Steve Waldman has a very good post over on his site about the concept of “net financial assets” and the way it is used by some economists (mainly MMT economists). Several of us covered this in excruciating detail several years ago when we had our big disagreements with the MMT people, but it’s always worth going over again because it’s an important concept in financial accounting.
For those who aren’t familiar, “net financial assets” refers to private sector assets issued by the public sector. That is, when the government borrows to spend money they issue a net financial asset because the private sector holds an asset without a corresponding liability (the liability is outside of the private sector). Steve details the accounting here in a very clean manner:
Every financial asset is also some entity’s liability. The sum of all financial positions is by definition zero. So we can write:
NET_WORLD_FINANCIAL_POSITION = 0[0]Suppose that, quite arbitrarily, we divide the world into a “foreign” and a “domestic” sector. Then we have:
NET_FOREIGN_FINANCIAL_POSITION + NET_DOMESTIC_FINANCIAL_POSITION = NET_WORLD_FINANCIAL_POSITION = 0 [1]
NET_FOREIGN_FINANCIAL_POSITION + NET_DOMESTIC_FINANCIAL_POSITION = 0[2]Suppose that, again arbitrarily, we decompose the domestic economy into a public and private sector:
NET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + NET_PUBLIC_DOMESTIC_FINANCIAL_POSITION = NET_DOMESTIC_FINANCIAL_POSITION[3]Substituting into our previous expression, we get
NET_FOREIGN_FINANCIAL_POSITION + NET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + NET_PUBLIC_DOMESTIC_FINANCIAL_POSITION = 0[4]We can also write this in terms of changes or flows. Since the sum above must always be zero, it must be true that any changes in one sector are balanced by changes in another:
ΔNET_FOREIGN_FINANCIAL_POSITION + ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + ΔNET_PUBLIC_DOMESTIC_FINANCIAL_POSITION = 0[5]Two of the flows in the equation above have conventional names, so we can rewrite:
CURRENT_ACCOUNT_DEFICIT + ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + CONSOLIDATED_GOVERNMENT_SURPLUS = 0[6]Rearranging…
ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION = -CURRENT_ACCOUNT_DEFICIT + -CONSOLIDATED_GOVERNMENT_SURPLUS [7]
ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION = CURRENT_ACCOUNT_SURPLUS + CONSOLIDATED_GOVERNMENT_DEFICIT [8]
Still with me? I hope so. Here are the three key points from this:
The crucial thing to understand is what the net means in net financial assets. It is precisely financial savings net of domestic real investment by the private sector. It is the farthest possible thing from a comprehensive measure of household savings. It is private sector savings excluding the vast preponderance of household savings, which is backed by private sector assets (whether owned by households directly or owned by businesses who then issue financial claims to households).
Private sector net financial assets are “special” precisely because they are not backed by domestic real assets, but instead by promises that are credibly independent of domestic real asset values, especially promises of states.
Net financial assets are special, because they serve insurance functions that assets produced by the domestic private sector simply cannot provide.
This is very nicely done. But the issue so many of us have here is not with the accounting, but with the way MMT sometimes presents this accounting and confuses people about it. I’ve been very critical of MMT people over the years because they sometimes say things like “The national debt is the equity that supports the entire global credit structure“. This is a rather misleading way to think of the economy and NFA. It’s as if government spending is the seed that gives life to the entire economy. And you can see how one might conclude that the answer to most economic problems is more government fiscal policy.
This reminds me in many ways of the Monetarist views on the economy. Monetarists often imply that the Federal Reserve has an Archimedean Lever over the economy and any deviation from trend growth is the result of the Fed. And in the MMT world you combine the Fed and the Treasury and the Archimedean Lever is fiscal policy.
These are two sides of similar political overreach in my mind. The Federal Reserve is a very important and necessary clearinghouse in an economy with private sector banking. And the government serves many important roles including acting as a support mechanism at times with its various tools. But we should be careful about viewing the government as the seed that gives life to the economy or supports the entire global credit structure. I would argue it’s quite the opposite. The credit structure of the global financial system is supported primarily by the strength and quality of private sector output. And the government can be used in ways to help support that credit structure at times. Start with the wrong understandings of the monetary system and you’ll arrive at potentially misleading conclusions about how best to utilize policy when it’ needed.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
