance sheet of one private sector agent, and a corresponding liability on another.

            Why do you say that sectoral balances doesn’t hold if you include them? I don’t understand your argument on this point.

          • To Delusional Economics – thank you very much for taking the time to understand my arguments. I have commented on a few blogs but this has been the most accommodating, and you have been a most objective and open-minded correspondent.

            To RA:

            Let’s say that in the private economy someone lends $100,000 each to 10 entrepeneurs. 9 of them crash and burn and waste the money. 1 of them however mines gold worth $2,000,000 (after expenses).

            That entrepeneur has assets worth $2,000,000 and a liability of $100,000. His “business” is worth $1,900,000. This is noone’s liability.

            There has been no government interaction, no government surplus or deficit, so the “Private Sector Balance” has not changed, but the value of the assets in the private economy has gone from $1,000,000 to $2,000,000.

          • Paul — You do make a good point here. That wouldn’t be captured in the private sector balance.

            However, if the entrepreneur incorporated the company and issued equity, those financial claims on the real assets of the company would show up as a liability for the company and a financial asset for the buyer of the shares. (I think. I am still trying to figure all this out).

            If the entrepreneur sold the gold to somebody else for cash, it would also show up in the flow of funds. [Correction – actually only if they sold it to a company or the gov in this case]

          • If the entrepeneur incorporated the business, the balance sheet of the resultant company would be:

            Assets:
            Gold: $2,000,000

            Liabilities:
            Loan: $100,000

            Equity:
            $1,900,000

            Equity is not classed as a liability. The act of incorporating does not affect the “Private Sector Balance”.

            The balance sheet of the individual entrepeneur would be:

            Assets:
            Equity in company: $1,900,000

            Liabilities: $0

            Net Worth:
            $1,900,000

            If the company then listed publicly, the company’s balance sheet would not change. Subscribers might well pay above the book value (equity) of the company, because they believe the company has the potential to make a lot more profit. However if we take the simplified case where a single shareholder purchases all the shares, and pays book value, and takes out a loan to do so:

            The balance sheet of the individual entrepeneur would be:

            Assets:
            Bank Deposit: $1,900,000

            Liabilities: $0

            Net Worth:
            $1,900,000

            The balance sheet of the shareholder would be:

            Assets:
            Shares: $2,000,000

            Liabilities:
            Bank loan to buy shares: $2,000,000

            Net worth: $0

            To round this off, the balance sheet of the bank would be:

            Assets:
            Loan to shareholder: $2,000,000

            Liabilities:
            Entrepeneur deposit: $2,000,000

            Equity:
            $0

            Again, no change to the “Private Sector Balance”.

            As you suggest, the sectoral balances are only affected if the gold is sold to the government or to a foreign entity.

          • Correction:

            The balance sheet of the shareholder would be:

            Assets:
            Shares: $1,900,000

            Liabilities:
            Bank loan to buy shares: $1,900,000

            Net worth: $0

            To round this off, the balance sheet of the bank would be:

            Assets:
            Loan to shareholder: $1,900,000

            Liabilities:
            Entrepeneur deposit: $1,900,000

            Equity:
            $0

          • Paul – The numbers look good to me. One thing though.

            Although shares are not strictly a liability, under the flow of funds that the sectoral balances are derived from, they are treated as a financial claim issued by the corporate sector and a financial asset held by the individual that owns them. Of course this nets out to zero for the total private sector balance, but it shows up when you disaggregate the household and business sectors, as I did in this post.

            You claimed before that sectoral balances doesn’t hold if financial claims on real assets (such as shares) are included.

            Do you now concede that this is not correct? You haven’t answered this question.

          • What I claimed was “Usually loans to create assets are not counted as “negative savings”, but they are counted in the way you are using “de-save” here. If you don’t count them then the sectoral balances equation does not apply.”

            By the sectoral balances equation I meant “Private Sector Balance + Government Sector Balance – Current Account Balance = 0”.

            My original objection (at the top of this comment thread) was to your statement:

            “Private Sector Balance + Government Sector Balance – Current Account Balance = 0

            As you may recall, this suggests that if the private sector desires to spend less than its income in aggregate, and the country is running a trade deficit, a government deficit is inevitable.As you may recall, this suggests that if the private sector desires to spend less than its income in aggregate, and the country is running a trade deficit, a government deficit is inevitable.”

    • I agree that Sectoral balances is basic double entry accounting. And I agree that it’s very simple.

      That doesn’t really bolster your argument.

      You need to explain to your readers how “an increase in the net sum of all private financial claims on others” equates to “an indication that the private sector desires to spend more than its income in aggregate”.

      • I had that the wrong way around, as another reader pointed out. Have fixed. The private sector currently desires to net save. ie it is spending less than its income. Which means there is a net flow of financial assets to the private sector. This is exactly what you would expect after a big recession. Do you not agree that households are likely to keep spending less than their incomes?

        In any case, there is nothing special about sectoral balances. You don’t have to agree with MMT do use the sectoral balance approach. Ed Harrison, for example, who leans towards the Austrian school and writes at Credit Writedowns and Naked Capitalism, regularly uses sectoral balances in his analysis. Goldman Sachs does too, as do many others who are not MMTers.

        The more interesting questions arise from where the sectoral balances analysis leads you. Do you agree with Godley’s analysis that the US needs to grow exports much faster than imports for a sustained period? Or that business investment needs to rise? These are more interesting questions to discuss.

        • Yes it was the wrong way around before, I didn’t pick that up as I knew what you meant. That is not the point I am making.

          “The private sector currently desires to net save. ie it is spending less than its income. Which means there is a net flow of financial assets to the private sector.”

          The terms are not clearly defined so it is not possible to determine the truth or otherwise of the statement.

          What does “private sector desires to net save” mean? The private sector is composed of millions of individuals. If 90% of the citizens desire to net save, and 10% want to take out huge loans, then that does not necessarily lead to an increase in private financial claims. It could be an increase, a decrease, or it could stay the same.

          What definition of “save” are you using? Usually it means “unspent income” meaning “income not spent on consumable goods”. A loan taken out to purchase an asset such as real estate does not usually count as negative saving. However in your definition it does.

          What does “financial assets” mean? As you are not using it in its normal sense, you need to always make sure your reader knows what you are referring to, or else use a different term, such as “financial claims”.

          “In any case, there is nothing special about sectoral balances. You don’t have to agree with MMT do use the sectoral balance approach. Ed Harrison, for example, who leans towards the Austrian school and writes at Credit Writedowns and Naked Capitalism, regularly uses sectoral balances in his analysis. Goldman Sachs does too, as do many others who are not MMTers.”

          I agree there is nothing special about it. My comments are designed to refute the inappropriate use of sectoral balances for policy prescriptions due to inconsistent use of terminology. I also agree that you don’t need to agree with MMT to use it. However I think you do need to agree with the sectoral balance approach in order to agree with MMT. It doesn’t matter what Ed Harrison does, or Goldman Sachs, I am pointing out errors in thinking, many of which are due to inconsistent use of terminology.

          “The more interesting questions arise from where the sectoral balances analysis leads you. Do you agree with Godley’s analysis that the US needs to grow exports much faster than imports for a sustained period? Or that business investment needs to rise? These are more interesting questions to discuss.”

          I agree that the US needs to grow exports faster than imports for a sustained period. I think sectoral balances provides a false picture of the reasons for the current imbalance, and does not provide the solutions.

          I agree that business investment needs to rise. Again, sectoral balances has in my opinion nothing to say about the reason for low business investment, and has no answers to this problem.

          How can an approach that does not treat the creation of new physical capital goods as “saving”, and does not count improvements to, and growth of, a business as “saving” have anything helpful to say about business investment?

          • I feel like we are going in circles here.

            Lets say the household sector is running a net financial surplus. If you are spending less than your income then this “savings” could go in the bank as a deposit (a financial asset) or you could buy shares (financial claims on real assets) or a bond (again, a financial claim).

            Alternatively, you could pay down debt, which would be a decrease in your financial liabilities. The result of all this would be an increase in your net financial wealth. Once again, this is just basic accounting.

            Your point about the 90% vs 10% is irrelevant, since it concerns the distribution of claims WITHIN the sector. The sectoral balance is an aggregate of all the millions of people you mentioned. Just because the sector is spending less than its income in aggregate doesn’t mean that some individuals can’t be doing the opposite.

            More later…

          • “How can an approach that does not treat the creation of new physical capital goods as “saving”, and does not count improvements to, and growth of, a business as “saving” have anything helpful to say about business investment?”

            Improvements to a business (ie spending on new capital equipment) are counted as investment, not savings.

            As for growth in a business, my understanding is that it is included in the sectoral balances approach. The net financial balance of the business sector over a period can also be thought of as the change in business financial assets minus business financial liabilities. (liabilities includes both debt and equity).

            And if you play around with the accounting identities, this in turn is equal to -(change in business nonfinancial (real) assets).

            I think part of your argument is that what is really important is that we grow the business sector’s real assets over time? As businesses grow and accumulate real assets like capital equipment, etc, you would generally expect their financial liabilities (debt and equity) to grow in line with this, which is a healthy thing.

            Anyway, back to the private sector balance being positive, which you say is meaningless in itself. You are right in the sense that a rise in the private sector surplus could have different causes. It could come from a rise in net household income, which would be good, or it could come from a fall in the value of business real assets, which would be bad, for example.

          • By “financial claims” I mean “financial claims on others” – i.e. credit/debt. I will use “financial claims on others” to distinguish from “financial claims on real assets”.

            If you include “financial claims on real assets” such as shares, as part of the “Private Sector Balance” then the sectoral balance equation does not hold. The “Private Sector Balance” is the net sum of all financial claims on others, and soes not include shares and other real assets.

            In a previous comment thread (http://macrobusiness.com.au/2011/03/should-the-us-balance-its-budget/#comment-14251) you stated that shares were not part of your definition of savings. In this thread you include shares in your definition. You either need to use consistent definitions (and explain them up front), or use finer-grained terms.

            Here is your comment from the previous thread:

            “It doesn’t make sense to count share holdings either”

          • “As for growth in a business, my understanding is that it is included in the sectoral balances approach”

            It is not. The “Private Sector Balance” in the sectoral balances approach is the net sum of all private financial claims on others. It does not take account of the value of any new or improved productive capital goods, new inventions, business improvements, etc.

          • Paul – All I was saying is that if you spend less than your income, there are several things you could do with these “savings” but they would all impact your net financial assets position the same way.

            Shares are financial claims on real assets. If you buy a share (or a corporate bond), that is an asset on your balance sheet, and there is a corresponding liability recorded on the balance sheet of the company that issued it. Within the private sector balance, this just nets out to zero. That’s all. It doesn’t change my analysis one bit.

            In any case it doesn’t matter if you disagree with the sectoral balances approach; the point of the post was to stimulate some debate about where the US economy is headed. If you have any thoughts on that, we could have a more productive discussion.

          • Could you please answer regarding the inconsistency in your use of the term “savings” pointed out at my comment of 9:34?

            Also important: if shares in a company go up in value, this is *not* reflected in the liabilities on the company’s balance sheet. 1. A company’s book value is not the same as their market capitalization. 2. Book value (aka equity or capital) is not a liability, it is merely the excess of assets over liabilities.

            There’s not much point debating where an economy is headed if we all use the same terms to refer to different things. We won’t achieve anything other than confusion.

          • See my other comment regarding shares, corporate bonds, etc. My thinking has evolved a bit on this. I now think they are properly accounted for in the sectoral balances. I do agree with you though that changes in the value of these shares, new inventions, and so on are not reflected. Just as they are not reflected in GDP. There are limitations to any analysis.

            To be honest though, I still don’t understand why you feel the need to accuse me of espousing “pseudo science”.

            So let’s go back to basics. I deliberately disaggregated the private sector balance into households and businesses to avoid confusion.

            Do you agree that the household sector is currently spending less than its income and running a large financial surplus (as defined by the Fed) and that this is a necessary process as we recover from the massive credit binge that led to the GFC? Yes or no.

            And then, do you or do you not agree that if the household sector runs a surplus, the other sectors of the economy must collectively run a deficit?

            As DE said, you have obviously thought a lot about these issues. I am not an expert on any of this stuff and always open to the possibility that there is a better way of thinking about things. At this point though, you have not convinced me that the sectoral balances approach is fatally flawed.

          • The pseudo-science doing the rounds is the statement “you need a government deficit to have a private sector surplus”, and the attempts to use this to justify running deficits. This is untrue by any normal definition of “private sector surplus”, and because of this, the statement is not suited as a basis for policy.

            I haven’t commented on the disaggregation into households and businesses up until now.

            “if the household sector runs a surplus, the other sectors of the economy must collectively run a deficit”

            Again, this is true if you define “surplus” as an increase in the net total of “financial claims on others” held by the entities in each of those sectors.

            It is not strictly true if “surplus” is defined as “an increase in the value of real assets” held by entities in those sectors. However, it may be closer to the truth due to the nature of the entities in those sectors.

            It would be great if you could make it clear to your readers exactly what you mean by a “surplus” in the above context, and consider using a finer-grained term to avoid confusion.

            I think one thing we may agree on is that debtors are too far into debt, and creditors are too far into credit. I don’t think we agree on the cause however. I think splitting things out into sectors can help understand what is going on, but only if the terms are totally clear.

          • I’m glad we are coming a bit closer to an understanding.

            I agree with you about too much debt. As for the policy prescription that we need government deficits, I did make the point in my post that the preferable solution is to grow exports faster than imports. And to encourage business investment, which would tend to lower the private sector surplus. (so yes, a rising private sector surplus on its own isn’t necessarily a good thing. we need to dig into the numbers to see what is really happening)

            Again, I think aggregating the household and business sectors (as I did in a couple of earlier posts) only leads to confusion here.

            I am working on a post where I will explain how all the terms are defined by the Federal Reserve, which is where the data for the sectoral balances comes from. Their definition of “savings”, etc, is not how the terms are commonly used, which I think is one of your issues.

            Agreed on that. We need to be more clear.

        • I agree with Paul. I believe we need a glossary of terms. There is absolutely no point having a semantic and/or definitional argument around this, we will simply go around in circles.

          I think it is best for us to provide a definition of each of the terms and an example of what we mean.

          For example what is a “financial claim on others” as compared to a “financial claim on a real asset”.

          For instance Paul said “By “financial claims” I mean “financial claims on others” – i.e. credit/debt. I will use “financial claims on others” to distinguish from “financial claims on real assets”.”

          The problem with that definition is that much of credit is backed up by a claim on a real asset . Housing loans for instant. So is that a financial claim on an other or a real asset ?

          • I agree on a glossary of terms. I myself get caught out when talking about inflation (real/nominal/artificial(i.e CPI measured).

            Perhaps a new page for the site linked to the menu bar?

            It would help a lot of new readers, and those who may be biased towards different ideologies but mix here with others (e.g Austrian, MMT, Post-Keynesian, etc…except you neo-classicals…. of course. Go back to The Age or The Oz) 😀

          • I agree on the glossary. In any case, Paul has raised some important issues that I think merit a proper response. So I am going to do a follow up post that explores some issues such as exactly what goes into the sectoral balances and how savings, etc, should be defined.

            Hopefully that will help clarify a few of the issues we have been discussing here.

  4. Given the Presidential elections are due in 2012, the Republicans will do every thing they can to keep the economy in the toilet and blame Obama for it.
    .
    So I expect to see some road blocks thrown at Ben to prevent more QE.

  5. Wasted Opportunities

    From a layman’s perspective, it seems that “the day of reckoning” from 2008 never really arrived. Has anyone really worn the losses as yet from debt write-offs and deleveraging? Or is the can just being kicked by negative real interest rates and QE?

    I am trying to get my head around the modern monetary theory principles mentioned on this blog, and I can see why hard-line austerity is not the best road to short-term recovery, particularly for a sovereign nation with the ability to issue its own currency.

    But it seems like in the long term developed financial economies rely on exponentially increasing credit growth to sustain “normal” GDP growth. Does this mean that ZIRP and QE in perpetuity are the natural end-game for advanced economies? And if so, doesn’t common sense say there will be a tipping point (such as inversion of the population pyramid, increasing energy costs or black swan events like massive natural disasters/nuclear plant meltdown) that could cause things to crumble, with a massive reduction in living standards?

    If I am missing the point entirely here, please be gentle.

    I think as you and the Prince identify, some more active direction from government in terms of taxation/subsidy signals to redirect investment to more productive endeavours than asset price inflation seems a reasonable course. If so, why whenever such things are suggested is there always a sentiment that “it’s never likely to happen.” Are we really all so short-sighted? Unfortunately it seems that way.

    • You’re not missing the point at all.

      One of the reasons that I go on about unemployment so much is that I think the lack of a proper social safety net in the US pushes too much of the burden for creating jobs onto the Fed.

      Their response to this has been to inflate asset bubble after asset bubble. That is essentially the strategy behind QE, although the Fed would never put it that way. Pump up equity prices, and hopefully households will feel good and start spending again.

      But households need to deleverage. Exponentially increasing credit growth is not sustainable. Which is why the only sustainable way forward seems to be somehow getting exports to grow faster, and, as you say, policies to redirect investment to more productive activities.

      And yes, we really are very short sighted!

  6. In rearrange this equation:

    “Household Sector Balance + Business Sector Balance + Government Sector Balance – Current Account Balance = 0”

    into this equation:

    “Household Sector Balance = Current Account Balance + Business Sector Balance + Government Sector Balance”

    some signs have been altered.

  7. Debt Saturation

    If you do the maths on US debt, falling tax revenues, sustained unemployment and continuing house price falls then the figures just wont add up for the US of A. There is nothing I can see into the future that will help their economy one bit (unless we start World War 3 somehow). There is no new “bubble” to start in something unless someone comes along with a new revolutionary invention in nano tech or bio tech (unlikely).

    They could inflate their way out but that will destroy almost everyone’s wealth.

    Hyperinflation anyone?

    • “They could inflate their way out but that will destroy almost everyone’s wealth.”

      Inflation only destroys financial assets (like currency denominated deposits) and debt. Real tangible assets (like houses) tend to retain their utility value.

      • Agreed, but people’s wage increases will not (and generally don’t) keep up with inflation in these sorts of situations, IMHO.

        Hence, on this sort of basis, the “wealth destruction” angle of the poster Debt Saturation is, IMHO, quite valid.

      • Houses are only as valuable as people are willing to pay for them.

        Ask the folk of Dublin District 4 with an “asset” valued at 950k now willing to accept 400k.

  8. Should the sentence below your first equation read in part ‘….if the private sector desires to spend less than its income…..’?

  9. The big issue with accounting these days is that a price is put on items even when they are NOT sold. From that price money is borrowed against it.What really determines market value is what an item is bought/sold for , not what it MIGHT be bought/sold for.