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Back to school macroeconomic basics …

|Includes: SPDR S&P 500 Trust ETF (SPY), TLT
    In the course of the last two years, we have again and again emphasised the importance of basic macroeconomic phenomena. in the asset allocation process, particularly with respect to debt deflation or money velocity 

      We have tried to put some light on fundamental capital shifts in the various asset classes, based on the scenarios laid out in the 1950s by 
Hyman Minsky on which basis we have argued against the Austrian monetarists, which explains our bias in favour of fixed rate government debt and our switch to risky asset aversion in June 2007.
  
      I would like to take advantage in the dip in big news items at this time to return to the basics. It will hardly surprise our long-time readers that I am taking up the major aggregates, the incorporation of which constitutes the major difference between the Keynesians and the ‘Chicago Boys’.
 
      For my fellow gluttons-for-punishment, I would suggest the reading of ’Can « IT » happen again’, published in 1982 by Hyman Minsky. This is an updating of his essays from the 1950s-1970s period, the "IT" in the title referring to the Great Depression of the 1930s.
 
      In short, these research papers put light on the original Keynesian theory (as opposed to neo-Keynesianism version, launched by John Hicks who created the famous IS/LM curve, unfortunately still dear to the hearts of certain central bankers), by incorporating the debt variable and, especially, the financing method (Hedge, Spéculative ou Ponzi).
 
 
      Aside from the pleasure of learning, we insist on the implacable mechanism of these phenomena because they give us an idea about the future evolution of the decisive variables affecting asset allocation, like business profits (stock markets) and inflation (interest rate markets), two fields in which the dispersion of anticipations has never been so strong.
 
 
      As such, I have decided to discuss business profits today via the renowned aggregate equation of John Maynard Keynes, which enables us to escape the laissez-faire framework of Smith and Ricardo, whose philosophy on the individual is undoubtedly one of the main reasons for the Fed's mistaken passivity in the early 1930s.  
 
 
      Definition of the variables for an open economy with an active state:
 
 
GW = Gross household wages                                                         GP= Gross profits of businesses 
W = Household wages after taxes                                                   NP = Net profits of businesses  (what we are looking for)
 
S = Savings                                                                                             C = Total consumption
      Sw = Employee savings                                                                           Cw = Consumption of employees
      Sc  = Savings fuelled by capital income                                                   Cc = Consumption fuelled by capital income     
           à  W = Cw +Sw                                                                                      à  C = Cw + Cc
                            
T = Taxes                                            I = Investments                            EX = Exports
G = Government expenditures                                                               IM = Imports
      à G - T = Def, budget deficit                                                                 à EX - IM = Bal, trade surplus.
 
 
In national accounting, GDP is equal to the sum of revenue from economic agents (households, business, government). It is also equal to the sum of these same agents' expenditures.
 
 
      On one side, we have revenues, i.e.:         GDP = GW + GP,                     and thus GDP = W + Pr + T
 
      On the other, expenditures:                       GDP = C + I + G + EX – IM       and thus GDP = C + I + G + Bal
                 
Thus:       W + Pr + T = C + I + G + Bal
 
 
If we subtract W and T from both sides, we get:           Pr = C – W + I + G – T + Bal
 
As per G – T = Def                                                         à        Pr = C – W + I + Def + Bal
 
As C = Cc + Cw, and W = Cw + Sw,
                                                                  We get:         Pr = Cc + Cw - Cw – Sw + I + Def + Bal
 
                                                     Thus:                           à        Pr = Cc – Sw + I + Def + Bal
                                                                           
 
The final equation is thus:
 
Not profits of businesses =  Consumption fuelled by capital income + Investments
                                                                                  + Budget Deficit + Trade surplus
                                                                                                             – Employee savings.
 
 
 
We will discuss tomorrow the consequences of this equation in today's economic situation…, but I think you will agree that we have already half there.
 
 
 
As a bonus, here are a few juicy statements on our favourite subjects without commentary from us:
 
 


Disclosure: Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.