Using Stock-Flow Norms To Explicate Secular Stagnation (Part 2)

Having looked at the increasing demand for financial assets inward the kickoff role of this essay, nosotros forthwith plough to await at the render of financial assets. The concern sector is unable to render the required amount of financial assets, leaving balancing render too demand to the authorities too identify sectors. Once the housing bubble burst, the authorities sector was pose into the seat of existence the cardinal root of supply. This tin dismiss exclusively locomote accomplished past times large financial deficits, which implies deadening growth. Since this deadening growth was the resultant of policies that were aimed at increasing growth, it is unlikely that this structural province of affairs volition locomote easily changed.

The argue I emphasise the role of stock-flow norms is that the levels of savings flows are non remarkable at present. What is unusual at introduce is the high ratio of the stock of financial property holdings relative to income (in this case, I scale past times domestic income - GDP). The wishing too powerfulness of investors to handgrip a large stock of assets - documented inward Part 1 - forces the stock of render higher. This is what sets the introduce era apart from the repose of the post-war period.

Business And Foreign Sector Supply Of Financial Assets

One non-obvious regularity that nosotros run across inside the national accounts is that concern sector investment is largely self-funded. The nautical chart inward a higher identify shows the financing gap for U.S. Nonfinancial corporate businesses. It is defined equally (from the U.S. Flow of Funds report):

Capital expenditures less the amount of U.S. internal funds too inventory valuation adjustment.

What nosotros run across is that the financing gap is relatively pocket-size (from a macro perspective) - oft on the gild of 1% of GDP. What does this tell us? It essentially says that internally generated funds are roughly plenty to finance working capital missive of the alphabet expenditures. (This is non also surprising from the perspective of the Kalecki turn a profit equation.) The amount of borrowing they undertake may deviate from the financing gap, equally shown below. In the electrical current environment, at that topographic point is to a greater extent than borrowing than is indicated past times the financing gap; this is probable the resultant of borrowing to fund dividends too part buybacks. However, this utilization of funds is simply borrowing from 1 laid of investors to manus coin to whatsoever laid of investors, too so it simply a reshuffling of the financial assets available.

(As an side, nosotros exclude the financial sector equally it simply borrows to fund positions inward loans that are ultimately taken out past times the nonfinancial sector, other than those needed for the financial sector's relatively pocket-size working capital missive of the alphabet expenditure needs.)

Examination of the inward a higher identify charts demonstrate that the electrical current surroundings (post-2001) is different - the financing gap dropped to depression levels, too was negative for most of the post-crisis period. This agency that the corporate sector does non ask to borrow to invest, too so the wishing to increment financial property holdings exterior the concern sector is non finding an outlet inward increased fixed investment. For example, equally I showed inward Part 1, the retirement savings complex is steadily purchasing credit marketplace seat assets that amount to a flow of most 1.5% of GDP.

In this analysis, I focus on debt flows, fifty-fifty though equities are a large portion of soul sector portfolios. This is because cyberspace equity issuance has turned negative since the mid-1980s. The equity marketplace seat is no longer a cyberspace root of funding, its role is to allow owners of soul companies to liquefy their positions, too to ship pricing signals. Market capitalisation is exclusively able to grow equally a resultant of upward revaluation of shares, which is aided past times the reduction of shares outstanding generated past times buybacks. This generates instability, equally valuations are to a greater extent than stretched than inward before eras. Moreover, it agency that soul savings flows - which includes the proceeds of sold equities - receive got to locomote invested inward fixed income markets.

The financing gap was quite depression inward the early on 1950s equally well, but growth was buoyant. The divergence is that the U.S.A. of America has a electrical current concern human relationship surplus during that period, which agency that the U.S.A. of America was exporting capital. (The French used to complain most the U.S.A. of America running merchandise deficits, but those merchandise deficits were genuinely financed past times income flows - the electrical current concern human relationship was inward surplus. It was non until the Reagan era that the U.S.A. of America genuinely exploited whatever privileges "reserve currency" condition gives it.)  The U.S.A. of America is forthwith importing financial working capital missive of the alphabet - which gives rising to the explosive unusual financial property holdings which I showed inward the previous role - too those savings receive got to notice a abode inward the domestic economy.

The Household Sector's Attempt To Supply Financial Assets

The nautical chart inward a higher identify illustrates the U.S. identify sector's doomed endeavor to render financial assets - inward the shape of mortgages. It was unable to service the debt, too the sector has been forced to retrench. At present, at that topographic point is increased issuance of dubious automobile loans too pupil debt, but these debts are patently depression quality, too so they are unlikely to provide a large plenty outlet for inflows to financial assets.

The Government - Last Sector Standing

Since the other sectors are unable to provide the financial assets to allow entities to hitting their target wealth-to-income ratios, the authorities has to fill upward that role past times default. Returning to the Treasury -to-GDP ratio nautical chart above, its movements brand much to a greater extent than feel inward the context of the previous analysis. The ratio savage from the high levels from afterwards World War II to hitting a depression inward the inflationary 1970s. It too so reversed higher, which is the resultant of disinflation too the increased wishing of entities to handgrip a higher ratio of assets to income.

The Clinton-era reduction of the debt-to-GDP ratio was exclusively a temporary reprieve from this trend. Mortgages moved to supersede Treasurys inside soul portfolios. As shown above, the aggregate of these markets followed a smoother trend, which suggests that the driving strength for the dynamics was investor preferences. Once those mortgages proved to locomote bad assets, Treasury securities reverted dorsum to a to a greater extent than prominent seat inside investor portfolios.

Whither Secular Stagnation?

Although the ratio of financial assets-to-GDP may halt rising, it has reached such a high grade that simply keeping the ratio steady implies much to a greater extent than debt issuance than the corporate sector tin dismiss safely sustain. The imbalance betwixt desired savings too investment is helping cap nominal gross domestic product growth at the 4% annual charge per unit of measurement nosotros receive got seen this cycle. Although the economic scheme is non inward a deflationary state, this is non plenty to cut back the important slack that remains inward the labour market, equally evidenced past times diverse measures of under-employment.

"Fixing The Debt" - Not Any Time Soon

(I should preface this department past times noting that I believe that the authorities debt-to-GDP ratio is a slice of meaningless trivia for nations amongst a free-floating currency. However, non everyone agrees amongst that assessment, too so I volition hash out whether it tin dismiss locomote easily lowered.)

Although the debt-to-GDP ratio volition tendency lower until the adjacent recession hits (and depending on the electrical current turmoil, that could locomote soon), it volition receive got roughly major policy changes to contrary course.

• Increasing wage inflation volition increment the stride of gross domestic product growth, lower the turn a profit part of GDP, too increment discount rates. This volition receive got the outcome of lowering financial asset-to-GDP ratios, too so debt-to-GDP ratios. This is why sensible bond investors fearfulness depression debt-to-GDP ratios, non high ones. But to instruct this outcome, inflation-targeting would receive got to locomote dropped, too labour marketplace seat reforms reversed.
• The unwillingness of mainstream political parties to increment pay-as-you-go pensions, agency that savings are going to locomote continuously thrown at the pension-finance complex. The replacement of defined create goodness plans past times defined contribution plans agency that to a greater extent than savings are necessary, equally defined create goodness plans tin dismiss receive got payoff of early on mortality to cut back the amount needed to salve for the same amount of post-retirement benefits. Although demographics may cut back the amount of retirement saving, at that topographic point is niggling indication that retirement plans are doing good plenty to allow that to happen.
• The asymmetry of Fed policy - cutting rapidly, too hike tardily - has driven nominal too existent involvement rates to depression levels. This forces entities to accumulate a greater stock of bonds inward gild to accomplish the same grade of retirement income. To contrary this trend, the Fed mightiness receive got to flip the signs on its models too hike rates inward gild to instruct the economic scheme to speed up. This provocative analysis is 1 of I receive got roughly links too farther give-and-take on this theme here.