In-depth analysis on Credit Writedowns Pro.

Where is the money going?

According to the Federal Reserve, money market fund holdings of households has declined by about $380 billion since the end of 2008. (According to AMG, all money market mutual funds—institutional and retail—have posted net outflows of about $1 trillion over that time.) When we see big flows like that, we scratch our heads and ask what’s going on.

It’s not going into bank accounts. Checking, time and savings deposits are about flat over that time. Is it going into bonds, in the form of savings searching for more yield perhaps? Perhaps some of it, but the net outflows of cash from money market mutual funds dwarfs the net inflows into bond mutual funds. And despite the run up in Treasury holdings, total credit market investments by households is only up about $160 billion, or 4%, which is probably mostly capital gains and not new money. It’s not going into stocks, either. Indeed, there has been an increase of over 30% or $1.9 trillion in the balance sheet holdings of corporate equities and mutual funds shares, but that is likely all capital gains, too. AMG reports that flows into equity mutual funds has been almost zero over that time period. Yes, household debt is declining over the period, so there is a certain amount of principal repayment going on as part of the great deleveraging: from the end of 2008 home mortgages and consumer credit have declined by $429 billion on household balance sheets. With the rise in involuntary and strategic defaults, however, it is unclear how much of that debt is being paid off or just liquidated.

One possibility, of course, is that a lot of the drawdown in cash holdings by households is going into consumption. Take a look at the following two graphs (presenting data from 1959 through April 2010), which are variations on others we have run in the past. The first is a graph of the broad components of personal income—wages and salaries, income from assets, proprietors’ income and government transfer payments—versus consumption of goods and services. The ratio of these two lines is a little over parity right now. The second graph backs out government transfers from our adjusted income number, to show what working people basically have to live on before any government assistance. Without the government transfers, income only covers 88% of consumption. In the latest point, it falls short by $1.24 trillion (government transfers totals $2.24 trillion). Now, let’s make one more assumption: Two-thirds of government transfers is Social Security and Medicare, which mostly goes to the elderly. We would guess if these two graphs could be broken down by age so it excluded the income and spending of people over the age of 60, it would show an even deeper spending hole that is not covered by government transfers. That hole used to be filled by cash from borrowing, home equity extraction and realizing capital gains. Today, in the post-housing-bubble-tight-credit-world in which we live, we think it is being filled by that cash that is moving out of money market funds. But we could be wrong and would love to hear other ideas. Where is the money going?

adjusted-income

income-before-transfers

About 

Annaly Capital Management, Inc. (NYSE:NLY) manages a portfolio of mortgage-backed securities, and its wholly-owned subsidiaries manage assets for and provide services to institutional and individual investors worldwide. Annaly’s principal business objective is to generate net income for distribution to investors from its mortgage-backed securities and from dividends it receives from its subsidiaries. Annaly has elected to be taxed as a real estate investment trust (REIT).

15 Comments

  1. Brendan says:

    We’re all living off of our savings now in a rush to eventual poverty.

    • Exactly. Hence the importance of continuing to run government deficits.
      This is not Keynesian theory. As a matter of national accounting, a
      government budget deficit adds net financial assets (adding to non government
      savings) available to the private sector and a budget surplus has the opposite
      effect. The last point requires further explanation as it is crucial to
      understanding the basis of modern money macroeconomics.
      While typically obfuscated in standard textbook treatments, at the heart of
      national income accounting is an identity – the government deficit
      (surplus) equals the non-government surplus (deficit). The only entity that can
      provide the non-government sector with net financial assets (net savings
      denominated in the currency of issue) and thereby simultaneously accommodate
      any net desire to save (financial assets) and thus eliminate unemployment is
      the currency monopolist – the government.
      It does this by net spending – that is, running deficits. Additionally, and
      contrary to mainstream rhetoric, yet ironically, necessarily consistent
      with national income accounting, the systematic pursuit of government budget
      surpluses is dollar-for-dollar manifested as declines in non-government
      savings.
      A simple example offered by Bill Mitchell reinforces this point:
      “Suppose the economy is populated by two people, one being government and
      the other deemed to be the private (non-government) sector. We abstract from
      the distinction between the external and private domestic sectors here –
      which mostly only involved distributional considerations anyway.
      If the government runs a balanced budget (spends 100 dollars and taxes 100
      dollars) then private accumulation of fiat currency (savings) is zero in
      that period and the private budget is also balanced.
      Say the government spends 120 and taxes remain at 100, then private saving
      is 20 dollars which can accumulate as financial assets. In the first
      instance, they would be sitting as a 20 dollar bank deposit have been created by
      the government to cover its additional expenses. The government deficit of
      20 is exactly the private savings of 20.
      If the government continued in this vein, accumulated private savings
      would equal the cumulative budget deficits. The government may decide to issue
      an interest-bearing bond to encourage saving but operationally it does not
      have to do this to finance its deficit. If the savers transfer their
      deposits into bonds their overall saving is not altered and it has no implications
      for the government’s capacity to spend. It has the advantage for savers
      that they now also enjoy an income flow from their saving.
      However, should government decide to run a surplus (say spend 80 and tax
      100) then the private sector would owe the government a net tax payment of 20
      dollars and would need to sell something back to the government to get the
      needed funds. The result is the government generally buys back some bonds
      it had previously sold. The net funding needs of the non-government sector
      automatically elicit this correct response from government via interest
      rate signals. Either way accumulated private saving is reduced
      dollar-for-dollar when there is a government surplus.”
      So it is clear that the government surplus has two negative effects for the
      private sector: (a) the stock of financial assets (money or bonds) held by
      the private sector, which represents its wealth, falls; and (b) private
      disposable income also falls in line with the net taxation impost.

      In a message dated 6/23/2010 6:52:23 A.M. Mountain Daylight Time,
      writes:

  2. I for one, don’t think you’re missing anything. As a big proponent of Occam’s Razor, I tend to believe the obvious answer is the correct one – rightly or wrongly. The correlation in the time series is undeniable to me.

    In reading Marshall’s response, I think I understand the point. It seems very similar to Koo’s point on balance sheet recessions and the government’s role in stopping the deflationary process. I guess my heartburn is simply trying to understand how this really helps.

    If we let a deflationary cycle run its course, it will eventually run its course. Trees don’t grow to the sky and they don’t crash straight to hell, either. If that’s a faulty thought process, I’d like to hear that and why it’s faulty. I guess I just see it as “getting through it by going through it.”

    In my mind, the way this plays out is a landscape where real rates of inflation (and real rates of return to go along with it) are squashed as borrowing costs stay lower than people realize, for longer than people realize (Japan redux, if you will). But with the excessive liquidity out there, volatility is heightened: little return for lots of excessive risk.

    If someone can enlighten me or show where I’m thinking about this incorrectly that would be great.

    • No, I think you are right. The existence of the automatic stabilizers
      does ultimately put a floor on economic activity and largely prevents the onset
      of Great Depression II. But properly targeted fiscal policy can do much
      more. I’m sorry this is causing you heartburn, but I suspect you’d feel
      something a lot worse if we really let Fisher’s debt deflation process go full
      rip. If households attempt to net save by spending less than they are
      earning, and businesses attempt to net save (reinvesting less than their
      retained earnings), then nominal incomes and real output will be likely to fall.
      Money incomes and economic activity will tend to contract until private
      savings preferences are reduced (with essential goods and services taking up a
      larger share of household income as incomes fall), or until depreciation
      leaves businesses and households inclined to invest once again in durable
      assets. Common sense suggests that a drop in private income flows while
      private debt loads are high is an invitation to debt defaults and widespread
      insolvencies – that is, unless creditors are generously willing to renegotiate
      existing debt contracts en masse.

      In other words, such a configuration is an invitation to Irving Fisher’s
      cumulative debt deflation spiral. Maybe you think that is desirable. Most
      people wouldn’t agree. The coming period, especially in Europe, will be an
      interesting test. I say interesting in the sense of an intellectual
      curiosity rather than anything that my sense of humanity might find to be
      acceptable. I am referring to the widespread acceptance by politicians around the
      world that fiscal austerity is good for growth. Governments are increasingly
      getting bullied into adopting austerity measures apparently thinking they
      will help their economies grow. My bet is that the austerity measures will
      undermine growth and when growth finally returns it will be tepid and as a
      result of other factors not related to the austerity. So the deficits and
      ‘wasteful government spending’ now being decried will be higher and the cry
      for even greater cutbacks will intensify. In the meantime there will be
      massive casualties among the poor and disadvantaged. So if you are correct that
      this whole process is wrong, well, in a few months we should be seeing
      rapid growth and reductions in the deficits. Of the countries that have led
      the charge (for example, Ireland) things don’t look good so far, but we’ll
      see.

      In a message dated 6/23/2010 9:58:54 A.M. Mountain Daylight Time,
      writes:

      • Appreciate the feedback. I never thought there was a panacea out of this situation, but frankly I think we’re trying to decide which choice is the least bad.

        I agree with you about the Fisher debt deflation spiral, in the sense that: 1) I’m in the minority and 2) The pain resulting from letting the spiral run its course will be extremely high; higher than most people will accept.

        So to me, it’s a choice: we continue growing deficits with government picking up the slack (from a velocity of money point of view; the decisions/best uses of that spending is highly debatable) so standards of living are stabilized and risks of social/political unrest are mitigated. Or we let things play out on the deflation front, possibly take our chances on the social/political effects, but have the potential of getting through the process faster, but with a bigger hole to climb out of.

        As for austerity I don’t put a lot of stock into its benefits the way it is currently being couched. I don’t think they’ll work as they’re being proposed, and the economic effects of austerity are well documented. Over time, I think there needs to be restructuring, though because looking at the developed world, we have deficits which, in & of themselves, don’t bother me. But when factored in with declining birth rates and economies that don’t innovate at the same rate as in the past (which implies lower GDP growth going forward), I have serious concerns. So my concerns are not for the hear & now, but in looking 20+ years down the road.

        For what it’s worth, reading what you & others have said about MMT has been fascinating.

        • Thank you for the nice words, Professor Pinch. To answer your main point:
          Well, 20, 30 or 50 years down the road, people are equally free to make
          their own decisions. There is no such thing as “bequeathing debt” to our
          grandchildren. Even on the orthodox understanding that today’s deficits
          lead to debt that must be retired later, tomorrow’s higher taxes used to
          service and pay off the debt represent a “redistribution” from a taxpayer to a
          bond holder. This might be undesired (perhaps bondholders are wealthier
          than taxpayers), but at least it is taxing one American and paying another
          American. Note also that the “redistribution” takes place at the time the
          payment is made. While it is often claimed that our deficit spending today
          burdens our grandchildren—as if we got to party now, and they get the
          hangover later—in reality we leave them with the government bonds that are net
          financial assets and wealth for them. If it is decided to raise taxes in, say,
          2050 to retire the bonds, the extra taxes are matched by payments made
          directly to bondholders in 2050.
          With regard to the decision to raise taxes in 2050—which does burden
          taxpayers in 2050—that is a possible but not necessary decision, and one that
          will be made in 2050. If the taxes are not increased later, we simply leave
          future generations with treasury debt that is a net asset in their
          portfolios, and any payment of interest provides net income to holders. Obviously,
          it will be up to future generations to decide whether they should raise
          taxes by an amount equal to those interest payments, or by a greater amount to
          equal retirement of debt. Even if we wanted to do it, we cannot put those
          burdens on future generations because we cannot dictate to them what the
          budget balance will look like in 2050.
          Moreover, unless the budget deficit really is a discretionary policy
          variable, future generations might find that their attempts to raise taxes (and
          slash spending) to achieve budget surpluses will fail because the budgetary
          outcome is mostly “endogenous” or nondiscretionary. That is a point that
          many of us have tried to make in these page (although I admit without much
          success, judging from some of the replies we get). Even if future
          generations do decide to raise taxes in order to burden themselves, they probably
          will not be able to retire the treasury debt we have left them with. So they
          might as well enjoy the treasuries as net wealth in their portfolios and
          avoid the pain of higher taxes. That is what generation after generation of
          Americans has done—they have kept the inherited debt. After all there was
          only one brief period in US history—back during President Jackson’s term—
          when a generation actually imposed sufficient taxes to retire all the federal
          government debt. And we had a severe recession after the fact. All other
          generations have adopted what we believe to have been a much more prudent
          approach: reducing the debt ratio by growing the economy rather than by
          raising taxes or slashing spending. That’s certainly how we did it after World
          War II.
          that economic growth outpaced the growth rate of public debt from the end
          of WWII to the late 1970s. As an isolated variable the level of debt to GDP
          cannot have a deterministic relationship to economic growth for this to
          have occurred. In fact, from the graph below we see that the relative growth
          rates break into two distinct periods—in the first from WWI through about
          1980 GDP grew faster than public debt and since then public debt grew faster
          than GDP. Also note that the GDP growth rates ending in both 1967 and 1997
          were approximately the same while the growth rates of public debt were
          dramatically different. So neither the level of debt to GDP nor the growth
          rate of public debt appears to determine economic growth rates.
          Left out of most discussions is historical context. Following WWII the
          U.S. had the only industrial infrastructure that was intact and faced greatly
          reduced competition for industrial inputs. The German army had moved deep
          into Russia before the war ended and therefore even the victorious nations,
          if victory can be a word associated with wars, were left with reduced
          productive capacity. And so, to the extent that global and local demand for
          goods existed, the U.S. was largely the only game in town. This was a recipe
          for outsized economic growth and that is what happened. Might the growth
          have been greater without the debt? Medieval philosophers left us with the
          curse of speculating about alternative universes. Reporting from the only
          universe that I inhabit, I have no idea and neither does anyone else. But it
          seems pointless to argue that there is some magical debt to GDP ratio, beyond
          which we are inexorably doomed.

          In a message dated 6/23/2010 11:12:36 A.M. Mountain Daylight Time,
          writes:

          Professor Pinch wrote, in response to Marshall Auerback:

          Appreciate the feedback. I never thought there was a panacea out of this
          situation, but frankly I think we’re trying to decide which choice is the
          least bad.

          I agree with you about the Fisher debt deflation spiral, in the sense
          that: 1) I’m in the minority and 2) The pain resulting from letting the spiral
          run its course will be extremely high; higher than most people will accept.

          So to me, it’s a choice: we continue growing deficits with government
          picking up the slack (from a velocity of money point of view; the
          decisions/best uses of that spending is highly debatable) so standards of living are
          stabilized and risks of social/political unrest are mitigated. Or we let
          things play out on the deflation front, possibly take our chances on the
          social/political effects, but have the potential of getting through the process
          faster, but with a bigger hole to climb out of.

          As for austerity I don’t put a lot of stock into its benefits the way it
          is currently being couched. I don’t think they’ll work as they’re being
          proposed, and the economic effects of austerity are well documented. Over time,
          I think there needs to be restructuring, though because looking at the
          developed world, we have deficits which, in & of themselves, don’t bother me.
          But when factored in with declining birth rates and economies that don’t
          innovate at the same rate as in the past (which implies lower GDP growth
          going forward), I have serious concerns. So my concerns are not for the hear &
          now, but in looking 20+ years down the road.

          For what it’s worth, reading what you & others have said about MMT has
          been fascinating.

          Link to comment: http://disq.us/exk5g

  3. Hambone says:

    Hi Marshall and Prof P,

    you are both well reasoned and well intentioned, so please understand my comments are w/ respect to both…and I’ll be honest that I’m only going to show why Marshall’s pov is problematic without offering any better proposal.

    Here goes – As of now the costs of the gov spending on interest are very low and not a significant issue in relation to GDP and this encourages, enables more stimulative spending.

    My concern is that the net savings will not return a great enough yield (GDP growth) to offset the interest payments on the public borrowings, particularly if there is a snap back to average short, mid, long term yields (this is particularly acute due to the current short term nature of T’s avg’ing 4.5yrs). The gov debts will, in essence, be indexed to inflation as they are rolled over (unfunded liabilities directly indexed). This means that either from a growth side at 5% GDP on $14T, the tax base would grow from $2 to $2.1T (yr 1) and not likely to keep up w/ a jump on $13+ trillion in T’s from current $200B to something like $400B or $800B (simply assuming short, mid, long rates return to average). Until we get min 3-5yrs out, assuming 5% GDP (likely?), the compounding won’t catch up.

    This spending leaves us in a downward spiral where we are forced to run greater budget deficits in search of the virtuous cycle. Every trillion in debt leaves another $40 to $80 billion annual interest payment primarily flowing out of our economy…and as we don’t pay principle on debt, these costs seem a structural drag onwards.

    Marshall has shown why not spending also has major issues. Points well taken.

    My point is both spending and not spending are a downward spiral and neither will lead to a satisfactory result (more spending with potential of inflation / hyperinflation vs. less gov spending will trend down immediately and likely result in a depression.

    A real discussion of the mid and long term impacts of both need to be debated. Does it really take a war or some similar event to break deflation or are we extrapolating from only one data point of the GD? What is the real risk and nature of inflation / hyperinflation? Are Weimar Germany or Zimbabwe credible or likely cases?

    I don’t have the answer but think a real open minded analysis is needed now to select our course w/ full knowledge of the devil with whom we proceed.

    • Well, if you don’t have a funding constraint per se, then I don’t see why
      the interest rate variable on the debt would be an issue. You are still
      thinking of this in terms of a government budget constraint (GBC), which
      doesn’t exist in reality.

      You also have to look at the impact that paying out higher rates of
      interest represents for the owners of the bonds. A higher interest rate simple
      means at maturity of the bond, the government credits the bank account with
      the face value of the bond plus interest and debit some account at the
      central bank (or whatever specific accounting structure deals with bond sales
      and purchases).
      There are many more examples of governments running continuous budget
      deficits with some central bank support (I don’t just the term printing money or
      even money creation as above) for extended periods where inflation has not
      been an issue.
      Most of the significant inflationary episodes in the last 50 years have
      been sourced in supply-side shocks rather than demand pull situations arising
      from aggregate demand outstrippling the real capacity of the economy to
      respond via output increases.

      In a message dated 6/24/2010 1:04:19 A.M. Mountain Daylight Time,
      writes:

    • Hambone you hit the nail on the head. Interest coverage is not an issue now, but if GDP growth rates don’t improve, tax collection doesn’t improve either. And if that doesn’t improve you do run into a debt servicing issue.

      In my mind, the only “solution” is to term the debt out. If you do this enough, you end up treating debt as equity. I’ve heard this argument before in rating companies (if the debt is low enough on the capital structure you can treat it as equity) and I don’t buy it. If there’s an interest payment that has to be covered and there’s no option/provision to convert the debt into equity, it’s a pointless conversation to have. It’s debt.

      • “Debt service” is not an issue in a country issuing its debt in its own
        free floating non-convertible currency. And the interest payments on that debt
        represent INCOME to owners of the debt. Ask any senior citizen about
        this.
        The ambition which seeks to reduce net public debt is also equivalent to
        saying that non-government holdings of government debt will fall by the same
        amount over this period. In other words, private sector wealth will be
        destroyed in order to generate the funds withdrawal that is accounted for as
        the surplus. What’s the point of that?
        Financial commentators often suggest that budget surpluses in some way are
        equivalent to accumulation funds that a private citizen might enjoy. This
        has overtones of the regular US debate in relation to their Social Security
        Trust Fund.
        This idea that accumulated surpluses allegedly “stored away” will help
        government deal with increased public expenditure demands that may accompany
        the ageing population lies at the heart of the intergenerational debate
        misconception. While it is moot that an ageing population will place
        disproportionate pressures on government expenditure in the future, it is clear that
        the concept of pressure is inapplicable because it assumes a financial
        constraint.
        A sovereign government in a fiat monetary system is not financially
        constrained.
        There will never be a squeeze on “taxpayers’ funds” because the taxpayers
        do not fund “anything”. The concept of the taxpayer funding government
        spending is misleading. Taxes are paid by debiting accounts of the member
        commercial banks accounts whereas spending occurs by crediting the same. The
        notion that “debited funds” have some further use is not applicable.
        When taxes are levied the revenue does not go anywhere. The flow of funds
        is accounted for, but accounting for a surplus that is merely a
        discretionary net contraction of private liquidity by government does not change the
        capacity of government to inject future liquidity at any time it chooses.
        The standard government intertemporal budget constraint analysis that
        deficits lead to future tax burdens is ridiculous. The idea that unless policies
        are adjusted now (that is, governments start running surpluses), the
        current generation of taxpayers will impose a higher tax burden on the next
        generation is deeply flawed.
        The government budget constraint is not a “bridge” that spans the
        generations in some restrictive manner. Each generation is free to select the tax
        burden it endures. Taxing and spending transfers real resources from the
        private to the public domain. Each generation is free to select how much they
        want to transfer via political decisions mediated through political
        processes.
        When we argue that there is no financial constraint on federal government
        spending we are not, as if often erroneously claimed, saying that
        government should therefore not be concerned with the size of its deficit. We are
        not advocating unlimited deficits. Rather, the size of the deficit (surplus)
        will be market determined by the desired net saving of the non-government
        sector.
        This may not coincide with full employment and so it is the responsibility
        of the government to ensure that its taxation/spending are at the right
        level to ensure that this equality occurs at full employment. Accordingly, if
        the goals of the economy are full employment with price level stability
        then the task is to make sure that government spending is exactly at the level
        that is neither inflationary or deflationary. “Servicing the debt” implies
        a government budget constraint which has no bearing in reality.

        In a message dated 6/25/2010 7:51:44 P.M. Mountain Daylight Time,
        writes:

        Professor Pinch wrote, in response to Hambone (unregistered):

        Hambone you hit the nail on the head. Interest coverage is not an issue
        now, but if GDP growth rates don’t improve, tax collection doesn’t improve
        either. And if that doesn’t improve you do run into a debt servicing issue.

        In my mind, the only “solution” is to term the debt out. If you do this
        enough, you end up treating debt as equity. I’ve heard this argument before
        in rating companies (if the debt is low enough on the capital structure
        you can treat it as equity) and I don’t buy it. If there’s an interest
        payment that has to be covered and there’s no option/provision to convert the
        debt into equity, it’s a pointless conversation to have. It’s debt.

        Link to comment: http://disq.us/f6vcb