The US budget deficit widened sharply to USD 77.0 billion in July 2018 from USD 42.9 billion in the same month of the previous year, slightly below market expectations of USD 77.8 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 comprehended the strategic importance of the accounting identity, which says that measured at current prices, the government's budget balance, less the current account balance, by definition is equal 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 above figures since 1960 and forecasted into the near future.
(Source: Professor William Mitchell)
The chart shows that the private sector balance is barely positive and not likely to improve.
The chart below shows the newly released data.
The chart below shows credit creation over the same period.
This is a big upside surprise. A large increase in private credit growth in July 2018 that added $44B to the money supply in just one month. The total now for 2018 is $83B. With just under half the year still to go, it is very possible that we will beat my estimate of $100B of credit creation for 2018 and that the estimate for 2018 might have to be revised upwards.
The chart below shows the current account over a similar period.
The chart below shows the stock market over the same period.
Comparing the charts above, one can see the impact on the stock market:
- 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, and that got larger in the following quarter as well.
- Federal government spending resumed at a healthy $200 billion per month in February and March 2018 and helped the stock market almost make a "V"-shaped recovery.
- A huge $200 billion 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 some people were going into debt to pay their tax bill.
- As expected, the Federal government spending pattern follows the pattern for preceding years and is a steady net add into June, July, and August 2018. This will see the markets generally rise. The result for July has confirmed this outlook.
- The stock market has almost recovered to all-time new highs after the plunge in February 2018.
The overall macro picture is supported by a steady growth in private credit creation. Credit growth is now much stronger and has surprised to the upside despite the hindrance of Fed rate rises. It could be that borrowers are front-running further rate rises.
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, $37 billion per month from the private domestic sector.
Impact on Fiscal Flows
Federal government net budget expenditures for July 2018 show that $77 billion was added to the economy. To fully expend the $804 billion congressionally approved Federal budget, the government must on average spend $67 billion per month to get there.
Accounting for calendar adjustments, the 2017 fiscal year deficit was USD 644 billion compared with USD 546 billion the prior year. To reach a year-end total of $804 billion through to September 2018, the end of the fiscal year, the Federal government must spend an additional $160 billion. This is an average of a further $80 billion per month. These positive fiscal flows entering the private sector will tend to push the asset markets 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] = [$77 billion]+[-$41 billion*]
*Estimate: The current account deficit is -$124 billion for the last quarter, and this works out to -$41 billion per month.
[P] = $36 billion 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 $83 billion to the private sector and is stronger in the current year than last. On average, credit growth is adding $11.8 billion per month to the money supply in 2018. This would total $142 billion for the year and add 0.73% to GDP if it can be sustained. 2017 saw a meager $23 billion. 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||$67 billion per month||$11.8 billion per month||$78.8 billion per month|
The chart below (M3 for the USA) shows that the net money supply is growing.
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.
The private sector balance in the US is positive, and credit creation adds further to aggregate demand. One could be quite sanguine about the direction of asset markets. There is one caveat, though. There is an unfortunate global trend developing, as illustrated in the chart below from Mr. Robert P. Balan and this recent article.
The simple takeaway is that when the monetary base of the big global central banks falls, so do asset markets. While the domestic front looks relatively good, though tax exemptions are expiring at the end of 2018 and a big drop in Federal discretionary expenditures is coming up, the global outlook is bleak.
The black dotted line on the chart above is falling in line with central bank balances as assets are sold, and liquidity absorbed. Asset markets tend to follow this trend with a three to six-month lag.
We are coming up to the end of the Fed government budget period, and already the first salvos of threats have been fired off about a government shutdown if specific budget proposals and not included in the next budget. One could expect a government shutdown to happen as the brinkmanship in Washington goes down to the wire.
The real fiscal impact of a government shutdown is a reduction in spending in the months of the shutdown. In our formula above this is the [G] in the calculation of GDP. The formula shows that a reduction in government spending results in a decrease in GDP and thus Gross Domestic Income [GDI]. As one must equal the other, as a matter of accounting, one can expect assets markets to fall during such an event. This is a buying opportunity as expenditures will be resumed and often there is a "catchup" spending boost once the drama is over.
The government shutdown is based on a myth that the government is broke and must tax and borrow to sustain itself and is covered in the following the article.
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.