Asymptosis

My gentle readers will know that I often struggle with economic terminology, both because I find usages are so vague, various, and poorly defined, and because I’m trying to understand fundamental terms’ fundamental meanings. Today I’d like to home in on one of the most fundamental — “assets” — and something even more fundamental that underpins it: “ownership.”

I’ll start with what I think is a usefully precise, technical, term-of-art definition:

Asset. n. A labeled numeric entry on the lefthand side of a balance sheet, designating the value of a claim (necessarily, designated in a unit of account).

This thing called an “asset“ only exists, only can exist, on a balance sheet. It’s purely an accounting term, and the entity only exists within an accounting construct. There’s no other meaning for the term. (Making it a usefully precise definition.)

This is contrary to the vernacular, where a house or a drill press is called an asset. (In this technical context these are more usefully called “goods” or “real goods” or “capital goods.”) Because really: how can both a house and the labeled tally of a claim on that house both be called “assets”?

“Financial assets” are distinguished in that they have related, offsetting liabilities on the righthand side of other balance sheets. That’s what defines the term. They’re claims on claims — claims against that other balance sheet’s assets/claims. That’s why there’s a liability entry over there. It’s the right side making a claim against the left side, on behalf of that other balance sheet that holds the asset. As such, financial assets only represent indirect (and variously contingent) claims on real goods, one or more claim-steps removed from claims on the goods themselves.

Purely “real” or nonfinancial assets have no such offsetting claims on other balance sheets. In theory, they represent direct claims on real goods.

That seemingly simple distinction, though, is far from simple when you start exploring it carefully.

To that end, consider the fundamental nature of “claims,” hence the nature and import of “ownership” and “property rights.” Full credit here to Matt Bruenig, who delivered the Aha! understandings for me on these topics — clear and (mutually) coherent definitions and explanations for concepts I’d been worrying at for years.

Mostly simply, ownership is an exclusionary legal claim. Ownership says you may have a picnic on your front lawn — which seems inclusionary, but that’s only meaningful because you may exclude anyone else from doing so. And you may invoke violence (farmed out to the police) to enforce that right of exclusion. As Matt has said so well, a modern ownership claim is best viewed as a violence voucher issued by government.

This imparts a decidedly sinister aspect to the lefthand side of balance sheets — a tally sheet of violence vouchers?

So now to return, with that understanding, to the notion of real vs financial assets. In large, in aggregate, in the big national or global picture, both types of assets ultimately constitute claims on real goods. Someone holding zero real/nonfinancial assets but significant financial assets can make an immediate and successful claim on a new Maserati — a very “real” good. Everyone else is excluded from claiming that Maserati.

If this exclusionary notion is safe, in a very real sense your “real,” “nonfinancial” asset claim is actually offset by a liability — on the (EverybodyElseIn)TheWorld balance sheet. Call the entry “Stuff that we’re excluded from touching.” If all those exclusionary claims wall off AllTheGoodStuff with violence, we’re talking a very real liability indeed — even though this imaginary World Balance Sheet doesn’t, and practically probably can’t, exist.

This notional balance sheet may seem crazy and outlandish to us. But our ownership, property-rights, and “asset” structures do and have seemed equally outlandish to other cultures:

…fee-simple ownership is not the only basis for ownership and possession of land. Many eastern cultures and tribal cultures throughout the world follow the “communal property system” in which ownership of land belongs to the entire social/political unit, like the tribe, families, bands, and nations.

From the inside, ideologies always look like common sense.

 

The remarkable discussion on “national wealth” and the national accounts that is running over at Interfluidity (373 comments and counting…) in response to my last post prompts me to recount an anecdote that I think is germane.

I took exactly one accounting class in my life, at the NYU MBA school — essentially Accounting for Non-Accountants, teaching us to deconstruct corporate financial statements into cash flow.

There were two profs. (I don’t remember their names.) The lead was an old hand, a long-time member of the Financial Accounting Standards Board (FASB), and a real comedian. The young guy was the straight man and enforcer — assignments, testing, and nuts-and-bolts lectures.

The beginning of the very first lecture, given by the old guy, has stuck with me ever since. He started with an anecdote. (Here recounted from distant memory.)

When I was an undergrad (he said), I hung out with these economics types. I was thinking of buying a new car. They told me, “don’t do that! As soon as you drive it off the lot it’ll lose a third of its value!”

But anyway, I went ahead and did it. I went through all the paperwork with the salesman, signed on the dotted line, and he handed me the keys. “Here you go,” he said. “Drive it away.”

I looked at him like he was crazy. “I’m not gonna drive it away,” I said. “It’ll lose a third of its value!”

Ba dum ba.

Then he explained why he used that anecdote right up front, framing the whole (rather grueling) semester-long exercise to come: Accounting, he said, is an exercise in assigning value to things that are often (mostly?) deucedly difficult to e-value-ate. Whether it’s the value of that car (before and after it leaves the lot), or the “wealth of nations,” accounting is inherently a problematic exercise in estimation. We just do the best we can.

Based on a decade or so of wrestling with the national accounts, I’d extend that thinking further. Sure, estimating value can be very iffy, but that estimation is also, always, a function of the accounting constructs and architecture used to do that estimation. Simply put, the national accounts are an economic model of the national economy. The map is not the territory. The presentation is inevitably stylized, like a Mercatus or Peters projection — and the choice of presentation has similarly important rhetorical and political implications.

The implication: as with any economic model, to understand what you’re seeing, you need to look not only at the results presented within the model, but at the model itself. You need to (at least) consider not just potential errors within a model, but model error itself. To get very philosophical: National account structures are, ultimately, epistemological structures — systems for trying to “know” things.

The national accounts, by their very status and position, discourage examination of their model. The notion that they’re “just accounting,” adding and subtracting straightforward measures, reifies them, and the model they present. The assumptions underlying that model are rendered invisible, apotheosized as god-given truths.

National-accounting sages are very much aware of this reality. Check out Jorgenson, Hulten, Hall, etc. on the “zero-rent” economic model that lies (hidden) at the core of the national accounts as constructed. (They mostly argue: appropriately so.) Or spend some time in that Interfluidity comments thread. If you haven’t thought critically and carefully about the national accounts’ economic model, you don’t understand the national accounts. (I’m not, by the way, claiming that I do. Despite lengthy exertions. Necessary versus sufficient and all that.)

That old-hand FASBer imparted, I think, a profoundly important truth. I’ve been struggling with its implications ever since.

To put across exactly how important and profound that truth is, I’ll end by passing the baton to John Maynard Keynes in his essay on “National Self-Sufficiency”:

Once we allow ourselves to be disobedient to the test of an accountant’s profit, we have begun to change our civilization.

I only got a B+ in the course, by the way.

Modern Monetary Theory has been revolutionary in economics, and its influence is — beneficially — ever-more pervasive. It has opened the eyes of a generation to a clear-eyed, accounting-based methodology that trumps dimensionless theory, and has brought a deep, nuts-and-bolts understanding of money, debt, and financial institutions to a discipline where that understanding has been inexcusably absent. Witness: a whole raft of papers from central-bank economists worldwide embracing MMT principles (though often not MMT by name), and eviscerating decades or centuries of facile and false explanations of monetary mechanisms.

But MMT’s terminology and associated accounting constructs remain problematic and contentious, even among some MMT supporters like the splinter group, the Modern Monetary Realists. Some of this contention results from the usual resistance to new ideas and ways of thinking. But some arises, in my opinion, because MMT terms and accounting constructs are indeed problematic. (The terminological confusion even causes some to object correctly, but for the wrong reasons — and vice versa!)

These difficulties are apparent when you consider one of MMT’s central and oft-repeated mantras and accounting identities, here in its simplified form for a closed economy ignoring Rest of World, courtesy of the redoubtable Stephanie Kelton:

Domestic Private Surplus = Government Deficit

This suggests an important truth, as far as it goes: public (monetarily sovereign federal government) deficit spending creates private assets out of thin air. The government spends new money, created ab nihilo, into private accounts. +Private Assets. No change to private liabilities. So: +Private Sector Net Worth.

But it doesn’t actually go very far. That “private surplus” (a term that is absent from the national accounts, and from MMT’s ur-text, Monetary Economics by Godley and Lavoie) is not defined in accounting terms, except circularly and tautologically: it’s the amount that private assets increase as a result of government deficit spending. That makes the identity true by definitional tautology.

But contrary to what’s at least implied by the equal sign, deficit spending is not the only way that private assets increase, or even the primary way. It’s not the only source of private-sector “surplus” or “saving,” as is often suggested in MMT discourse. Not even close.

Start by thinking in terms of Household Net Worth. This measure has the virtue of encapsulating and telescoping all private-sector net worth, because households ultimately own firms, at zero or more removes, but firms don’t own households (yet…). Citibank may own some GE shares, but Citibank is ultimately owned by households. Because: firms issue equity shares; households don’t. It’s an asymmetric, one-way ownership relationship.

Then take a look at this paragraph from MMTers extraordinaire Eric Tymoigne and Randall Wray:

MMT does differentiate between saving (in the flow of funds it is the change in net worth: ΔNW) and net saving (saving less investment). Net saving shows how the accumulation of net worth occurs beyond the accumulation of real assets. For the domestic private sector, this comes from a net accumulation of financial claims against the government and foreign sectors.

Some of the problems with this paragraph:

• Pace T&W, there is no “saving” measure in the Fed’s flow of funds accounts (FOFAs) that equals ΔNW — whether you’re talking net or gross saving (with or without consumption of fixed capital), including or excluding capital transfers.

• The “net saving (saving less investment)” bruited in that paragraph is confusingly at odds with the existing definition of the term as used in the national accounts — gross saving minus consumption of fixed capital.

• “Net accumulation of financial claims” does not appear anywhere in the national accounts, and has an uncertain relationship with a measure that the FOFAs do provide: “Net acquisition of financial assets.” Are these the same measures? If not, what is their accounting relationship?

I find here a set of terms that I’m unable to resolve into a coherent set of accounting statements — despite years of diligent and highly motivated efforts to do so. (I’m an ardent MMT supporter; I wouldn’t be thinking these thoughts if it weren’t for the MMT cabal.)

The core problem is these measures’ opaque relationship to net worth, and change in net worth. The problem exists because they don’t incorporate the primary way that net worth (wealth) is accrued: market revaluation of existing assets, a.k.a. capital gains. Market runups increase private-sector assets, without increasing liabilities. Voila: higher private-sector net worth. “Money” created, ab nihilo.

MMTers seem to have these conceptual, terminological problems for the same reason as more traditional economists (and due to MMTer’s efforts at speaking in those economists’ language): they’re still “thinking inside the NIPAs” — despite MMTers well-founded devotion to the FOFAs.

The BEA’s National Income and Product Accounts, pioneered by Simon Kuznets in the 1930s, are essentially income statements. They are one of the primary data sources for the FOFAs. But the NIPAs have a key failing: they don’t include balance sheets (the essential second component of a coherent accounting, which the FOFAs add). And the NIPAs completely ignore (with good reason) existing-asset exchanges and revaluations.

Absent balance sheets, and accounting for existing-asset revaluation, it’s impossible for balance sheets — and net worth, period to period — to…balance. Economists who don’t deeply understand that — and I will assert that few economists do, because they’re conceptually trapped inside the NIPA’s balance-sheet-free definitions of income and saving — cannot form a coherent understanding of an economy’s workings.

In Monetary Economics, Godley and Lavoie (G&L) do show a deep understanding of revaluation’s importance — they give extensive coverage to the Haig-Simons accrual-based mark-to-market accounting approach that I also favor. But you’ll be hard-pressed to search Google for top MMT names (Wray, Tymoigne, Kelton, Fullwiler) and find asset revaluation, capital gains, or Haig-Simons accounting incorporated into their discussions of income or saving.

This even though the FOFAs (presented in the Fed’s Z.1 reports) provide exactly that: balance sheets and income statements based on Haig-Simons  accounting — using accrual-based, marked-to-market revaluation of existing assets — wherein the sum of accounted flows totals to balance sheets’ period-to-period net worth changes. See for instance the Household tables B.101 (bottom line: net worth) and R.101 (top line: change in net worth).

Those FOFA tables are the source of the Integrated Macroeconomic Accounts for the United States (IMAs), which unlike the NIPAs, conform (mostly) to the international System of National Accounts (SNAs). See for instance Household table S.3.a, which includes the income statement and balance sheet on a single page (bottom line: net worth).

You will find a similar Haig-Simons approach in Armour, Burkhauser, and Larrimore 2013, an analysis that merits significantly more attention, and replication. (The authors, inexcusably, have not made their data set available.) The FOFAs and IMAs provide the necessary revaluation estimates for such a replication, estimates which Armour et. al. achieve by their own methods (somewhat different from the Fed’s, but using similar indices).

This is all important because the widespread MMT statement (at least implied, and frequently explicit) — that government deficits are the source of private saving (or “surplus”) — is at least a poor explanation of economic workings, and at worst just wrong. Government deficits are a source of private saving.

The two primary sources of private assets (hence saving) are:

1. Surplus from production (how “surplus” is commonly used in the national accounts), monetized by the markets for newly produced goods and services.
2. Revaluation of existing assets — assets produced in previous periods — realized in the existing-asset markets.

I would even go so far as to say that these are the primary mechanisms whereby “money” is created. Deficit spending is small beer compared to cap gains. Asset markets go up, and there’s more money. This eschews the widespread confution of money with “currency-like things,” suggesting rather that all assets — which since they exist on balance sheets are necessarily designated in a unit of account — embody “money.”

As an aid to untangling the confusion that I still find inherent in MMT discourse, I offer up the following taxonomy of sources for household income. It’s explained in detail here.

Household Income Sources
Comprehensive Income (gross contributions to net worth, before netting out expenditures)	Non-Property Income (compensation for labor)	Other Labor Income	Social benefits and other transfers received (including employers’ social contributions)
		Primary Income	Primary Labor Income: Wages and salaries
	Comprehensive Property Income (compensation for ownership)		Primary Property Income: Dividends, interest, proprietors’ income, rental income, and operating surplus
		Other Property Income	Market asset revaluation (capital gains)
			Other changes in asset volume

Here’s what that looks like in an accounting statement, here using IMA data:

Before you raise objections, I point you again to further explanation of this construct, here.

Like Armour et. al., I use a measure labeled “Comprehensive Income” that includes accrued, marked-to-market capital gains. I go a step further, however, and propose another measure based on that, a residual of sources and uses: “Comprehensive Saving.” That measure has a singular virtue: it equals change in net worth.

“Primary income” — the vestige of the NIPA’s “income” measure that is carried over into the FOFAs and IMAs (but properly labeled as “Balance of primary incomes”) — is given as an addendum measure. The measure here varies from the FOFAs/IMAs only in that interest paid is not deducted from income; it’s tallied under Uses.

Comprehensive Saving does not, of course, equal government deficit spending. (Nor does Primary Saving.) Such spending contributes to private-sector saving, but it’s not even vaguely identical.

Before concluding, I’d like to touch on private-sector bank lending. (Modern Monetary Realists, are you listening?) Its direct effect on net worth is zero. It creates new assets — bank deposits. But unlike government deficit spending, it also creates equal and opposite offsetting liabilities on both the borrower’s and the bank’s balance sheets. Both balance sheets expand, equally on the left and right sides.

Borrower: +Assets (new bank account deposits)  +Liabilities (new loan payable)

Bank: +Assets (loan receivable)  +Liabilities (customer deposits withdrawable)

So the act of private lending itself creates new assets, but it doesn’t directly, in accounting terms, increase private-sector net worth.

But: borrowers use many of those loans to create real assets — goods, capital — that are then sold at a higher value (or marked to market at a higher value). That markup increases private sector net worth, and private lending is a huge catalyst for that process. But that is an economic effect, not an accounting identity.

So yes: private bank loans create new private-sector assets, and they have the indirect economic effect of increasing net worth, but they don’t, directly and in and of themselves, increase private-sector net worth. Government deficit spending does. MMTers are right that it’s special in that way.

What they’ve missed — or caused many of their followers to miss — is that it’s not the only thing that’s special in that way.

Really, it’s not even close:

Runups in stock and real-estate markets create new wealth, net worth, “savings,” money, out of thin air — just like deficit spending, but by a different mechanism.

The markets create money too.

Cross-posted at Angry Bear.