Tuesday, January 6, 2009

The "Paradox of Savings"

This is a video I did for a show called "Meet the Bloggers." It highlights one of the central problems of the US economy: we consume at massive rates at the expense of savings.

Here is a chart from the St. Louis Federal Reserve of the personal savings rate:

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Notice it has been declining since the early 1980s. Let's coordinate that data with this chart of household debt:

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This chart has been increasing for some time.

And finally, here is a chart of consumer debt payments as a percent of disposable income:

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This number has been increasing since the early 1990s.

Usually an increase in the savings rate is a good thing. But not now:

Usually, frugality is good for individuals and for the economy. Savings serve as a reservoir of capital that can be used to finance investment, which helps raise a nation's standard of living. But in a recession, increased saving -- or its flip side, decreased spending -- can exacerbate the economy's woes. It's what economists call the "paradox of thrift."

U.S. household debt, which has been growing steadily since the Federal Reserve began tracking it in 1952, declined for the first time in the third quarter of 2008. In the same quarter, U.S. consumer spending growth declined for the first time in 17 years.

That has resulted in a rise in the personal saving rate, which the government calculates as the difference between earnings and expenditures. In recent years, as Americans spent more than they earned, the personal saving rate dipped below zero. Economists now expect the rate to rebound to 3% to 5%, or even higher, in 2009, among the sharpest reversals since World War II. Goldman Sachs last week predicted the 2009 saving rate could be as high as 6% to 10%.

As savings increase, economists say, spending is likely to contract further. They expect gross domestic product to decline at an annualized rate of at least 5% in the fourth quarter, the biggest drop in a quarter-century.

"The idea that the American family will quickly spend us out of this recession is a fantasy. It won't happen," said Elizabeth Warren, a professor of law at Harvard University who last month was named chair of the Congressional oversight panel tasked with overseeing the distribution of the government's Troubled Asset Relief Program funds.

BUT consider this:

The flaw of looking at savings as undercutting spending and deepening a recession is that it looks at the beginning of the down cycle and not what helps bring about the end.

As prices of everything from cars to housing fall, the money which has been taken out of wages and put into savings to reduce credit balances is available for purchases. Items get so inexpensive that consumers are drawn back into the market. But, drawing them in depends on their ability to capitalize on weak demand and falling prices. A tax cut and stimulus package will increase that ability geometrically.

The trend toward savings may be bad this year, but it may be a salvation in 2010.