The purpose of this article is to assess the macro fiscal flows for April 2019 and determine what effect these flows will have on the stock market and the economy.
Macro fiscal flows impact investment markets with a lagged effect of typically one month. A flush of funds now from government spending or credit creation by banks will lead to a boost in investment markets one month later.
To understand the fiscal flows, one has to look at the balance of sectoral flows within the US economy using stock flow-consistent sectoral flow analysis from the national accounts.
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 recent sectoral balance flows is shown 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.
A recession has never occurred while the private domestic sector balance is in positive territory and has always occurred when it is in negative territory. It is the best-kept secret of the national balance of accounts accounting.
The chart below shows the newly released government budget data:
It shows a surplus [blue] for April 2019 of $160 billion, which in reserve accounting terms means money taken vertically out of the economy by the currency issuer that now appears on no measure of any money supply, such as M1, M2, and M3. This money has been deleted at a keystroke as a result of the government taxing the money out of the economy. Money that can no longer be spent on real goods and services, capital for the advancement of loans, or invested in paper assets such as the stock market.
The chart below shows credit creation over the same period:
Credit creation was negative in April 2019 and -$3.8B of debt credit money was deleted out of the financial system by the paying back or writing off of loans. Credit creation has been weakening since December 2018 and has now rolled over.
A recession comes after the following two events have occurred:
1. The federal government extracts a surplus from the private domestic sector; this has not yet happened.
2. Private credit creation peaks and reverses and thus reduces aggregate demand. Less demand means fewer sales, less production, less employment, and a downward self-reinforcing spiral. This has happened! We will have to wait and see if the trend persists going forward.
The following chart shows the current account over a similar period:
The current account is "lumpy" in that unlike the government budget and credit creation which are reported monthly it is reported quarterly. An idea of how the monthly current account figure might be trending can be gained by looking at the balance of trade and capital flows as these are reported monthly and add together to make the current account. Charts for these are shown below.
Taking the information above one can now calculate the private domestic sector balance and total fiscal flows.
This month, the balance of account looks like this for the private domestic sector balance:
[P] = [G] + [X] is an accounting identity true by definition.
Inserting the numbers:
[P] = [-$160 billion] + [-$60 billion]
[P] = -$220 billion net drain.
To this number, one can add the impact of credit creation [C] for April 2019 to work out the net change in the money supply and aggregate demand.
P + C = Net Money Supply Change = Domestic Aggregate Demand
-$220 billion + -$3.8 billion = -$223.8 billion net drain.
This is a negative for aggregate demand overall and is why the market has retraced into the first half of May so far with or without the trade war news. Macro fiscal flows of this sort have a one-month flow-on effect on the stock market.
April is tax time in the USA. On the 15th April, $535.5B was drained out of the private domestic sector when income taxes were paid. This is a huge blow to markets and the seasonal impact is shown on the monthly treasury statement shown below.
It is a bigger blow to the real economy due to the tax structure. Earnings and profits are taxed much more than other forms of income. This takes proportionately more purchasing power away from those segments of the economy that have the highest propensity to spend, wage earners and small businesses.
On the other hand, the skew in the taxation base against lower income earners also means that higher income earners are able to save more and are more likely to pool their savings in paper asset markets such as equities and debt.
The impact of this government 'surplus' and the other 'surpluses' in September and January can be seen in the chart below that tracks the government budget value and the Dow Jones index. Last year the Dow Jones dipped strongly in April due to the tax extraction. It is likely to continue to do so into June this year as well.
The good news is that after April, we have four good government spending input months until a bad month in September.
Federal government spending is very important to the US private domestic sector given that the current account is always negative and taking money out of the private domestic sector. The Federal government is the currency issuer and has to make good the loss to the flow of funds. Generally, over a year the Federal government does do this however there are months such as April where antiquated taxation practices rupture markets.
This is best encapsulated by Robert P Balan:
The confluence of periodic flows of liquidity coming from the Fed and Treasury creates a period of “liquidity drought” from late April to early September, which creates equity market sinkholes from early May to June, and then again from early August to September, if there is no change in their published reduction schedule of the balance sheet. This recurring liquidity drought is what gives rise to the so-called “Sell In May and Go Away” phenomenon. Conversely, there is a “liquidity flood” from early November to early January (of the subsequent year), which also tend to boost prices into year-end. If indeed, the Fed takes a pause in the “normalization” by September, the equity markets should have a rip-roaring “Santa Claus Rally” starting early November.
The following chart illustrates this point and shows how the lagged effects of these fiscal flows can be used to forecast the market.
As one can see from the chart above liquidity flows are declining into summer. The blue and green lines are the S&P 500 and track to the present date. The other lines are Fed liquidity measures and show a large sinkhole coming up due to the effects of monetary and fiscal policy decisions already baked into the cake from lagged effects.
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.