Friday, August 06, 2010

Personal Savings Increase Both Good & Bad

After rising at a three percent pace in the first quarter, consumer spending leveled off in the second quarter, another sign of a cooling economy.

Spending was flat in June, the third straight month of lackluster consumer demand. The reason, perhaps, was that incomes were also flat, amounting to their weakest showing in nine months.

Instead of spending, Americans have started saving.

Reaching 6.4 percent in June, the personal savings rate is now about three times the 2.1 percent average for all of 2007, before the recession began. It was also the third straight month with an increase, and the rate is now at its highest level in a year.

This is both good and bad news.

For many years, Americans had been tapping into their savings to fuel spending increases. What they weren't able to afford outright, Americans bought with credit.

Total household debt is now nine times what it was in 1981 — rising twice as fast as disposable income in the same period. Though it's been dropping for the last two years, household debt is still $13.5 trillion, exceeding disposable income by $2.5 trillion.

Debt-fueled spending indicates a lack of savings. Simply put, Americans have been spending money they don't have for quite some time.

In the 1970s and 1980s savings as a percentage of GDP were in the 5 - 7% range. In the decades since, personal savings have declined to the 1 - 3% range.

In 2005, the savings rate actually turned negative for the first time since the Great Depression, and it stayed that way for about two years. The lack of savings has some far-reaching effects. Millions of Americans are unprepared for a financial emergency, or for retirement.

As of this year, 43 percent of workers said they had less than $10,000 savings, up from 39 percent in 2009, according to the Employee Benefit Research Institute's annual Retirement Confidence Survey. That excludes the value of primary homes and defined-benefit pension plans.

Workers who said they had less than $1,000 jumped to 27 percent, from 20 percent in 2009.

In recent years, as interest rates decreased, so, too, did the American savings rate. In search of better investments, some Americans shifted out of savings accounts because of declining rates of return. Other Americans simply had nothing left to save; wages have been stagnant since the 1970s.

In early 2009, savings in aggregate as a percentage of GDP went negative for the first time since 1952, and has continued its downward trend. This includes consumer savings, corporate savings, and government savings/surpluses.

The lack of savings creates an inability to domestically fund the huge deficits being run up by the federal government. That forces the nation to continue relying on foreigners to finance our debt.

But, rather suddenly, consumers are saving again. Cautious Americans saved more in May than at any time since September. According to the Commerce Department, the personal savings rate in May -- the part of every paycheck that goes unspent -- rose to 4 percent, the highest amount in nearly a year. And it increased again in June.

While this has its virtues, it will also present some challenges.

Consumers have begun saving at a time when the U.S. economy needs their dollars the most. Any hope for a recovery rests on consumer spending, which comprises 70 percent of our nation's GDP.

Unfortunately, Americans weren't saving during the salad days of the last decade. Instead, they were consuming and creating debt. And now, when they are needed to spend the economy out of its doldrums, there is very little to tap into.

American consumers are rightly worried about the economy and about their own personal finances. So they are paying off debt. And recent reports indicate they are putting off large purchases, like homes and the durable goods that fill them.

An increase in the personal savings rate, while usually a welcome sign, is just exactly what the US economy doesn't need right now. On the other hand, all the debt creation of the last decade is what got us into this mess in the first place.

At the moment, it is both a blessing and a curse. But given the state of the economy and wages, a savings increase is probably just a temporary phenomena. Most Americans will likely end up spending all of their income on essentials anyway.

Whether that will be enough to jump start the economy seems unlikely.

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