Government Surpluses Threaten Consumers’ Savings.
In politics today, there is too much misinformation associated with economics and too many opportunities for politicians to hoodwink people into believing something because it sounds right, rather than something else, which is right.
If people understood the principle of the three sectoral balances, which is an accounting principle not a matter of opinion, they would be immune from comments that are simply false and misleading.
A better informed public would force politicians to temper some of the more inaccurate and misleading things they say.
The key to understanding the three sectoral balances can be realised through the application of a simple formula, one that can be understood easily by the ordinary person in the street.
People are not so stupid as to be beyond grasping the fundamentals. They just need to have them explained in simple terms, in a way they can relate to, in their ordinary everyday lives.
Explaining firstly, that in a national economy their savings, as consumers, represent one of the three sectoral balances would immediately stimulate their interest.
Consumer savings are the most important of the three and collectively, the biggest contributor of the three.
The other two are a) what the government spends minus taxation receipts, and b) the net value of our exports minus our imports.
So, if we give each of the three sectoral balances an identity, we can refer to consumer savings as C, government spending minus taxation as G, and the value of our exports minus our imports expressed as XM. We can then construct a simple formula expressed as:
G + XM = C
But what does this mean? It means that the deficit of one sector must equal the surplus of (at least) one of the other sectors. It means the private sector balance plus the government balance plus the foreign balance must equal zero.
Let’s look at each of them separately.
C (consumer savings) represents total private savings of the nation minus private investments.
G is government spending minus taxes collected.
XM is net export value (the difference between what we export and import).
Therefore, as an accounting principle, consumer savings minus investments must equal government spending minus taxes plus the net value of exports.
We can express this as: (G-T) + XM = (S-I).
So, if we just took some random figures to demonstrate the formula, we can say that if (G-T) is $1 billion and XM is minus $200,000,000, then (S-I) would be $800,000,000.
That is because the government spent $1 billion more than it received in taxes (a deficit) but there was also a trade deficit that saw $200,000,000 given away to overseas suppliers which left the remaining $800,000,000 in the hands of consumers.
Note that all spending goes somewhere and all savings come from somewhere. Put another way, someone’s surplus is someone else’s deficit.
Now, if we take another example and say that (G-T) is minus $1 billion (i.e. a government surplus), and XM is -$200,000,000, then we can calculate that (S-I) is -$1.2 billion.
This demonstrates that consumer spending has had to make up for the government surplus and the only way this can happen is if consumers draw down on savings and/or take on debt.
The only way this can be avoided is if the government spending is increased and/or we have a external surplus. If we assume our external trade remains in deficit, which it usually does, then to avoid consumers sacrificing their savings or going into debt, government spending needs to be greater than the amount it raises in taxes.
This is particularly so in times where economic activity is sluggish, like now. Yet our government, and to its shame the Opposition, insist on a fiscal path that will bring us back to surplus.
Such austerity will only force the private sector to become more indebted at a time when our private debt is already at record levels.
This is a recipe for a recession. That is why most economists are telling us in blogs and other means that if we continue along this path, a recession is unavoidable.
A recession means people stop spending other than for essentials, demand falls, businesses downsize and people are put out of work.
What is difficult to grasp is that this is not new. We have known this for decades. Yet, neo liberal governments spurred on by the IMF (International Monetary Fund) insist that only austerity economics will help restore growth.
This is the economic rubbish we have to eliminate if we are to return to growth patterns that lead to near or full employment.
If the government does not spend enough to enable every person who wants a job to get one, all the goods and services provided by both the government and the private sector will be underutilised, meaning demand will be lower than it could be and the unit production costs of those goods and services will be higher than they could be.
This means higher retail prices that inhibit the average worker’s ability to save.
Explaining to people that surplus budgets threaten peoples’ savings is probably the best way to improve their understanding of a national economy and help rid us of the false statements that our politicians spew forth.
It’s not rocket science.
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Is it just me or do you mean 1 million not 1 billion. 1 billion plus $-200,000 would equal 999,800,000. Just as -1 billion plus -200,000 would be -1.0002 billion. I may be wrong. Other than that, thanks for the explanation.
Thanks Mick. Those damn zeros and decimal points. Hope it’s right now.
Good on you, John Kelly,
for understanding the economic equations and your understanding of how to explain it in understandable language for everyday people. Keep up the good work.
Lagarde and her bunch IMF of deadbeats need to go.
Hear, hear, stephentardrew. How to start campaigning so?
Good article John. One criticism: we have to understand why sectoral balances work the way they do. They work this way because this is how money works: someone’s surplus is someone else’s deficit. Double (triple) entry accounting.
Thank you, Zolbex. I have added a further sentence to reflect that point.
Thanks John. I am in complete agreement (not that it’s necessary as you are simply stating how the economy works). I just suspect, however, that the problem is that whenever you start talking figures (and i’m not singling you out here … i’m referring to anybody, anywhere talking numbers) a lot of people tune out. It doesn’t matter how much you try to show that it’s a common-sense concept that just happens to involve numbers, people just tune out. I myself am quite good at mathematics but my ex-wife, unfortunately, is not, Whenever our kids needed assistance with their maths homework I was naturally called on. At those times when I tried to do a two in one and also explain the basic concepts to my ex-wife, she would just tune out and state that she isn’t good at that stuff (even considering she is a Registered Nurse at the top of her profession working in a busy Emergency Dept). My point being (through the use of a clumsy anecdote) is that I think some people just won’t let their brain go there. It is really unfortunate as the point has to get across that a national economy in control of it’s own currency is nothing like a business or household but our so-called leaders/representatives continue to hood-wink the populace that this is the case. I’m not sure what can reasonably be done though (although, as you, i’m trying to get the message across).
so if this is thr truth..why is it not on ABC 24..why is it not in every jurnos question..why dont economists come out and talk about it.
I don’t think any of them understand it, Lawrence. it’s just too hard. They prefer the simple issues like, what colour scarf will Jacqui Lambie wear this session?
They are talking, Just not getting heard by MSM
Aah, Lawrence. Now we’re getting into the area of ‘who benefits?’ No surprises there.
Thanks John, you do an excellent job of teaching the fundamentals.
Read this 4 times before it made sense. I always distrusted surpluses from the point of view that it is a furtive way to get people who pay little to no tax a larger tax return &/or a return on a sizeable donation before an election. Your explanation is a bigger picture to view.
Gareth, what you say about exercising the brain is true. Progressive parties have suffered because of that for centuries. Just look at how long it took Bob Brown to bring the Greens into a position of influence. But, we must keep trying. Eventually the penny drops with enough people to force change.
This article needs and deserves a much wider audience. Have you submitted it to any other publications?
Yes, thanks John. It will take a re-read or two for me as well but you see the problem is constantly being perpetuated – by MSM, witness Leigh Sales to Morrison, when will the budget be back in Surplus? But all treasurers, Swan included, repeat the same mantra, surplus good, deficit bad so it’s no wonder most people take that at face value. As Jaqix says this needs to be disseminated widely and hammered constantly. Good work.
I’m putting this article on Twitter.
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Ive put it on Facebook – doesnt seem much but all I can do!
Good work John! I think you have found the right “frame” for raising this issue – people’s savings. And boy, do people need to start saving!
Read here how Australian households are the most indebted in the world!
So does it follow then that the end of a “boom” is a good time to increase taxation on the accumulated wealth of the top end? If savings have to go down then doesn’t it make (economic and political ) sense to claw some back from those who have benefited the mist and will feel it the least?
Hear, hear Waajuice.
Retrospective tax on large corps and wealthy super beneficiaries would be a very good start.
You say “Now, if we take another example and say that (G-T) is minus $1 billion (i.e. a government surplus), and XM is -$200,000,000, then we can calculate that (S-I) is -$1.2 billion.”. Does this mean that to help Consumer savings, the Government can redress the surplus by buying $2 billion of military supplies from the USA and increase C by that amount? I gather there’s something I’m not understanding here.
Paul, no it doesn’t mean that. $2 billion of US military supplies does not create jobs here. It would, however, create a much bigger trade deficit of $2,200,000.000 which is money taken out of circulation, thus bringing about no improvement in the private sectoral balance.
As a dropout in “Economics for Idiots 1” and having only achieved a conceded pass in the pre-requisite subject, “Counter-intuitive Economic Logic”, I have had much trouble with your laudible attempt to simplify the economic relationship between three sectors of the economy: the government, the population (and I presume that this includes all Australian businesses?) and our overseas terms of trade.
You proffer, without explanation, that the arithmetic relationship is:
(G-T) + XM = (S-I)
I cannot see this relationship.
If the unit of each of the terms is “Australian dollars available for spending or saving”, wouldn’t the banking sector come into the calculation as they seem to be able to create money as easily as the government?
You then say, after introducing the above equation (again without explanation as to why it is so):
“It means the private sector balance plus the government balance plus the foreign balance must equal zero.”
Is there a basic, simple, logical statement that justifies this assertion (or your first equation) and would I find it in Chapter 1 of any standard text on macro-economics?
Without this logic, I and a lot of others, are unable to go into bat against some frothy-mouthed conservative howling to the moon about debt & deficit disasters.
It is ironic, of course, that if I manage to win them over to MMT logic, they will be able to claim that the current government has done a fantastic job because they’ve almost matched the debt in three years that took Labor six years. Corman will be able to claim that it’s a debt & deficit recovery!
Query. What effect would MMT predict if the government suddenly doubled all pensions?
If you are up for it, this article explains much of what you ask. Personally I find Bill Mitchell very long winded and a tad obscure but if you have the time to wade through his explanations, it might help you.
As for effect of doubling the pensions, I don’t think MMT enters into those sort of debates. For myself, I have argued for a substantial increase to welfare payments for quite a while. Every cent would be recycled through the economy. Lifting people out of poverty and reducing inequality has proven benefits.
Thanks for the link, Kaye.
At first glance, it looks pretty indigestible but I’ll start to gnaw on it when I get a chance. The comments reveal a mixture of disagreement, support and confusion all three of which apply to me.
I would have expected that, with no change to the other elements in John’s equation, MMT would predict that government debt would rise (which is not a problem since it would be in terms of a soverign currency) and that savings would rise a corresponding amount.
Rocket science and brain surgery are starting to look like a doddle.
Geoff, I understand your confusion. I suffer from it as well so have broken it down to this for myself. Deficit spending can be funded by just crediting an account at the RBA and, provided we spend the money on things that will improve productivity like health, education, infrastructure and research, and we do not exceed our productive capacity (something we are in no danger of doing with unused labour and resources), this will stimulate jobs and growth and not be inflationary. I am less sure of the affect on exchange rates.