The pessimistic economists have it wrong. More savings does not mean less growth. The rise in our nation’s personal savings rate will provide fuel for stronger future growth.
It is called the paradox of thrift. The idea dates back to the days of the legendary economist John Maynard Keynes. It is alive and well today, coloring economic forecasts and painting a dim picture of the long-run outlook for the economy. Consumers represent roughly 70% of the economy. If consumers pull back too much, as they did after the Lehman Brothers’ collapse, the economy suffers. Fortunately, the level of fear and panic has subsided and consumer spending has picked up again. In the first quarter, consumer spending rose at a 1.4% rate. But the savings rate has also risen, to 6.9% in the opening quarter. The savings rate was zero in April 2008. This dramatic rise in the savings rate is seen by many economists as a direct subtraction from spending and therefore a threat to economic growth.
The paradox of thrift has the nation’s economists and media in its grip. The Wall Street Journal carried this headline: “Hard-Hit Families Finally Start Saving, Aggravating Nation’s Economic Woes.” I find it astounding that so many are so easily swept up for so long in this notion. During the boom times, the lack of American savings was lamented. Consumers were steadily demeaned by the media for borrowing too much, saving too little and spending too much. Now they are demeaned for the opposite and accused of hurting the economy by saving and not spending every dime. The first-quarter data shows how distorted the popular wisdom on spending has become. In the opening quarter, consumer spending went up and so did the savings rate. Consumers enjoyed more income and spent part of it. Economic growth and personal prosperity are compatible. We are not going to suffer a permanently slower rate of economic growth because consumers behave sensibly. From 1960 to 1990 the savings rate was about 9% of after-tax income. It rose above 10% in the early 1980s when short term interest rates were double-digit. That relatively high savings rate did not blunt the economic and stock market boom that followed the recession of the early 1980s. Quite the opposite, savings were fuel for economic growth. That is still the case.
Too little savings and too much debt are bad for individuals. We can see that all around us as homes are foreclosed and individuals file for personal bankruptcy. Is there any doubt that our economy would be in far better shape today if Americans had behaved sensibly when buying a home and managing their finances? Our economic difficulties are due to excessive borrowing and anemic savings. It is lopsided to think you can have a sustainable economic boom financed by no savings, just borrowing. Solid long term economic growth is built on the opposite, reasonable savings and reasonable borrowing. Finally, the U.S. economy is getting back to sensible personal economics. This will be positive for economic growth.
Our economy is open and dynamic. One family’s savings becomes another’s opportunity. Higher savings will mean more investment in productive enterprises. Savings in the hands of entrepreneurs and successful business managers will create jobs and increase incomes. More jobs and more income will mean more spending. Thrifty people tend to earn more and spend more than those with no savings and too much debt.
Our higher savings rate has other benefits. For example, it reduces our dependence on foreign governments. We will be able to finance more of our own economic needs including the government’s deficits. But the key point is the productive nature of savings. Look at China with a very high savings rate and a strong economy. When I first traveled to China I was amazed at how businesses sprung up even while the banking system was a total mess. Families would use their savings to help start businesses. For many years economic growth in China was financed by direct family savings. Savings are fuel for growth, not a growth inhibitor.
Theoretically, there can be excessive savings. A family that saved everything and refused to spend on essentials would definitely be doing the wrong thing. But as a nation, we will not be accused of excessive savings if the rate rises to 8% or 9%. We are in a transition from a serious recession to economic recovery. Because of all the uncertainties that accompany transitions, it is all too easy to swallow the slow growth forever predictions. It is also easy to confuse the fundamentals. The fall into recession, the demise of General Motors, the rise in unemployment, the housing mess, and the financial crisis did not have a single cause. It wasn’t individual borrowing and spending alone that caused the near depression. Let’s not forget that sky-high oil and gasoline prices took a huge bite out of car sales. That is what sent General Motors down the slope to bankruptcy. Outlandish risk-taking with derivatives by major banks and insurance companies contributed to the recession. And overbuilding in housing likewise has contributed to the recession. It will take time to repair all the damage. So we may have slow growth for a while.
But thanks to a higher savings rate the long term outlook for the U.S. economy is still bright.