This is the first of at least three posts in relation to deficits and public debt. I hope by the end of this you should have enough knowledge to understand why things haven’t returned to normal since 2008. This post covers national accounts, which underpins most of what I will mention.
At the simplest level, the economy is compromised of 3 sections, namely the government sector, the non-government (private) sector, comprised of households, business firms and banks and the foreign sector (the sum of which equal to imports – exports).
Following the rules of double-book accounting (i.e. if I pay you, my balance goes down by the amount I pay, and yours goes up by the same amount, so in the end between the two of us there is no net change in the amount of money) these sectors must (no ifs, no buts!) add up to zero. In essence, a deficit (the amount of spending that exceeds income) in one or two of the sectors must be balanced by a surplus (unspent income) in the remaining sector(s), this applies at all times.
Our current government has decided to aim for a surplus by 2020, a noble aim if you don’t understand national accounting. Unfortunately, we are currently running a trade deficit, as such, the foreign sector is running a surplus! This means we are spending more on goods abroad than we make from selling our goods abroad. Therefore for the government to derive its surplus, the private sector as a whole must run a deficit to fund the foreign sector’s and government’s surplus, so the accounts will add up to zero.
As the government’s deficit falls, the private sector’s deficit will rise, and our ability to spend less than we earn is compromised, making deleveraging (paying off our debt) increasingly difficult and, could be a driving factor in why household debt has risen so rapidly since 2010 as consumers resort to debt to make ends meet.
So next time you hear someone on TV or radio insisting on balanced budgets, what they are really doing is promoting unsustainable economic growth based on private debt, a tale that only ends in tears.
Note. There are times where running a surplus is appropriate, something I might touch on later. For a more mathematical explanation (simple algebra) of national accounting, click here.