The US budget deficit widened to USD 147.0 billion in May 2018 from USD 88.0 billion in the same month of the previous year and compared to market expectations of USD 144 billion.
Why Is This Good News?
To understand this better, one has to look at the balance of sectoral flows within the US economy using stock-flow consistent sectoral flow analysis.
The good news is that dollars are being added to the economy by the Federal Government. When dollars are added to the economy, it increases the net money supply and allows the economy to grow.
Professor Wynne Godley first apprehended the strategic importance of the accounting identity, which says that measured at current prices, the government's budget balance, less the current account balance, is equal, by definition, to the private sector balance.
GDP = Federal Spending [G]+ Non-Federal spending [P] + Net Exports [X].
As a percentage of GDP, all three sectors sum to zero and balance each other out.
A table of the sectoral balance flows is presented below:
(Source: FRED plus author calculations)
*Estimate to be updated when the end of year numbers are known.
#Forecast based on existing flow rates and plans.
The chart below shows the newly released data.
The chart below shows credit creation over the same period.
The chart below shows the current account over a similar period.
The chart below shows the stock market over the same period.
The four charts above have roughly the same timeline, apart from the current account which is reported and shown quarterly. One can see that the stock market responds to the flows between sectors.
1. Steady growth through June, July and August.
2. A dip into September as a small Federal Government surplus was drained out of the private sector.
3. Growth resumed into the balance of the year with steady Government spending. The current account deficit for the last quarter of 2017 was low, thus keeping about $100B in the domestic economy and helping explain the rise into through December 2017 and into January 2018.
4. The impact of the surplus budget drain in January 2018 was felt in February when the stock market retraced 10%. Adding to this drain was a large current account deficit for the same quarter.
5. Federal Government spending resumed at a healthy $200B per month in February and March 2018 and helped the stock market almost make a "V" shaped recovery.
6. A huge $200B surplus budget in April 2018 put an end to the "V" shaped recovery. Private credit creation jumped in April 2018 and could well have been because people were going into debt to pay their tax bill.
7. One can now expect Federal Government expenditures to follow the pattern for preceding years and be a steady net add into June, July, and August of 2018. This will see markets generally rise.
8. The overall macro picture is supported by a steady growth in private credit creation. Credit growth is weak at the moment and for now, plays a minor but positive role.
9. The positive flows from Federal Government spending and private credit creation offset the negative outflow from the current account. President Trump's efforts on international trade may lead to lower tariffs overall and could improve the current account picture. The current account drains, on average, $37B per month from the private domestic sector.
Impact on Fiscal Flows
Federal Government net budget expenditures for May 2018 show that $147B was added to the economy. To fully expend the $804B congressionally approved Federal budget, the government must on average spend $67B per month to get there.
The gap for the fiscal year, which began last October, was USD 532 billion, compared to a deficit of USD 433 billion in the same period of the previous fiscal year. To reach a year-end total of $804B through to September 2018, the end of the fiscal year, the Federal Government must spend an additional $272B. This is an average of a further $68B per month.
These positive fiscal flows entering the private sector will tend to push asset market upwards.
This month, the balance of account looks like this for the private sector balance:
[P] = [G]+[X] is an accounting statement of fact.
Inserting the numbers
[P] = [$147B]+[-$37B*]
*Estimate: The current account deficit is -$450B per year or around -$37B per month.
[P] = $110B net add.
To this number one can add the impact of credit growth to work out the net increase in the money supply.
The credit growth is shown in the chart above at the start of the article.
This year credit growth has added $36B to the private sector and is stronger this year than last. On average, credit growth is adding $9B per month to the money supply in 2018. This would total $108B for the year and add 0.58% to GDP if it can be sustained. 2017 was a meager $23B. 2018 is looking much stronger.
When one adds this to the Federal Government contribution, one can see that the money supply is growing monthly as per the table below
|Year||Government [G]||Credit Growth [C]||Total|
|2018||$68B per month||$9B per month||$77B per Month|
The chart below shows that the net money supply is growing. M3 for the USA.
This is good short-term news for investors as it means that assets in the private sector such as stocks, bonds, and real estate can expand in value to fill this fiscal space.
The stock market, and other asset markets in the USA, can be expected to rise into the end of the year.
Longer Term Picture
The longer-term picture does not look so rosy and is discussed in detail in this article.
In a nutshell, there are automatic income tax expirations coming up that will see the Federal Government drain around $123B per year out of the economy. The CBO has graphed the impact of this change in fiscal flows in the following chart.
GDP is forecast to drop from 3.5% to 1.5% over three years. A 2% drop in GDP is $371B or a drain of $123.6B per year in additional taxation.
This will cause a slowdown and most probably a recession, certainly a stock market retrace.
The good news is that overall the Federal budget deficit for 2019 is estimated to be $981B, thus adding even more money to the economy than in 2018. There could be some difficult months during the time of the tax exemption expirations where the private sector will experience income shocks similar to an April tax drain at times of the year when it normally does not. At this time, stock market volatility can be expected.
When one adds rising oil prices and Fed rate increases, the outlook is murky.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.