Tito's Blog

Private, Government, Foreign Financial Balance

The March 2010 Absolute Return Letter (pdf) picks up the national income accounting identity mentioned earlier:

( T - G ) + ( Y - T - C - I ) + ( M - X ) = 0

Where:
T Taxes
G Government Spending
Y GDP
C Private Consumption
I Private Investments
M Imports
X Exports

In other words, the sum of net inflows of money into the stock of capital of a country’s economy from the government, the private sector and foreign investors (that counterbalance the net imports) is always zero, unless there is creation of paper money within a country or a change in foreign reserves.

That entails that as the consumer spending retrenches (and private savings go up) during the ongoing balance sheet recession, government deficit must worsen and/or the country must reduce its current account deficit (i.e. reduce net foreign capital inflows). Another way to look at it is that every dollar saved flows back (as a mathematical identity) to finance additional government debt and foreign capital outflows.

The global economy is messing up GDP and balance of payment accounting. Think about US companies building their factories in China, whose revenues are included in the Chinese GDP and whose exports from China are added in the Chinese current account.

For all the huge trade surplus that China is purportedly ‘enjoying’ it turns out that little benefit is being derived from it. Over 50% of China’s exports are produced by foreign corporations.