The Nation's Balance Sheet and Crowding Out

By: Michael Ashton | Tue, Dec 4, 2012
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Recently, I pointed out (in "Kissing Assets Goodbye" from November 1st) that disasters lower a country's net worth. Therefore, even though they will tend to increase flows-based measures of economic activity, such as today's New York ISM where the "6-month outlook" subindex jumped from 57.7 to 75.3, it's not good news. I lamented that, although the numbers are not wrong per se, they are misleading. And they are misleading because there is no economic "asset" and "liability" account for the nation.

I recently saw a paper which attempts to create just such a "balance sheet" for the nation, albeit with a very long lag. It is a project to define "the integrated macroeconomic accounts" of the United States, and it is jointly produced by the Bureau of Economic Analysis and the Fed. You can find a discussion of the effort here, and if you search on "disaster losses" you can find evidence on household, government, and business balance sheets of the impact of Hurricane Ivan in 2004 (about $28bln) and Hurricanes Katrina and Rita in 2005 (about $110bln).

Read through the paper and you can see this is an ongoing project with many current shortcomings, but it's progress. However, it's doubtful it will ever be used by economists in anything approximating real time, which means my objection - that economists ignore the fact that a disaster is a net negative even though it is positive in an activity sense - stands. Still, with as much as I bash economists, it's only fair that sometimes I point out when they're trying to do things the right way.

Now, one interesting part of the paper is on page 6, where the economists detail the sources of net lending and borrowing in the capital and financial accounts, broken down by sector. For those who think that deficits don't matter, this is something to chew on. According to the table, in 2007 we were all borrowing: households, businesses, state and local governments, and the federal government. This was financed by our overseas trading partners. Everything changed in 2008, when the government borrowing "crowded out" private borrowing. The table below is a summary of two columns from the paper, and compares net lending or borrowing by sector for 2007 and 2011.

(billions) 2007 2011
Households & nonprofits -126 476
Nonfinancial noncorporate businesses -74 -6
Nonfinancial corporate businesses -94 422
Financial business -3 125
Federal government -315 -1357
State & local governments -93 -113
Rest of the world provides the difference 716 484
- indicates net borrowing
+ indicates net lending

The last number in the column is essentially the number needed to make the column sum to zero (although not exactly, due to statistical discrepancies...that is, it isn't a "plug" number but rather is measured directly), and it clearly is bounded at some level. The rest of the world will not lend us, especially in the current economy, a bazillion dollars. And when so many other countries are running large deficits, there is great competition for those dollars. So the "rest of the world" line cannot simply rise to any level in order to balance out the column. (When our economy was less open, this line was far less flexible even than it is today).

Consequently, when the "Federal government" deficit rises by a trillion dollars, it essentially forces (in a mathematical and accounting sense that the books must balance) the other sectors to become lenders. Or, put another way, if no one buys the bonds then the federal government can't run that deficit; ergo, the existence of the deficit implies that other sectors have lent.

A more-generous interpretation would be that the other sectors became savers due to the crisis and so, in order to maintain economic growth, the Federal government was forced to borrow. Aside from being a false choice (the government could have chosen to let the economy solve its own problems), that interpretation is less plausible now that we are four years out from the crisis and the deficits still persist.

There are other ways to illustrate this same proposition, such as through the numbers the Fed produces in the Z.1 report, which show that Treasury debt has gone from being 25% of total domestic non-financial sector debt to 40%, in only four years (see chart below, source Federal Reserve Z.1 report).

Government Debt as Percent of Total Domestic NonFinacial Sector Debt

However, this doesn't illustrate the "crowding out" causality as well as the table above does. The following chart (Source: Fed Z.1 report) shows it better, but it still begs the question a bit because it shows levels and not flows. For my money, I like that table.

Total Debt as Percent of GDP

All in all, the paper is worth reading - it's only 17 pages, and lots of great charts and numbers to go with that.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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Source: The Contrarian Take