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Sectoral Balances

by on May 22, 2013

I know it may seem unbelievable but there was a time when I was a follower and avid fan of the Austrian school of economics. I believed that government spending crowded out private sector spending, that all government expenditures were somehow passed onto my grandchildren, that government spending lead to inflation, and a myriad of other beliefs that stemmed from what I thought was a logical approach to economics. I read Ayn Rand, listened to John Stossel, almost voted for Ron Paul in 2008, and I drank beers with fellow libertarians.

So what happened between then and now? Back in 2008, after the election, I told myself I would suspend any ideology I had when it came to economics and other political issues and refocus on just finding what was really going on with our country. During many years of engaging with people via blogs and forums I collected a myriad of economics experts as friends and so I had plenty of information to digest, to come to where I am at today as an MMT’er. My “conversion” (not to be confused with a religious or ideological conversion that relies on morals and faith) came about in a gradual way, but one particular fact really gave me that “A HA!” moment, and that was seeing a “sectoral balances graph”, like the one below.

Sectoral Balances

In the above graph the blue line represents the private sector, the red is the government sector and the green is the capital account (aka the trade balance). What is amazing, and what gave me the “A HA!” moment, was how mirror like this relationship is. Not many things in economics are as perfect as this.

This is what economists call an accounting identity, it is factual and can’t be disputed. It is as basic in economics as debits and credits are to accounting, it allows for accurate predictions, and is being used that way more and more by the financial industry.

And what this means on the most basic level is that one sectors income is another sectors spending. So when the government spends it becomes income for the private sector. Or when the U.S. has a deficit on the trade balance with other countries it removes income from the private sector. And as seen in the graph these accounts ALWAYS have to balance, and ALWAYS do.

So why haven’t economists and politicians caught onto this? Well it is fairly new in the economic world and has yet to become mainstream, so it is likely they are unaware of it. It wasn’t until the early 1990’s that Wynne Godley first pointed out this identity. With the stranglehold that neo-liberals have on the media and in most of academia it takes time or a crisis for concepts like this to gain traction. In fact it was the crisis that made me rethink my previous economics ideology, and it is doing that for many people I have ran into.

The one important thing to take away from this is that only one sector, the public sector, can run deficits forever and always be able to pay it back.

The government can print currency to pay off any of its debts, the private sector can’t. Yet all the media and political outrage is focused on the government debt, at $16 trillion, and the total private sector debt, at $38 trillion, is completely ignored! It appears our media and politicians have their concerns confused, and they completely misunderstand which sectors total debt is news worthy.

I still consider myself a libertarian, a small government libertarian as well, but as a libertarian I pride myself on economic freedom as well, and burdensome private debt is not economic freedom in any sense of the word. The more we try to reduce the government debt, the more we put pressure on the private sector to go into a deficit.

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6 Comments
  1. “It wasn’t until the early 1990′s that Wynne Godley first pointed out this identity.”

    It was used heavily by him in the 1970s.

  2. SteveD permalink

    Government pays off its debts by debiting securities accounts and crediting reserve accounts of debt holders at the FRB. Government doesn’t print currency to pay off its debts. It’s totally unnecessary for a currency sovereign. The currency sovereign sends INSTRUCTIONS, not dollars/currency to mark up/down account balances. You should NEVER use that ugly word “print” and the word government in the same sentence as it outrages operations challenged morons (especially libertarian ones). Otherwise your piece is spot on.

  3. fresno dan permalink

    essentially, your saying that old economic aphorism, everybody’s debt is somebody’s asset…..
    Unfortunately, we had this great financial crisis, where we find out that houses in Fresno are NOT worth half a million dollars, but only 50K.
    Now the government bought all the mortgage debt in default instead of letting the evil and stupid (i.e., the shadow financial system) eat their losses, but the money these people got from the government has real purchasing power.
    Now, with all the houses the government now owns, it could give every homeless person in American a free house, plus a few hundred thousand other people as well – think how much that would increase aggregate purchasing power.
    But somehow it never does. Funny how this theory is used to bail out the rich, but never the poor…

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