Gavyn Davies comments:
"The graph shows the financial balances of the three sectors which comprise the US economy – the private sector, the government sector and the foreign trade sector. The financial balance of each sector is equal to its income less its total expenditure. A financial surplus indicates that the sector is a net acquiror of financial assets, while a deficit indicates that the sector is running down its net assets (or increasing its borrowing) to finance its activities. Because the three sectors cover all of the activities of the US economy, at home and abroad, their financial balances must sum to zero.
The first point to note is the dramatic reversal which has taken place in the past 3 years in the private sector’s financial balance. This sector includes both households and corporations, and in most economies it tends to record a small surplus most of the time. This was true in the US until the late 1990s, when the household sector started to run a financial deficit. Basically, rising equity prices, and then rising house prices increased personal wealth, and this induced households to reduce the amount they saved out of current income. As a result of this deficit, the private sector’s leverage ratio (the stock of outstanding debt/income) rose to record levels...
the key point to note is that a recovery in the economy is compatible with a continuing improvement in the debt ratio. Many people have claimed that these two things are not compatible, but that is wrong. A decline in the financial surplus (a flow variable) can be fully consistent with a fall in the debt ratio ( a stock variable). In fact, the pattern we are now observing in the US has been observed before in post-crisis economies, and it can persist for several years. If it does, the recovery will continue."
