John Hussman gets it, as the following excerpts summarize.
Many of the misconceptions that investors hold about the economy and the financial markets can be clarified by understanding the relationship between the “flow” and “stock” of various quantities in the economy....
If one carefully accounts for what is spent, what is saved, and what form those savings take (securities that transfer the savings to others, or tangible real investment of output that is not consumed), one obtains a set of “stock-flow consistent” accounting identities that must be true at each point in time: 1) total real saving in the economy must equal total real investment in the economy; 2) for every investor who calls some security an “asset” there is an issuer that calls that same security a “liability”; 3) the netacquisition of all securities in the economy is always precisely zero, even though the grossissuance of securities can be many times the amount of underlying saving; and perhaps most importantly, 4) when one nets out all the assets and liabilities in the economy, the onlything that is left – the true basis of a society’s net worth – is the stock of real investment that it has accumulated as a result of prior saving, and its unused endowment of resources. Everything else cancels out because every security represents an asset of the holder and a liability of the issuer.EconMatters
Conceptualizing “saved or unconsumed resources” as broadly as possible, the wealth of a nation consists of its stock of real private investment (e.g. housing, capital goods, factories), real public investment (e.g. infrastructure), intangible intellectual capital (e.g. education, inventions, organizational knowledge and systems), and its endowment of basic resources such as land, energy, and water. In an open economy, one would include the net claims on foreigners (negative, in the U.S. case). Understand that securities are not net economic wealth. They are a claim of one party in the economy – by virtue of past saving – on the future output produced by others.
Because the surplus of one economic sector must be identically equal to the sum of deficits across all other sectors, the net funds available to acquire financial assets across the economy as a whole (including net flows from abroad), will always be precisely zero. However, each sector taken separately will acquire net financial assets, or issue net financial liabilities, equal to that sector’s saving or deficit (the difference between the sector’s income and its spending). The importance of stock-flow consistent economic accounting was well-recognized by many economists sometimes dubbed the “New Cambridge” school (Godley, Cripps, Kaldor, Kalecki, and Tobin among others) but stock-flow consistency is rarely taught in economics courses, largely because the models often include additional arbitrary decision-making rules (like Keynes’ simplistic consumption function) that aren’t based on rational choice or optimization. Instead, mainstream academic models often exclude the financial sector completely, and include money as if it were simply dropped from the sky.
The failure to recognize that stock-flow consistency must hold in the economy and the financial markets is the basis for an enormous amount of misunderstanding in both fields. That omission of clear thinking about the link between economics and finance contributes to misguided policies that ignore the impact of financial distortions on the real economy, and invite speculation, malinvestment, and ultimately financial crisis.....
The Coming $10 Trillion Loss in Paper Wealth
John Hussman of Hussman Funds
5 comments:
"In an open economy, one would include the net claims on foreigners (negative, in the U.S. case). "
Is this actually true?
"Because the surplus of one economic sector must be identically equal to the sum of deficits across all other sectors, the net funds available to acquire financial assets across the economy as a whole (including net flows from abroad), will always be precisely zero."
Well, that's roughly true as an accounting matter, but since the government sector can create funds at will, then in terms of constraints imposed on government action it is a relatively meaningless statement.
The "net funds available" in an economy are not the net financial assets of the economy. The net funds available, otherwise known as "money", consists in a particular class of government liabilities. The more of such liabilities that exist, the more funds there are available for acquiring other assets. The government has a practically infinite capacity to issue such liabilities. Since whoever holds that money possesses an asset whose accounting value is equal to the accounting value of the government's liability, then issuing more money does not increase the quantity of net financial assets. But it does increase the quantity of monetary funds.
In actual fact, these so-called liabilities are not genuine liabilities at all. Calling them such is a BS accounting fiction that allows the Fed to produce a fantasy-land "balance sheet" that gives people a vague comfort level with Fed operations, operations that would otherwise be scary and mysterious.
Stock-flow consistent accounting would be more important in an economic system where all financial assets were ultimately founded on the values of real assets underpinning them. But in a system with money of the modern kind - bogus "loopy liabilities" that are redeemable only for other loopy liabilities of the same class, and that are connected with real values only through the shifting vicissitudes of psychology, expectations, animal spirits, social conventions and a few supporting laws - it doesn't really get you much.
""In an open economy, one would include the net claims on foreigners (negative, in the U.S. case). "
Is this actually true?"
It is if you decide to account by national border rather than by currency zone.
The problem with doing that is that you *convert* your, say, Euro denominated assets into the reporting currency of, say, US dollars and that actually distorts the picture of the currency zone - since it creates more things in the accounts that are apparently in US dollars even though they are not.
A better approach would be to account for both real and financial assets on a control basis. If you do that then you find that entities can be in several zones.
For example if a US company owns and controls an oil well in Scotland, is that real resource really part of the Scottish asset base, or the US asset base?
Dan,
It's even more than that since anybody can create a form of money via credit expansion.
So if I'm in Company A and I trade with Company B, company A buys something from Company B and Company B buys something from Company A then they both have a debtor asset and a creditor liability.
Snapshot the balance sheet while that trade is half open and you'll find there is a flow -which will show up if those companies happen to be in different sectors.
Yet they would settle that trade not with public or bank money but with a simple contra journal in both sets of accounts.
It's the balance sheets expanding and contracting that does the work - like breathing in and breathing out.
Dan Kervick: In actual fact, these so-called liabilities are not genuine liabilities at all. Calling them such is a BS accounting fiction ... Just saying again, that this is very, very wrong. Government liabilities / debts are just like any other liability. Thinking otherwise - changing the definition of "debt/liability" - makes things soooo complicated - to no purpose whatsoever. Mitchell-Innes & Co. = MMT is right. But so many don't have the patience to actually read & ponder what they wrote. And so they do not understand MMT, and are unable to criticize it (or support it!) coherently.
For there is no such thing as a "debt for" = non-bogus liability. Only "debts to".
If these so-called liabilities are loopy & bogus - and are are redeemable only for other loopy liabilities (of course untrue) - just send them - dollar bills, cashiers checks, bonds, whatever, to me. I will provide the SASE!
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