RebelCapitalist: Financial Information for the Rest of Us

It’s All About the Sectors

May 28, 2010 | By: Mr_Blue | Tags: economy, budget deficit, deficit, obama

This is a follow-up to “Deficit Hysteria: Oligarchy Gone Wild”. At the end of that story was this equation: Private Savings or Net Saving = Government Deficit + Current Account Balance. Understanding this equation will go a long to understanding why deficits are NOT necessarily a bad thing.

Deficit tidbits:

1) Deficits have been the norm through out history. Balanced budgets or surpluses have been brief periods in time;

2) Every attempt to balance budget or budget surplus has been followed by a recession or depression;

3) Deficits are cyclical - meaning that when the economy is strong deficit goes down but when the economy is weak deficit goes up Why? Because when economy is weak there is a double whammy: tax revenue is down and automatic stabilizers kick in such as unemployment compensation.

4) Government spending is not the only thing that determines deficit/surplus - tax revenue is part of the equation too.

The issue is not the size of the deficit but who is benefiting from the deficit? Over the past 8 years, Top 5% income earners and corporations via privatization of war and other government services and yes, Wall Street bailout have benefited from deficit. Obviously, this must change.

Back to the equation. It’s actually an accounting identity of our national economy. This isn’t a theory. This is the accounting of what happens in the economy (:

Private Savings or Net Savings = Government Deficit + Current Account Balance

Private Savings/Net Savings - this is the financial wealth of households and businesses. If Private Savings/Net Savings is negative then that means private sector is borrowing/increasing debt.

Government Deficit - this the difference between government spending and tax revenue (state and local governments are included in this).

Current Account Balance - the flow of goods, services, income and transfer payments into and out of the US.

Again, this is not a theory. As Professor Scott Fullwiler says:

Disagree with this akin to believing the world is flat.

The important thing to understand about our economy: 1) there are a fixed number of sectors - mainly private sector (households and businesses), government sector and export-import sector and 2) financial flows in our economy are closed meaning that if one sector is running a deficit some other sector must be running a surplus. There is no way to avoid this.

Source: Sector Financial Balance Model of Aggregate Demand, Prof. Scott Fullwiler

Professor Fullwiler also compiled this graph that illustrates the above accounting identity:

Incredible how private savings and government deficit move together. Look at 1997 to 2001 that was when Clinton balanced the budget and we had a budget surplus. Notice the result: private sector was not saving - we were going into debt!

All this means that deficit hawks are completely wrong. According to history, any attempt to balance the budget and push for a government surplus will result in a recession and more debt in private sector. Also, push to balance the budget now while we are struggling to recovery will definitely throw us back into a recession or possibly worse. Remember the issue is not the size of the deficit but who is benefiting from the deficit.

Good luck.