Wednesday, August 20, 2008

Saved by U.S. Savings? Don't Count On It

The new happy talk goes like this: Americans are getting thrifty, paying down debt and saving money. Interest rates will drop because they're going to dump all their savings into safe U.S. Treasury bonds. Once they've lowered their non-mortgage debt payments to 10% of income from the current 14%, then this gloriously low-interest rate environment and these trillions in new savings will spark the next Bull Market cycle of growth--in, say, mid-2009.

Nice story, and I love the Hollywood ending. But is there any shred of reality in the fairy tale? It turns out academics have been struggling for the past 15 years to explain the declining U.S. savings rate, which dropped into negative territory in 2006 and 2007. The number of causal agents in the U.S. economy is huge, so quite naturally there is no one academically vetted "answer." Nonetheless, there are a few theories which have gathered some constituencies.
Let's start with a chart of the U.S. personal savings rate:

Please go to to view all the charts.

The happiest story is that Americans don't need to save anymore because the equity in their 401K stock market holdings and in their homes has skyrocketed, creating a huge pool of wealth. Well, at least that equity skyrocketed for awhile. Now that the bubbles in tech stocks and housing have popped, then Americans will start saving again. (i.e., we still get a happy ending despite bubbles popping.)

I submit that the underlying reason Americans' savings rate has been in decline for 25 years is that Americans' wages and incomes have been stagnating for 25 years even as their expectations rose to astonishing heights.

I also submit that the rising income inequality in the U.S. means that the top 10% of earners will indeed be saving, but the bottom 60% will have more in common with this couple:

Rising inequality of incomes is simply a fact, and whether this is a good thing or a bad thing or exactly why it is so is not my focus here. The point is that middle incomes have been squeezed for decades.
This also shows why we have to be careful about drawing conclusions based on "savings rates" drawn from the entire population. If the top 10% of earners start saving 20% of their income while the bottom 60% save nothing, the savings rate for all Americans will be positive and cheery.
Such a conclusion would be deceptive, to say the least.
Before we completely rain on the Hollywood Happy Ending of thrifty Americans saving scads of cash and enabling a new Bull Market in 2009, let's look at a few charts for context:

And let's not forget that our "prosperity" of the past 25 years has been based on borrowing and spending trillions of dollars:

There's a few other flies in the ointment for the happy story about Americans savings trillions and sparking a new Bull Market.

Number one is Peak Oil--no, it did not go away because the U.S. cut its demand by a meager 3% and the Saudis pumped an extra 500,000 barrels a day--more on that tomorrow.
Rising energy costs act as a huge tax on the economy and incomes.

Readers continue to ask me about inflation-deflation, and my answer is: you can't lump everything together and get an answer. 100+-year cycles of inflation and wage stagnation are driven by stupendous demographic forces of demand which outstrip supply of energy, food, etc. We are in such a period.

At the same time, vast global overcapacity in manufacturing insures that the cost of manufactured goods will not rise as fast as input costs (energy and commodities).
Concurrent with these forces, we have asset deflation on a vast scale which will remove "the wealth effect" and actual buying power from everyone owning assets which are dropping in value/buying power (stocks, real estate, etc.)

Last but not least, we have government-mandated costs which are immune from global competition and wage arbitrage: public sector wages, medicare/healthcare costs, education, etc. All of this can be seen in the following chart:

Last but not least, let's recall that "personal income" includes dividends, interest and rental incomes--the "earnings" from owning capital. Since capital is highly concentrated in the U.S., so is this capital-derived income.

OK, now let's dig into some numbers. Total Personal Income in the U.S., 2007: $11,645,882,098
Here is how "negative savings" works according to the BEA--emphasis added by me:
2006 GDP Highlights:

Personal saving -- disposable personal income less personal outlays -- was a negative $50.5 billion in the first quarter, compared with a negative $15.8 billion in the fourth. The personal saving rate -- saving as a percentage of disposable personal income -- decreased from a negative 0.2 percent in the fourth quarter to a negative 0.5 percent in the first.

Saving from current income may be near zero or negative when outlays are financed by borrowing (including borrowing financed through credit cards or home equity loans), by selling investments or other assets, or by using savings from previous periods.

Here is a paper from the St. Louis Fed on The Decline in the U.S. Personal Saving Rate. The point made here cannot be overstressed: so-called capital gains or increases in equity cannot actually be realized by everyone, because selling (to capture the gains) instantly sends markets plummeting, destroying the gains. Paper profits are indeed illusory, and everyone claiming they are the equivalent of savings is wrong.

Furthermore, it has been observed that a large portion of unrealized capital gains tends to arise in the presence of volatile "bubbling" conditions (e.g., the stock market boom of the late 1990s and the housing price surge of 2002-05); as such, these gains have to remain unrealized almost by definition—if households tried to cash them in, they would cause the bubble to burst, causing the capital gains to vanish.

Many readers have pointed to insurance companies and pension funds as buyers of T-bills and other U.S. debt. Undoubtedly they have been buyers, but rather clearly their buying is only a fraction of what's needed to fund most domestic borrowing with domestic savings. How do we know this? Because the U.S. has been relying on foreign funding while we borrowed and spent so carelessly:
How Long Can The U.S. Count On Foreign Funding? (March 5 2007)

The Happy Story Fantasy of Americans saving enough to fund their own deficit spending requires that Americans save at least $1 trillion a year and devote every penny to Treasuries and muni bonds. To fund our mortgages, corporate paper and other borrowings: better save another trillion or two.

Next up, Fed Vice Chairman Roger W. Ferguson on why how household expectations of ever-increasing spending may be one culprit in the abysmal savings rate:

Remarks by Vice Chairman Roger W. Ferguson, Jr.
Another explanation for the decline in the personal saving rate relates to possible upward revisions to households' expectations for their long-run or permanent income. Credit card usage has grown exponentially over the past two decades, and the ratio of consumer credit to income has increased 50 percent.

It is reasonable to expect that the saving rate of the top quintile of the income distribution will do the bulk of the rebounding. (emphasis added: CHS) As I noted earlier, the saving rate of this quintile accounted for virtually all of the decline in the aggregate personal saving rate. Because households in this income quintile own about 65 percent of aggregate net worth, any revaluation of assets will be felt strongly in this group and consequently their saving behavior should most clearly reflect this influence. So Mr. Ferguson is saying the 20% will be doing whatever saving will be done. Nice for them, but what about the other 80%? What he is also suggesting is that as we've collectively expected more and more income, we've compensated for the gap between reality (stagnant incomes and declining purchasing power) and our expectations ("I deserve it!") by borrowing off credit cards and our equity.

For more on typical households' financial decline, please read: Family Income Report.
Let's run some numbers. According to the U.S. Census Bureau, the top 20% of households earn about 50% of all income. Since total personal income is $11.6 trillion, that gives the folks who are most able to save a total income of $5.8 trillion.

Let's say the Happy Story kicks in and these fortunate few (interestingly, the Pareto principle 80/20 rule appears to be in play here) start saving 8% of their income, i.e. a return to the pre-borrowing-binge rate.

That would yield a sum of $464 billion--roughly the current anticipated Federal deficit. Meaning: if the Happy Story comes true, then the top 20% better buy nothing but U.S. Treasuries.
But what about all those municipal bonds? And what about all the Treasury debt that comes due and has to be rolled over? What about corporate bonds, and mortgages and all the other flavors of debt/borrowing in the U.S. economy?

If pundits like Mr. Bill Gross are correct, Federal deficits will zoom to $1 trillion next year as the bailouts and shrinking tax revenues collide with rising entitlements and war expenses. Add in the Treasury debt rollovers, state, county and agency bonds (muni bonds), corporate bonds and paper and new mortgages and you'd need about another $1 trillion a year in savings, for a total of $2 trillion.

So for the happy story to work out, the top 20% will have to save not 8% of their income but 34%--a staggering sum.

Even if all wage-earners managed to save 8% of their total incomes, that would create $928 billion in savings--perhaps half of the debt that public and private entities in the U.S. will issue next year.

Back in the real world, the other 80% will be struggling to keep up with rising energy, food, education and healthcare costs even as every level of government skims an ever-larger share of their income via junk fees, levies, and just flat-out higher taxes.

Clothing, houses, used SUVs and second-hand furniture will be cheaper--if anyone still wants to buy them.

Lastly, based on my own observations, Mr. Ferguson pinpointed something important: people's expectations have not yet declined to map reality. Back in the 60s, very few people ate out, regardless of their income. Fast-food outlets were rare. Even middle-class families rarely ate out (my father was a mid-level manager and I can count the number of times we bought anything away from home but hamburgers on one hand. This was typical, in my experience.)

Overseas travel was reserved for very high-income families or retirees who'd saved a lifetime.
Now, every teenager feels it is his/her "right" to have a fast-food meal or costly drink/snack every single day. Millions of households consider exotic travel a standard feature of life. Ditto having your pet in a kennel during your vacation, having pet sitters and personal trainers, going to the gym, hiring a crew of housecleaners every month, having your oil changed, buying fancy prepared meals at the supermarket deli, store-bought haircuts for kids, and all the other accoutrements of "middle-class" life.

What few seem to recall is all of these services used to be performed by the household members or in the case of dog-sitting, neighbors or extended family. The general cultural zeitgeist in the U.S. is that doing such things for oneself is declasse, and besides, "we deserve it" or "we're too busy." Yet astoundingly, we collectively find time to watch TV 8 hours a day and spend other valuable hours texting, talking on the phone, surfing the Net, etc. Too busy, indeed.

The mismatch between expectations and reality has never been greater, except perhaps in 1928 just before the Great Depression--and I suspect we are far more out of touch with reality than the Roaring 20s denizens.

Saved by U.S. savers? Dream on, and gimme another hit of Euphorestra.

Oh, and there's one last fly in the happy-savings ointment: jobs are lost in recessions, and we're in the first inning of this recession. It is hard to save when your income is cut to unemployment benefits, and even harder when those run out.

New Book Notes: My new "little book of big ideas," Weblogs & New Media: Marketing in Crisis is now available on The price is currently listed at a default of $15, but I am working on getting it lowered to $10.99. Check back later in the week to order a copy at the lower price.

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