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Tuesday, April 12, 2011

Economic Accounting Identity

There is a basic Accounting Identity that states that

Private Sector Financial Balance (change in book value)
+ Governmental Fiscal Balance (fiscal deficit/surplus)
= the Current Account Balance (trade deficit/surplus)

Or, in plain English, the sum of public and private debt (or surplus) equals the trade deficit (or surplus.) 

I've seen this displayed in various ways in several locations.  This presentation is courtesy of  David X. Johnson.  A quick glance at Johnson's Post today, plus the one cited above, is just about enough to suggest to me that he and I would have very little common ground.  Frex:

The end game is the raping of retirees and the middle class of their savings and a collapse of the wealth transfer system (including for those who are truly needy). The more the Fed prints, the poorer we all become (but the wealthy know how to protect their wealth from confiscation).

Got gold?

But that is a digression.  When talking about the accounting identity, Johnson says this.

If the goal is to reduce the trade deficit, we can either reduce government debt or we can reduce private debt, but not all three at the same time. 

 Somebody help me out here.  I think there are several things wrong with this statement.

1) An accounting identity is not only a resultant, it is a static description of a moment in time.  He is treating it as a dynamic function.

2) Even worse, he is ascribing a causal relationship among things that are at best resultants of many other factors, and at worst, simply correlated in book-balancing theory. 

3) And if there were to be a causal relationship, wouldn't it be the other way around?  Doesn't the trade deficit drive the need for some combination of public and private debt?

4) Doesn't this assume that none of the variables above affect GDP?

Johnson goes on.

Reversing the trade deficit requires that corporations manufacture more (and therefore invest more) and be more productive. Investment requires that people save their money* rather than spend it or being credit card rich. It also means that we need to attract more investment from abroad - i.e. those evil rich people that the White house likes to vilanize.* It means that tax policy doesn't create dis-intensives to invest in America. It also means that the government goes on a diet.* Increased savings, less debt, improved productivity, more competitive, lower taxes, a weak dollar, no deficits ... exports will increase.*

So then how do we achieve this new balance? More deficit spending? Paying zero interest on deposits? More progressive taxes for the wealthy? Import restrictions? No, no, no and no ... yet this is exactly the President's plan. This administration is also trying to run the economy from the top down,* like a Soviet style Politburo - i.e. statism (19th century) or mercantilism (15th century). For all these reasons, the five-year Obamanomics plan will fail. It's just basic economics.*

 * Here I've indicated items that strike me as either naked assertions, baseless right-wing talking points, or example of erroneous thinking.  Rather than engage in a point-by point refutation, I'll leave pondering these flaws as an exercise for the interested and ambitious reader.  Except for the last one.  Economics is bunk!

Best of all is the way Johnson pushes the Obama as Commie meme.

Understanding the above economic accounting identity can help you understand why the President's Soviet-style 5-year plan to double exports in 5 years has little chance of success. The five-year plan is certainly achievable, but hardly a success story in the past. It happened in the 1970s and early 1980s, and almost occurred in the five years ending in 2008. Realize, however, that all of these periods experienced high-inflation and a weak dollar. The five year Obama Politburo plan will require a weak dollar (it's currently strong), more inflation (it's currently relatively low) and our trading partners will have to experience strong economic growth with demand for American products (they are currently weak and the demand is low). Nevertheless, in real terms (inflation adjusted) the U.S. has never doubled exports in 5 years. So much for central planning.

As revealing as this text is, you really have to visit his site and check out the accompanying picture to get the full effect.

I had no intentions of writing this post.  I just happened to stumble on Johnson's elaboration while tracking down the accounting identity using TEH Googly.

But, when I saw it, I couldn't resist this Molly Ivins moment.

Further, isn't the real point of this accounting identity that, given some level of trade deficit, DGP, currency strength and interest rate that a government deficit is a requirement   (and actually a good thing) at a time when the privates sector is deleveraging?


Update (4/21/11):    In a different context, Niklas Blanchard explodes Johnson with a simple sentence fragment:

doing economics from accounting identities leads to patently absurd conclusions.



The Arthurian said...

C'mon, call the guy a THUG!!!

Jazzbumpa said...

You got me!

Somehow, it just wasn't on my radar screen.


Steve Roth said...

All the textbooks tell you, right up front: accounting identities do not in any way imply causation, and they certainly aren't normative statements.

Government deficit = private savings

Savings = Investment

So we should obviously increase government debt to increase investment! It's *obvious*!

The Arthurian said...

re: "savings = investment"

Keynes recognized that savings and investment must be equal, but said that if the desire to save exceeds the desire to invest, the difference may be seen as an increase in inventories.

I like the idea that "accounting identities do not in any way imply causation," but facts are facts, and if things have to be equal then they have to be equal.

Things can become equal through natural processes like inflation or deflation...


Jazzbumpa said...

The savings = investment "identity" is not so cut and dried. There is a temporal element that makes it a bit long-runnish.

It also seems abstract and artificial. What assumption underlie this identity, and how are they validated?

I read something in the last few days pointing out that savings and investment are categorically different, but don't remember where, alas.

Further, it seems to me that the identity takes no account of hoarding behavior. Besides, can't savings ultimately flow into consumption, rather than investment?

As an identity principle, the whole thing seems quite dicey.