The Treasury has just released the budget numbers for last month, and so I thought it an opportune time to update the sectoral fiscal flow information and assess its impact on investment markets going forward.
An assessment of the national accounts was used to assess the macro-fiscal flows.
One can summarize the national accounts in the following formula:
GDP = Private Sector Spending [P] + Government Sector Spending [G] + External Sector Spending [X]
These are accounting entities and are true by definition.
See the methodology section below for more detail on this formula.
The private sector is where the stock market is, and we as investors want the stock market to go up. The stock market can only go up if the flows into it are positive. The private sector derives income from three sources:
Credit creation from banks: Banks lend more than is repaid in loans. Credit money, also known as inside money. [P]
Externally from overseas commerce: Exports bring in more than imports cost. Combination of credit money and state money from overseas. [X]
Government spending: More is spent than taxed. State money or high powered money or outside money, it has many names. [G]
In an ideal scenario, the private sector would receive large, and growing income flows from all three sources, and at the very least, the overall impact should be a positive flow even if one or two of the three flows are negative.
The stock market in the private sector, as well as all other private financial assets, should rise if the overall income flow into the private sector is positive. Certainly, the stock market would be unlikely to rise if the income flows were negative.
We will look at each inflow in turn and start with the private sector, all the while updating our forecast result based on the latest data.
2017 was a weak result with just $23B of new loans created, and this contributed 0.1% of GDP. China for instance created over $US1.8T of new credit money in 2017.
The flow of new loans adds to the stock of private debt in the private sector. The chart below shows how this stock of private debt is developing.
The stock of private debt is 150% of GDP, down from 170% of GDP in the GFC peak.
Professor Keen's research shows that economies tend not to become more indebted once reaching 150% of GDP or more.
For the U.S., one can model the impact of this private debt on the economy over a range of interest rate levels, and this is shown in the table below.
(Source: Author calculation based on Trading Economics dot com GDP data and Prof. Steve Keen private debt data)
One can see at present that over about 4.5% of GDP/aggregate demand goes to private commercial banks as debt service cost and not on real goods and services in the real economy. This estimate is based on the assumption that the loan book averages a return of 3%. Four to five percent is nearer the truth when one adds in business loans and auto loans that tend to be at a higher rate. Not to mention credit cards at over 10% or more and exploding rates when one misses a payment.
The stock of private debt represents the private sector deficit to the government and external sectors.
The external sector is trade and commerce with other countries and shown in the current account. The current account is exports less imports, and it also includes capital flows in and out of the country from financial transactions and investments. A positive overall result is best and adds money to the money supply. A negative flow drains it out overseas and is deflationary.
The chart below shows the current account balance. The chart shows the current account for 2016 is a leakage from the economy of -2.6% of GDP each year.
For 2017, shown in the chart below, the leakage is about -$450B or -2.42% of GDP. This assumes the last quarter is an average of the preceding three and will be updated in a further article when the final figure is known.
The government budget is shown in the chart below:
The contribution to the private sector by the government sector in 2017 is about $666B or 3.5% of GDP. This is very positive for the private sector and explains the recent expansion in financial markets.
What the above figure does not include is the interest income to the private sector from Treasury deposits.
An estimate of how much income can be produced from the existing stock of treasuries is shown below.
Each rate rise of 0.25% adds $51B in state money income to the economy. The Fed plans to reduce its $4T+ balance sheet of long-dated bonds, to unwind QE. Banks are one of the main recipients of such securities, it was where they came from in the first place during the GFC. If this $4T were returned to the banking sector the income stream from the bonds would also add to banking income streams. Three percent of $4T is $120B per year of additional income as an estimate of how much this could be. That is 0.64% of GDP.
The prevailing neoliberal model leaves credit creation and allocation to the private banking sector on the assumption that the free market does this most efficiently. Government is encouraged to be small and not interfere with the operation of the free market. If the government had not been there in 2017, the flow rate would have been a recessionary -2.32% of GDP.
The sector flows at present and for some key historical points of reference are shown in the table below:
Private Sector Credit Creation
2009 post GFC Trough
2007 pre GFC Peak
1943 War economy
2000 pre-Dot Com Boom peak
2001 Dot Com Bust, peak flows
(Source: Trading Economics, FRED and Author calculations based on same)
*estimate to be updated when the final end of year numbers are known.
# Forecast based on existing flow rates
By comparison, China has fiscal flows of over 20% and is representative of a war economy setting but used for civic purposes such as infrastructure, education, and healthcare.
The estimate for 2018 assumes private credit creation remains the same, the current account worsens a little and government spending increases in line with recent announcements and plans.
Macro-fiscal flows are increasing in America, and this allows financial assets in the private sector such as stock, bonds and real estate to increase in value.
The flows are not very strong at 2%, however, are not at recessionary levels and also no recession has occurred while flows have accelerated.
An investor wanting to take advantage of advancing fiscal flows in America can do so with a broadly diversified exposure via the following ETFs:
Guggenheim S&P 500 Equal Weight ETF (RSP)
iShares Global 100 ETF (IOO) tracks the S&P Global 100
iShares Core S&P 500 ETF (IVV) tracks the S&P 500
SPDR S&P 500 Trust ETF (SPY) tracks the S&P 500
Vanguard S&P 500 ETF (VOO)
iShares Russell 2000 ETF (IWM) tracks the Russell 2000
iShares S&P 100 ETF (OEF) tracks the S&P 100
Guggenheim S&P 500 Pure Growth ETF (RPG)
Guggenheim S&P 500 Pure Value ETF (RPV)
SPDR Dividend ETF (SDY)
Disclosure: I am/we are long UDOW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.