My father is a saver. He had a lucrative career as a corporate lawyer. But, he didn’t spend like it. Although I never wanted for anything, we were certainly not awash in things. My mom and dad have had the same washing machine for 20 years. It works fine, so there is no need to replace it or upgrade to the newest model. My parents conspicuously saved for their retirement. And now, they are fine. I often joke with my dad that he should get the crowbar out, open his wallet and spend some money on himself. The point is my dad is a saver. And I am damn proud of his actions.
My dad is also in the distinct minority of Americans. Collectively, we don’t save anymore. We spend everything we make. And it is a problem that is now an epidemic.
Why is savings important? There are two very important reasons. First, at the macro-economic level savings is the engine of future growth. Individuals deposit their savings into the financial intermediaries such as banks, stock brokers, life insurance etc…. The intermediaries in turn lend the money in larger amounts to businesses that in turn invest in assets to increase their profits. The more money available, the lower the interest rates charged for loans. A key concept to remember is savings flow-through the economy from households to financial intermediaries to business. Secondly, and more practically, savings is vital in case of an economic downturn. If a person loses his job and has enough savings to still pay his bills for an extended length of time, that person has the ability to manage his affairs more prudently.
At the national level, the US savings levels are pathetic.
The only organizations actually putting aside money are corporations. The amount of money they put aside was 174.9 billion in 2000, which increased to 397.3 billion in 2004.
The Republicans are in charge at the federal level. This means borrow and spend is in full force. The federal budget deficit has ballooned under the fiscally conservative party again.
At the household level, the numbers are poor. First, economists define “savings” as disposable income (personal income – taxes) minus consumption expenditures. A non-ecogeek way to say this is savings is what is left over after you pay your taxes, bills and general expenses. Essentially, we are trying to isolate money households don’t spend today that they can readily access tomorrow with no financial strings attached (such as interest) should they need it.
In 2000, savings was 2% of personal income and 1.7% of GDP. In 2004, the numbers were 1.5% of personal income and 1.26% of GDP. The latest personal income numbers indicate that number is nearing 0%. In words, at the macro level, people are spending more and more of their income every month and putting less and less away for future consumption.
Over the same period that people were not putting money away, they were increasing their debt levels. Total household borrowing was 5.5 trillion in 2000 and a little over 10 trillion in 2004. Explosive growth in mortgages is the primary reason. Total mortgage debt increased from 3.36 trillion in 2000 to 8.78 trillion in 2004. People aren’t saving from their paychecks. Instead, they are borrowing against future earnings and anticipated asset appreciation.
The above examples illustrate a fundamental US economic problem: we are too dependant on consumer spending for economic growth. We are slowing moving away from the concept of making things to the concept of consuming things. A primary argument used by this administration in trade talks is other countries have insufficient demand. What they fail to recognize is the US has too much demand and is too dependant on demand for economic growth.
More importantly, savings allows the US consumer to weather financial storms and enjoy retirement. The less we save as a country, the more vulnerable we are to economic downturns. A lack of savings is essentially a huge problem that is waiting to cause serious damage.
Let me start off by saying: Saving is important. Not only on the macro-level, as Bonddad has shown, but also on the micro-level – individual entities.
Cutting through some tediousness I’m going to assert savings is a micro-level phenomena, focus on that, and pretty much ignore the macro-level.
The easiest way for individuals to save is in their local financial institutions: banks, savings and loans, and credit unions. The majority of people use a bank in order to have a checking account. One of the predicates of savings is, at a minimum, the savings hold their purchasing value; the goal, however, is to have those savings increase over time from a series of interest payments.
So let’s look at the return:
M1 money you can immediate ‘get at’) savings in my area return ~2.5% giving $102.50/year.
CPI (from the Economist of three weeks ago) is 3.6%. I will estimate total taxation at 20%. (I can’t find my current copy of the Economist!)
Total Net in constant dollars at the end of the year is $98.81 when the CPI is computed and $98.31 when tax is added to the equation.
A loss of 1.69 per year per $100 if tax is included. A loss of $1.29 per year per $100 excluding taxation.
Individuals, according to this ‘back of the envelope’ analysis, are being perfectly rational – in the near term – by not saving. The savings does not retain its purchasing power nor is a positive net return gained on monies previously saved; neither the minimum or goal is achieved.
Note the above is focused purely on savings. The way ’round the problem is investment … a different animal.
For most Americans ‘savings’ should be conducted by paying off debt which gets the greatest return per dollar. If a consumer is getting ~2.5% in a savings account and getting charged 12% or more on a credit card – it’s a no brainer. Pay off the fracking credit card.
So at the micro-level the most rational action is to not save and pay off consumer debt.
And that is a great big ‘irk’ for two reasons:
So, the rational micro-level economic action an individual can make suppresses local economic activity.
irk
It also explains the net outflow of funds from money market funds over the same time.
However, net acquisition of financial assets for the last 5 years is also negative. Essentially, people are acquiring more liabilities than assets. So, regardless of the form of generic savings, it is still a net losing game at the macro level.
Great post.
One thing that I’d like to throw in there though, is an addendum to this:
This is obviously the right path from a math standpoint, but from real world experience, I can say that you’ll pay off credit cards (or other high interest debt) a lot faster and easier if you’ve at least got a bit saved away.
The reason of course is that if you’re putting all your income towards consummables and debt reduction, you’re unprepared for unexpected expenses. It can be disheartening to pay down a credit card, only to be hit with a needed car repair bill, etc., and see that balance climb back up.
By having at least a little bit put away for an emergency fund, you can pay down your debt while remaining prepared for those little inconveniences.
My $.02.
Any chance that this links to the fact that wage growth in the US has been pretty much stagnant for a long time?
I can’t prove the connection, but I think they are directly related. With the rise of home equity loans and home price appreciation, I would bet that people with stagnant wages are using home equity loans to supplement their income.
As fewer people have discretionary income, fewer people will save.
If people start saving though, doesn’t that put us in danger of a recession at this point? It seems that the consumer debt is a major factor in fueling the economy right now.
Am I correct in thinking that the situation is basically : We need to start saving more in order to be better prepared for the economic downturn that will eventually come, and which might be partially fueled by our starting to save more?