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.