The Flow of Funds report for the second quarter was released on Friday and it confirms, almost inevitably, the point I made earlier about the aggregate financial balance for the domestic private sector being in the meh phase.
From this perspective, there is no longer a ton of pent-up demand, but nor is the domestic private sector dangerously overextended. We already knew that, but the Flow of Funds gives us some additional granularity.
Let’s start by refreshing on what we already knew. Without needing to wait for the Q2 Flow of Funds, we knew from National Accounts data that the aggregate financial position of the private sector was fine. An accounting identity dictates that (net of measurement error) the financial balance of the domestic private sector is just the general government fiscal deficit less the current account deficit.
Note that in this conception a larger fiscal deficit is stabilizing, so long as government debt is considered a riskless asset, which is clearly the case.
The dummies at CNBC cannot process this, but there are many things they cannot process.
During the recession and its early aftermath, the fiscal deficit soared, which accommodated a huge improvement of the financial balance of the domestic private sector, which had previously been a problem.
As the recovery has progressed and the fiscal deficit has narrowed, this balance has “deteriorated”, but not yet to a seemingly dangerous level.
I hasten to add that the fiscal deficit decline did not “cause” the erosion of the private sector balance. The causation runs both ways here, but the net result as of today is neither bullish nor bearish. More meh.
The Flow of Funds allow us look at how the overall domestic private financial balance is distributed across the various sectors, most important (typically), the household sector and the non financial corporate sector.
Note in the right panel in the chart immediately above the the Flow of Funds measure of the implied domestic private sector balance is pretty close to that provided by the National Accounts, which are actually less noisy. That is no surprise, which is why we need not wait for the Flow of Funds for the high level analysis here.
Note also, from the left panel, that just two sectors, explain most of the variation in the overall private sector financial balance. Let’s look at these sectors individually, but as 4-q moving averages to dial down the noise.
A couple things are interesting here:
Measured simply as a share of GDP, the variation in the corporate sector balance is about half that of the household sector. The range of the vertical scale of the left panel is 7 percentage points of GDP, while that of the right is 14. The household sector is big and can get exuberant sometimes, as during the NASDAQ bubble and housing bubble.
The household sector never really recovered after the 2000 recession. You might say that this is why folks called the 2000s the bubble economy. We needed a housing boom to crowd housing demand in to offset the drag from the large current account deficit then — call it excess Asian savings, if you can avoid being thus pulled into a semantics debate — and the fairly small fiscal deficit, which provided insufficient recycling of those Asian savings.
As things stand now, the corporate sector balance is about average, and so too is the household sector’s. Thus from a top-level macro perspective, there is not much to say here.
There are pockets of financial risk in the corporate sector, most recently evident in, for example, the energy patch. But they are better monitored through a credit strategist than with these macro data. From a macro perspective, there is no glaring story here either way.
This is very closely related to the fact that the most cyclical components of aggregate demand, basically all forms of investment, are also showing neither much pent-up demand nor excess. I will write a note on that issue later. It will be confirming or — less grandly — consistent.
There is always the chance we are missing something.