• Edward Ballsdon

Follow the Cash

The US Treasury (UST) has issued a record amount of debt this year, $2.23 trn in the last 9 weeks alone ($2.5trn year to date), taking the total outstanding marketable debt on the 28th May to $19.8trn.

Judging by the UST's quarterly refunding announcement, and taking into account some additional small net bill issuance, the UST will issue a further $550bn of additional debt over the next three months.

When the UST issues debt to the market, it raises cash which is made available to the government to spend. Until those dollars are spent, they can be held at an account at the Federal Reserve. Chart below shows how that account balance has ballooned, reaching a staggering $1.4trn.

There is a lot of discussion about "money creation" and how this will be very inflationary when its passed on to the private sector and gets spent. Is this cash balance part of that money creation?

The US Government, like many companies and individuals, has a large cashflow problem with Covid19. Its income (i.e. tax revenues) has quite literally fallen off a cliff, whilst its expenditures have remained steady (and even increased).

The 20 year chart below shows the US Government's

  • Receipts (composed predominantly of Income Tax, Social Insurance Contributions, Corporate Tax and Tax on asset income).

  • Expenditures (Transfer Payments, i.e. Social Security, and Consumption Expenditures).

  • Deficit, simply the receipts less the expenditures.

N.B. The quarterly data seasonally adjusted at annual rates.

Of note, and refer to the chart below which shows the quarterly change in receipts and expenditures during the GFC:

  • The deficit had already been increasing pre Covid19 due to the widening gap between Total Expenditure and Total Receipts.

  • There were two Expenditure peaks in 2008 and 2009 due to the increases in Transfer Payments (+$384bn annualised between 2Q08 and 2Q09) .

  • the sharp decline in Receipts in 2009 (not 2008), due predominantly to a decline in Income Tax. Total tax receipts declined by an annualised $460bn between 4Q08 and 2Q09

On the 17th March the US Government announced that income and corporate tax due on the 15th April could be delayed by 3 months, and then on the 7 May there were suggestions this could be pushed back even further to to September or even December. This will mean that not only will tax revenues be materially lower, but they will also be received later, creating a cashflow funding problem. On the expenditure side, the unemployment rate has reached almost double the levels of 2009, suggesting that the expenditure requirement will increase materially higher than it did during the GFC.

Whilst this is all plain and obvious, the absolute numbers and timing of the cashflows are important when considering an impact on consumption and inflation. Like the aid to companies, which are primarily in the form of loans rather than grants, the delayed income and corporate tax will still have to be paid sometime in the future. In other words, the deficit today should be recouped when the taxes are paid later and that money is not there to be spent.

There is a good argument, therefore that the huge UST cash balance at the Fed is just a substitution for delayed cash from tax receipts, and thus cannot be inflationary in nature, assuming that income and corporate taxes will still have to be made. Likewise the huge cash Expenditure on Cash Transfers is unlikely to be inflationary because it will be income substitution for those who have lost their jobs.

The big question that remains is what the Federal Reserve will do with its balance sheet. It has itself purchased $1.8trn of US Government Bonds in 2020 by printing "temporary" liabilities on its balance sheet. There is a good argument that it has substituted the private sector deleveraging that occurred in March, allowing risk assets to maintain their values (which they might not have done had the private sector had to fund an additional $1.8trn of the deficit out of their savings).