Tuesday, May 29, 2012

The American Condition: Debts Remain High, Disposable Incomes & Savings Remain Low

The U.S. is a consumption-based society. It is also a materialistic society. After all, we have entire TV networks dedicated to shopping.

In addition to overwhelming debt, our consumption and materialism produced another rather remarkable result: 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.

However, after the financial collapse in the fall of 2008, the U.S. savings rate started to climb. Although those who lost jobs or took pay cuts had nothing to save, most Americans began to change their spendthrift ways.

The savings rate jumped from 1.3 percent in January of 2008 all the way to 6.9 percent in May of 2009 — the highest level in 15 years.

The resulting fear and panic from the Great Recession led people to stop the frivolous spending of the bubble years and instead begin paying down debts and saving. Those were wise and, perhaps, expected choices given the economic environment.

Historically, savings rates tend to increase during times of recession.

During the early 1980s, when the economy was in a severe double-dip recession, the annual personal saving rate (effectively, income minus spending) averaged around 10%. But by the time of the 1990-91 recession, it had fallen to an average of 7%.

However, that savings rate now seems quite high, given how far it fell over the next 15 years, or so.

By 2001, the rate had fallen below 2 percent and as the decade progressed it fell below 1 percent multiple times. Finally, in 2005, at the height of the American spending and debt binge, the savings rate turned negative. Americans were actually spending more than they were earning.

All of that spending and consumption resulted in a whole lot of debt; total U.S. household debt reached a whopping $13.8 trillion by 2008.

A higher savings rate is critical because it makes more money available for business investment. And it can reduce the need to borrow from overseas. The downside is that it also leads to a slow down in a consumption-based economy.

Since consumer spending accounts for 72 percent of our GDP, it's a good indicator of how the economy is faring. If people are saving instead of spending, the economy will tend to shrink — unless the government leaps in to fill the void, as it did with the stimulus in 2009 and 2010.

Consumers have long been the engine that continually powered the ever-expanding U.S. economy. However, for many years, American consumers propelled the economy with debt-based spending. If Americans don't maintain their high-level of spending, the economy will fall into recession once again.

In the previous decade, Americans fueled their spending binges with home equity extractions.
From 2003 to 2007, people extracted more than $2 trillion from their properties in the form of home equity loans and cash-out refinancing — about 20 percent of which went to fund personal spending.

The obvious question now is, Where will Americans find the money to continue spending at a rate that will keep the economy humming along at a sufficient level?

According to the Federal Reserve, household real estate assets rose by more than two-thirds from 1999 to 2005. Americans used all that home equity to finance an unprecedented spending spree. Those days are long gone and now the economy has come back down to reality as a result. All bubbles eventually burst.

By the end of 2009, total household debt was nine times what it was in 1981 — rising twice as fast as disposable income in the same period.

Fed data also shows that the end of 2011, household debt was down to $13.2 trillion. Meanwhile, total disposable income was $10.7 trillion.

Household net worth—the difference between the value of assets and liabilities—was $58.5 trillion at the end of 2011. Though that was about $1.2 trillion more than at the end of the third quarter, for 2011 as a whole, household net worth fell close to 3/4 percent, the first annual decrease since 2008.

Perhaps falling wages and salaries have driven Americans to save less and instead spend what they must on necessities. The U.S. savings rate plunged from 4.7 percent in December to 3.7 percent in February, the lowest level since December 2007's 2.6 percent.

The lower savings rate is problematic for a number of reasons. For instance, it leaves people unprepared for retirement, or even an emergency.

The percentage of workers who said they had less than $10,000 savings grew from 39 percent in 2009 to 43 percent in 2010, according to the Employee Benefit Research Institute's (EBRI) annual Retirement Confidence Survey. That excludes the value of primary homes and defined-benefit pension plans.

Consequently, the EBRI found that many workers' retirement saving will run out too soon.

In this year's Retirement Confidence Survey, 60 percent of workers reported that the total value of their household's savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000.

Perhaps this is why just 14 percent of Americans polled in this year's survey said they were “very confident they will have enough money to live comfortably in retirement.”

A recent study by LIMRA, a life insurance and financial services research organization, found that nearly half of American workers are not contributing to any form of retirement plan.

Outside of those who work in government, most people no longer have an employer pension plan to fall back on. The shift from defined benefit to defined contribution retirement plans has put the responsibility for saving solely on the employees. Apparently, that's not working out so well.

Even more worrisome, just 36 percent of workers said they had $1,000 in emergency savings in 2011. This means that nearly two-thirds of workers don't even have $1,000 set aside for an unplanned expense. That could prove crippling should an unexpected medical cost, home repair, or personal disability arise.

In another survey last year, 24 percent of respondents said they had no emergency savings whatsoever.

With interest rates running well below the rate of inflation, money in a savings account or other deposit vehicle is actually losing purchasing power with each passing day. Perhaps that's part of the reason that Americans aren't saving.

As interest rates have fallen, many Americans have sought a higher rate of return form other investments, shifting out of savings accounts in the process.

Other Americans simply have nothing left to save; adjusted for inflation, wages have been stagnant since the 1970s.

It's clear that the hard times we're living in have made it quite difficult for many Americans to plan for retirement, or even a family emergency. Long term unemployment has long since dried up the savings of millions of Americans who now live day to day.

According to financial planners, most people need three to six months of living expenses in emergency savings, amounting to about half of one's gross income.

However, for a vast majority of Americans, it seems this is nothing more than a pipe dream.

And when you're struggling to get by, trying to make ends meet from week to the next, retirement can seem a long way off... until it isn't.

Then what?

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