UBS senior economic adviser George Magnus addresses the issue of Washington’s budgetary crisis on Monday.
As he points out, to some there is a major fiscal imbalance that has to be addressed, but no crisis — while to others the US is bust and nothing short of an immediate downsizing will neutralise a looming austerity crisis.
For Magnus, though, both sides are wrong.
He knows this, he says, from the Flow of Funds data published by the Fed — in which the numbers simply do not add up:
Magnus believes that this is — quite crucially — down to a chronic under-reporting of private sector surpluses:
The answer is that there appears to chronic under-reporting of the private sector surplus. So, look at Chart 2, where the solid line is the private sector financial balance as reported in the Flow of Funds, but the dashed line is the private sector as a
residual, calculated as the government plus the overseas balance. Mostly, these two series are in the same ballpark – until the financial crisis. To make the flow of funds data balance as they should, the private sector surplus ‘needs’ to be a lot closer to 8.5% of GDP, which is 3.5% GDP larger than officially stated, and 5% GDP larger allowing for the inclusion of financial institutions.
Now, the idea that the private sector surplus is much bigger than has been stated gives rise to a number of interesting interpretations, in Magnus’ opinion.
Amongst other things, it supposedly rubbishes the theory that China or any other sovereign creditor may hold the US over a barrel on account of US dollar asset holdings:
Unless China wanted to deliberately engineer a financial ‘casus belli’ by dumping US assets en masse and provoking US retaliation – in which case sovereign funding would be the least of our worries – it can choose to accumulate US assets or not, through its economic policies and exchange rate regime. As it happens, it chooses to accumulate, though exposing itself to chronic losses and central bank recapitalisation when the Yuan eventually rises more significantly. In the meantime, the US need not fear incremental tweaks in sovereign asset allocation, in which the US dollar composition remains reasonably stable.
It also provides every reason to believe that the US economy can grow even through a deleveraging and rebuilding of private sector saving.
Which is why Magnus concludes:
Even Japan did from time to time, although its trend rate dropped sharply. When the household savings rate drops as it has done in the US since Q3 2010, from 7% to 5%, the economy can grow a tad faster. But we shouldn’t forget how sensitive the economy will be to a) fiscal drag when it starts in earnest b) restraint by the Fed and c) the ongoing call to rebuild savings for deleveraging and demographic reasons, even if they move against trend for short periods.
All in all, the deficit is not a problem while private sector surpluses prevail.
For more, see the full report in the Long Room.
Related links:
Magnus: ‘An existential crisis for the euro-system’ - FT Alphaville
Deleveraging and consumer-led growth – FT Alphaville
The FY2012 “budget” – FT Alphaville