[Given the sectoral balances model] ... consider the US deficit and explain how on earth we can still have profits as a record percentage of GDP. There is no way that we can have had a fall in the fiscal deficit to GDP ratio from ten percent to three percent (we are in the middle of fiscal yr 2014 remember) without some kind of significant decline in the profit share of GDP.
But NIPA says there is no such fall. All the people who use this sectoral balance analysis keep saying that the profit decline is coming which of course is nonsense. If it is to be it is here and now; we are dealing with an identity. This cannot be ignored, but it is by virtually every single Wall Street analyst.
This does pose the real possibility that we have a massive overstatement of profits. The economist, Andrew Smithers has argued for this (most recently in last Saturday’s Financial Times). And it’s not an argument that is restricted to the Left. Former Reagan OMB Director, David Stockman has argued the same though less analytically than Andrew. Both analyses point to misinformation on profits is a really serious problem for policy and the Fed is totally in the dark.Macrobits
The Profits’ Conundrum
Marshall Auerback
Marshall Auerback
'Profit' isn't 'savings" ?
ReplyDeleteSP500 'profits' are global while gdp is domestic?
I'm not sure what measure of 'profits' Marshall is using.... need more info...
rsp,
"Profit" is a gain…it means revenue dollars must be greater than expenditure dollars.
ReplyDeleteThis is draining one container to fill another in a closed system.
If we put two balls in a container and take 3 out the extra ball had to come from somewhere…in a closed system its zero-sum, one agent's gain must be another's loss...but the other's ball to lose had to come from somewhere too.
This is where public investment comes in…it completes the loop (by enabling deficits) necessary for capitalism to succeed…it provides for gain in the aggregate…it allows for agents to accumulate stocks of financial wealth…to save.
Every successful transaction loop (achieves a gain) in capitalism results in a net transfer of funds from one group to another (consumers to business entities), and this occurs in the aggregate.
We have gains for all companies in the non-government) in aggregate, and if the group receiving the net gain does not spend all of it's income, then profit becomes saving, either as retained earnings or distributions.
This dynamic is constantly moving funds to the top of the income spectrum…it isn't insidious, it's just the way the system math works where profit is involved.
Profit means gain. When we save we spend less than our income…a gain. The gain is a stock, not a flow, and the growing stock causes decay in the flow.
Which is also known as the Paradox of Thrift.
Using the Kalecki equation - the offsets to the decline in government deficits have been increases in investment, increases in net exports and increases in consumer spending relative to wages. The latter has been fueled not only by more consumer borrowing but also by sharply higher corporate dividends.
ReplyDeleteCharles,
ReplyDeleteWhat about consumption facilitated by direct govt transfer payments to non-govt agents who then spend it on consumption? Are these amounts in "your" consumption figure here?
rsp,
Matt good question. My understanding is that the people who do these types of profit calculations exclude government transfer payments, etc. from "consumer spending" since transfer payments are counted, in effect as part of the government "deficit". So consumer spending "in excess of wages" (which becomes a profit) includes consumer borrowing, dividends, etc. but not transfer payments. This avoids "double counting"
ReplyDeleteThanks.
There is no way that we can have had a fall in the fiscal deficit to GDP ratio from ten percent to three percent (we are in the middle of fiscal yr 2014 remember) without some kind of significant decline in the profit share of GDP.
ReplyDeleteWell, that doesn't follow just from the sectoral balances right? Firms can increase their net income as a share of GDP, even if the total private sector share is falling, do long as household net income as a share of GDP is falling too. What do the household numbers show? I just created a chart at Fred showing employee compensation as a share of GDP and the picture isn't pretty.
https://research.stlouisfed.org/fred2/graph/?graph_id=163942&category_id=0
Isn't it obvious? Firsm are getting richer, faster by stiffing their employees.
another thing is how did the deficit get to 10% in the first place?
ReplyDelete350B in TARP to have govt take an equity position in the banks, 100s of $B to the agencies for another sort of equity stake in those nationalized firms, equity stakes in the auto manufacturers, etc...
All of those transfers were counted by the Treasury in their computations of "the deficit" which isnt the same thing as what the SBE counts as "G-T".... as G should not include govt buying equity in firms... now as these govt equity stakes are being redeemed by the firms, the govt (Treasury Dept) is including these receipts as "deficit reduction"... and even worse as the Agencies i have reason to believe are taking principle and interest payments they receive from mortgage payers and currently paying these "profits" so-called to their US Treasury department owner as 'dividends' of 100s of $B which again they are reporting as "deficit reduction".... so that isnt supposed to be in the "G-T" either...
so it should be of no surprise that we can see oddity between the NIPA and the SBE type numbers as the assumptions are different between what Godley assumed in the SBE and what the govt is really doing/reporting as "the deficit" these days...
I believe the SBE talks of the public balance and there are assumptions to be used when computing this... this is NOT what the Treasury reports as "the defict"... the assumptions are different...
"G" is i believe supposed to be government spending on final goods and services.... I dont think this is supposed to include buying a $T of preferred shares in defunct banks and defunct mortgage agencies or defunct auto manufacturers...
rsp,
Dan lower wages are not having a positive impact on profits. Check Kalecki - wages are not part of the "profit equation". If a company pays lower wages, this also means less money spent and lower business revenues - so its roughly a wash overall in terms of the impact of wages on profits.
ReplyDeleteIt's an aspect of the a paradox of thrift. If a single company reduces wages to reduce costs relative to price, they improve the profit margin. If all or many companies do this, then they reduce incomes, which reduces aggregate demand and contracts the entire economy, hurting the companies' profits.
ReplyDeleteDan lower wages are not having a positive impact on profits. Check Kalecki - wages are not part of the "profit equation". If a company pays lower wages, this also means less money spent and lower business revenues - so its roughly a wash overall in terms of the impact of wages on profits.
ReplyDeleteCharles, do you have any data to demonstrate that claim? The idea that suppression of wages across the economy by capitalists automatically results in a reduction of demand and business income that entirely offsets the benefits the capitalists receive by reducing the wages seems like a just-so story to me. We are seeing a trend toward higher returns to capital and reduced returns to labor.
@charles
ReplyDeleteWages can be susbstituted by debt to produce profits. So with growing debt and wages at the still profits can still keep rising.
This should tell you that debt is new money. Nothing new.
What Matt says:Corp profits are global while GDP is domestic.
Corp profits are comming from global wages, not only domestic. But they pay taxes only on domestic profits, if even that much. It is accounting rules that give cross matched info.
Globalization also works on formula for inflation MV=YP where quantity of goods is global for fully sovereign countries.
This makes change in price irrelevant to domestic ammount of money. Acctully, only nonimportable goods and services will inflate with change in Money and Velocity. Goods and services like health, housing, financials, governing can inflate while goods that come from abroad can not from domestic money.
That is what globalization also means.
Wages can be substituted by debt to produce profits.
ReplyDeleteOr just by lower levels of saving.
Dan the identity (Kalecki) for profits is profits (after-tax) =
ReplyDeleteNet investment (after depreciation)
plus
Consumer spending in excess of wages
plus
Government deficits
plus
Net Exports.
In terms of data, if you go through the NIPA accounting, you will get the total.
So if wages are reduced and spending is reduced by the same amount, it has no impact on profits at the overall level.
Yes, if wages are reduced by, say, $1000 and spending is reduced by only $900 (people dip into their savings or borrow to pay the bills) then profits go up by $100. That shows up in consumer spending relative to wages.
I see data on this provided by others and what has been keeping profits OK, despite the decline in the deficit (Marshall's puzzle),
has been improving net exports, higher investment and, most significantly, consumer spending relative to their wagers. So, maybe to your point, if wages are so low that people must borrow to make ends meet or dip into savings, then the "profit share" of GDP will go up. But it's nevertheless interesting that if all wages are spent, then the level of wages (low or high) have no impact on profits. Henry Ford once said "if I pay my workers more, they will be able to buy more cars". So he intuitively understood this idea. Your "big picture" point is correct, then. Wages could be increased which would help everyone and, if this money is spent, profits would not be adversely impacted.
Thanks.
If the flow of funds is traced back to the origin of funding, there are only two sources of money creation, government deficits and private credit. If there is new money and the deficit is falling, then private debt is increasing.
ReplyDeleteExports and return on foreign investment cannot create new money if that money is held in foreign currency or assets and report on income statements and balance sheets in the domestic unit of account even though it is not actually converted. If it is converted that is by using old money unless new money is borrowed for the purpose.
Spending down saving is of course using old money.
This doesn't show when looking only NIPA.
At least this is my understanding of it.
Tom Agreed. NetExports are not new money. Indeed, exports = imports for the world as a whole - so no net money anyway. However, for an individual country, net exports add to profits. NIPA Table 4.1 Line 29 - Balance of the current account.
ReplyDeleteI think you were saying it shows up in NIPA but it is not new money. Good point. Thanks.
Yes. Most just assume money without regarding its source. Loanable funds assumes a fixed money stock in which existing savings are lent on.
ReplyDeleteThat was one of the factors of the financial crisis. The increasing rate of private indebtedness was brushed off. Greenspan blamed it on the "global saving glut."
What was actually happening if that US consumers were funding lifestyle out of debt rather than income or savings, i.e., new money created by banks that doesn't add to net equity in aggregate since credit money nets to zero. Only creation of government money adds to net equity as non-government net financial assets in aggregate.
Those profits come from somewhere that is either equity ($NFA) or private credit that nets to zero and is temporary since loans are extinguished on repayment or default. $NFA remains as net equity unless drawn down by net taxation.
So we really need be asking where the corporate profit increase is coming from. To what degree is it redistribution of existing (old) money and to what degree is it from new money, and if new money, what is the source, equity ($NFA) or credit.
This shows how stable the system is.
Charles - Offhand, I don't see what the Kalesci "profits equation" actually has to do with corporate profits. It seems to be a measure of something broader like net private sector income.
ReplyDeleteFor example, a portion of net investment consists in payments for labor services, most of which goes to individuals and households, not firms. Why would we add that portion of net investment into a computation of profits?
If you break the domestic private sector down into two sectors, households and firms, both of which are involved in the production and sale of investment goods and services, it is easy to see how the net income of one sector as a share of total national income could go up while that of the other goes down.
"If there is new money and the deficit is falling, then private debt is increasing."
ReplyDeleteTom, money and net financial assets are not the same thing. The private sector money supply can increase, even net financial assets remains constant. The negotiable liabilities that comprise bank demand deposit accounts can be increased, thus increasing the money supply and creating a new private sector asset and liability at the same time. The asset and liability cancel out, so net private sector indebtedness hasn't changed, but the supply of money has changed.
To be clearer, there are two sources of money, state money (chartal) and credit. If the state is not adding new money and new money is increasing, then the source can only be credit, since ultimately there are only two sources of funds. New money created from increases credit-debt simultaneously so there is no increase in net indebtedness in aggregate but the fact that the money stock increases without an increase exogenously shows that credit-debt has increases. Often this graphed as an increase in private debt, even though it is also an increase in private credit, too. But this issue is debt, since it is the debt that must be repaid and that is always contingent on the ability and willingness to pay. It's also an issue from the credit side, since increase in credit means an increase in risk exposure.
ReplyDeleteNew money from credit money cannot increase non-government net financial assets in that money created through credit necessarily nets to zero. However, through the investment of new money, real assets, hence equity, can increase and this is reflected as an increase in household financial assets. An increase in real asset value and firm equity increases the value of shares, for example, which adds to household wealth. However, this increase in the value of financial assets corresponding to the creation of new real assets from investment of new money is only "paper wealth" until realized.
"The asset and liability cancel out, so net private sector indebtedness hasn't changed, but the supply of money has changed."
That's why many economists were not concerned with increasing levels of private debt leading up to the crisis and why no one was paying attention to the people warning about it. Since there is no increase in net indebtedness, how could anything go wrong? That turned out to be a false presumption. Not only does the money supply increase but also the net borrowing cohort becomes more financially fragile as their debt increases while income to support it does not. That means the the credit system becomes more fragile also.
Another observation worth adding. Some think that new money is created with the creation of real assets that increase equity. That is true in the sense that value has increased and that value is denominated in the unit of account, which is a function of money, some would argue the chief function.
ReplyDeleteBut that value is not realized prior to exchange at the marginal price, which fluctuates. That exchange does not bring new money into being of itself. Existing money is used, or new money is created through credit, as in sales on margin using leverage (credit).
@Tom Hickey
ReplyDeleteThe mainstream also had a problem understanding the risks of rising indebtedness in that they apparently did not realize debt is a transfer of output from the real economy to the financial sector.
Dan The Kalecki equation is an identity which equals corporate profits. I believe Levyforecast.com has a paper "where profits come from"
ReplyDeleteavailable for free - which explains it all.
Regarding investment, the reason investment becomes a corporate profit is that investment is funded from borrowing or past savings. To Tom's point, it is not funded with "new" money. Investments are capitalized on the income statement and therefore do not negatively impact current profits. However, on the other side of the investment are the entities receiving the money. For the overall system, this is all new revenue without an additional cost - and hence a profit. So, for example, if a company buys new machinery, the seller of the machinery gets the revenue and makes some profit from the revenue. However, all of the entities in the chain, all the way down to the entity selling the raw materials to build the machinery, in effect, get part of the revenues and part of the profits. If the seller of the machinery received $100000, for the overall system there is $100000 in total profits, as no costs were added. The buyer of the machinery, in contrast, did not subtract the cost from profits, as it was capitalized.
The reason why Kalecki uses net investment is this is net of depreciation. As you know, corporations deduct depreciation from income as a non-cash charge.
If you use gross investment in the Kalecki equation, you end up with corporate operating cash flow (which adds back the depreciation - instead of profits.)
Hope that's helpful and not confusing. Thanks.
http://www.levyforecast.com/assets/Profits.pdf
ReplyDeleteI should have added to address your question, the payments for "labor services, etc - which go to "households", are part of the costs of each entity in the chain - and are not counted as part of profits.
ReplyDeleteOK, Charles, so then return to that equation. The second term in the equation is consumer spending in excess of wages. Thus if wages are reduced while consumer spending either holds steady, or decreases by a lesser amount than the decrease in wages, and if the other terms in the equation remain the same, profits will increase. There is no basis in the equation for saying that a reduction in wages will be a "wash" as far as profits are concerned.
ReplyDeleteDan you are correct. If wages are reduced and consumer spending falls less, profits will increase. All I was saying is that if your wages are cut by $1000 and you cut back your spending by $1000, profits are unaffected. Similarly, if wages are increased and spent, there is no impact on profits. In general, one business's costs are another business's revenues. But,yes, your inference is probably correct. If wages are cut back by $1000, spending probably doesn't drop quite as much. But I'm comfortable with the statement,,
ReplyDeletethat "changes in wages don't have a significant impact on changes in profits". I don't know exactly what the marginal impact on consumption is for changes in income, but at lower levels of income I would think it is relatively high. But I could be wrong. In any case, having the "equation" at least allows us to ask the right questions, as you did. Thanks.