3 Sector Financial Balancing Act

For a clear overview of the the zero sum game the government is playing see Robert Parenteau‘s diagramme from Financial Perspectives from Kansas City..

…On the vertical axis we track the fiscal balance, and on the horizontal axis we track the current account balance. If we rearrange the financial balance identity as follows, we can also introduce the domestic private sector financial balance to the map:

Domestic Private Sector Financial Balance = Current Account Balance – Fiscal Balance …

..Or to put it more bluntly, if European countries try to return to 3% fiscal deficits by 2012, as many of them are now pledging, unless the euro devalues enough, then either a) the domestic private sector will have to adopt a deficit spending trajectory, or b) nominal private income will deflate, and Irving Fisher’s paradox will apply (as in the very attempt to pay down debt leads to more indebtedness), thwarting the ability of policy makers to achieve fiscal targets. In the case of Spain, with large private debt/income ratios, this is an especially critical issue.

The underlying principle flows from the financial balance approach: the domestic private sector and the government sector cannot both deleverage at the same time unless a trade surplus can be achieved and sustained. We remain hard pressed to identify which nations or regions of the remainder of the world are prepared to become consistently larger net importers of Europe’s tradable products, but it is also said that necessity is the mother of all invention (and desperation, its father?). Pray there is life on Mars that consumes olives, red wine, and Guinness beer.

Rob Parenteau, CFA
MacroStrategy Edge
February 22, 2010
* This article originally appeared on NakedCapitalism