Are Americans Killing The Economy By Saving Too Much?

by golbguru on February 14, 2009

This appeared on CNN Money a couple of days ago about Americans saving too much:

Why saving is killing the economy
Saving more and cutting debt might sound like a good plan to deal with the recession. But if everyone does that, it’ll only make matters worse.

That’s probably the most misleading (almost irresponsible) statement/observation that I have come across during this unhappy recession.

I think I now understand why this country is going through a recession in the first place. Remind me, why are we currently being chased by this dark financial cloud - was it saving too much … or perhaps, was it spending too much (in fact spending too much of borrowed money)?

It is not like Americans were saving “enough” all these years and suddenly they have started to hoard every penny they have leading to an economic crisis. Consider the situation in 2005-2006 as reported by MSNBC:

Americans’ personal savings rate dipped into negative territory in 2005, something that hasn’t happened since the Great Depression. Consumers depleted their savings to finance the purchases of cars and other big-ticket items.

The Commerce Department reported Monday that the savings rate fell into negative territory at minus 0.5 percent, meaning that Americans not only spent all of their after-tax income last year but had to dip into previous savings or increase borrowing.

… “Americans seem to have the feeling that it is wimpish to save,” said David Wyss, chief economist at Standard & Poor’s in New York. “The idea is to put away money for old age and we are just not doing that.”

Now that should have been like a slap on head - those numbers were indicative of the fact that people were spending money that didn’t even belong to them (borrowing). Sure enough it propped up the economy in the short term (markets did great in 2006 ~ 2007, housing demand/prices did great, etc.), but it seems now (20-20 hindsight) that we were just heading higher up the cliff, inflating the bubble, and increasing our chances of a successful financial harakiri in the future.

It reminds me of those situations in cartoon films where the characters run off a cliff … walk in the air for a while … and then suddenly realize that the freaking ground is no longer beneath their feet.

The current saving rate is higher than in the past, but it’s not like it is way out of whack. In fact, I am not even sure that increased saving rate is going to be sufficient when extrapolated a few decades into the future.  PBS reported this about a week ago:

Amid fears of further job cuts and economic uncertainties, Americans boosted their savings rate to 3.6 percent of their after-tax incomes in December. That was the highest level since tax rebate checks temporarily pushed the rate up to 4.8 percent in May, the Associated Press reported.

That’s saving $36 out of $1000 disposable after-tax income - nothing to write home about.

Anyways, increased savings rate,  however small, suggests to me that Americans are now coming to their senses and doing what is necessary to ensure some level of financial security over the long run.

Whatever the numbers are, here is the truth. A good economy doesn’t need consumers who spend “freely” - it needs consumers who spend “wisely” - better still, a good economy requires consumers that save and invest wisely. If Americans don’t save for their retirement now, they are going to increase the financial burden on national reserves in future - if they save now, they would be in a better position to spend later.

What would hurt the economy is “hoarding”. However, there is a subtle difference between hoarding and saving. Hoarders don’t have a reason to hoard, but savers always have a reason to save - and more often than not, the reason is to be able to spend wisely in the future on things that matter.

For those who are interested in furthering their knowledge about savings rate and its effect on the economy, this paper (pdf file) on federalreserve.gov will give you some clues.

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1 Rob 02.14.09 at 9:36 am

It is important to realize that significant negative effects to the economy are a short-term effect of saving, not an infinite loop. It is safe to say that the increase in savings reduces total economic demand. If the business you work for was on the brink a year or two ago, that $36 that might have gone to you from 100 different customers might represent the difference between staying open, and closing for good.

If they close, now the business’ employees don’t have any income at all. Which means they now won’t spend anything (which is a much bigger hit than the $36 cited above). With other businesses going through the same problems, some individuals will be forced into bankruptcy. Which then poses more ongoing problems for creditors.

I think everyone in the U.S. agrees that the savings rate should go up. The question is to what extent the nation as a whole should allow that positive effect to also become a Pyrrhic one.

2 Louise 02.15.09 at 11:29 am

It seems to be the same here in Australia. Everyone I’ve talked to is using the extra money from the stimulus package ( one before Xmas & one coming soon) to pay down debt instead of spending.

It’s difficult because although spending is good for the economy and helps us collectively, people are afraid of job losses and trying to put themselves in the best financial position they can in these uncertain times.

3 Craig 02.16.09 at 1:12 pm

I have read things like this as well and disagree with them. People need to worry about their own situations and can’t just spend for the hell of spending because of some theory that the economy will suddenly turn around. Consumer spending is still relatively high despite the times, people need to worry about themselves.

4 Jennifer 02.21.09 at 6:19 pm

I don’t think people should spend just to help the economy. You have to worry about yourself. And honestly, if people are finally starting to save a little money again (we recently had the first negative savings rate in the US) then that is great for everyone involved. The US is going to have to go back to some of its old ways of doing things. Businesses are going to have to adjust. People have to stop spending so much money. Businesses don’t need to grow as rapidly as they think they need to. We don’t need a drug store on every corner and a dry cleaners in every strip mall. We also don’t need a big box retail stores all over the place either. It will be painful, but the US and the individuals have to make some changes and it is finally happening.

5 bocachica 02.26.09 at 12:27 pm

Personally, I think each of us has the responsibility to get the most for our money. It may not immediately “help” the economy but rampant consumerism is one of the things that got us all into this mess in the first place.

For example , my daughter HAS to have a phone, No negotiation there, and I got tired of fighting with her over the high bills.

But I discovered that you can get out of your expensive cellphone contract if the company changes its terms.

When Sprint changed its charges for texting, I called them and was able to cancel the contract!

They won’t tell you, of course. You have to ask!

I turned around and got a pay in advance phone from Net10 and only pay what I can afford up-front and it’s now a part of my daughter’s “allowance” which has turned out to be a very good way to get her into the habit of budgeting.

It may not be a “necessity” to everyone but any way to reduce costs is good to me!

6 Jerry 03.13.09 at 2:41 pm

The credit party is over? The credit party should have been over a long time ago. You can’t live the way Americans were living and expect to sustain it. It’s irresponsible and now we’re paying for it. It was a house of cards which would eventually lead to disaster and we’re here now. There’s no insurance that things will bounce back quickly but I don’t think telling Americans to spend money they don’t have right now is the smart thing to say.
Jerry
http://www.leads4insurance.com

7 Mercy Mei 03.25.09 at 10:44 am

Unfortunately, Americans have been really poor about saving money. If we took saving and investing seriously, many of the so-called “structural” economic issues might go away or at least be alleviated.

Having money in the bank engenders confidence and security. Shopping as a form of “recreation” is insanity. And paying more for something “just because” or out of laziness or carelessness is similarly stupid.

I’m not saying that we shouldn’t spend money when necessary but I like to get my money’s worth. I’ll pay a little extra for something of higher quality because the price in the long-run will be less.

I don’t see any reason to pay extra for something when there’s no reason.

And speaking of prepaid cellphones (as mentioned above), I read this article and it showed how they really save, so why not?

8 tom 04.03.09 at 7:43 pm

You know I actually agree with you completely here.

We are so used to spending so much money that now when we look around and we see people saving its like wow what the hell just happened.

And 36 dollars for every 1000 is a joke actually, I mean before this recession people were in the negatives, so savings didn’t even exist for them.

But like I said, we are so used to living way above our means that it is like a shock for everyone now.

Worse, politicians and the media think getting out of the problem means to keep spending. I mean we got into it by spending too much, and now we are being sold on stimulus packages and told we should stop saving and keep spending.

Just plain stupid, I say let businesses fail, let it all flush through and start fresh.

9 tightwadfan 04.22.09 at 4:23 am

ugh I have heard this awful statement so often recently and I just want to throw something at the tv!

I don’t think it would help matters AT ALL for people who were already buying everything on credit to continue doing so. These people really do need to start saving.

There’s a small percentage of people in this country who are debt-free and have cash reserves and I do think it would help if these people would cut back on their usual frugality and open their wallets at this time.

10 Eric 05.21.09 at 1:14 pm

In the short-term, the additional savings are hurting as we are a consumption based society. However, in the long-run we should all be much better off.

11 FruGal 08.13.09 at 8:13 am

“A good economy doesn’t need consumers who spend “freely” - it needs consumers who spend “wisely” ” - so true.

We can’t just spend our way out of debt. That’s why throwing money at a problem never works. I love hearing people say that stimulus packages would work if it weren’t for the people who don’t spend them. Of course people are going to save money right now! It’s the only good thing that has come out of this recession; people are finally starting to take their finances seriously.

12 Miel @ dinkfinance 08.22.09 at 12:32 pm

I still can’t help but cringe at the reality that savings hurts our economy. I understand it intellectually, but I can’t help feel that it is contrary to how things should be. I suppose infinite growth is in theory a good thing, but not when it is all just going into debt.

I think the rain in DC is getting to my mood! :-)

Miel

13 Richard E. Savoy 10.30.09 at 7:21 am

Thanks to James Schaefer for the insightful comments, with kind attribution to the Journal’s Jonathan Clements and to Jim’s own brother, about the intriguing and powerful concept of “opportunity cost”. James’ letter appeared in Letters on October 23.

When we spend money on things we don’t need, not only do we lose that money, but we permanently deprive ourselves of what that money, better applied, could have yielded. $1 million (and maybe much, much more) is not lost by your carelessly misplacing it. It is lost $50 and $100 at a time. When you buy $10 glasses of beer, $15 glasses of wine, $50 lunches, $100 dinners, $125 ties and $500 shoes, you lose out on the future value those funds, if invested even in a poorly performing market, would have produced. Over a lifetime, the poorly performing markets will fade into nothingness and the long term results take effect. Indeed, the financial crises of the hour will one day be but a memory. The shock of realizing what you could have had will floor you and last a lifetime.

$1,000 per month invested at 8% for 35 years amounts to almost $2.3 million. Adjusting for 3% inflation, you would still have over $800,000 in today’s dollars. Take a look at your annual expenditures on things you don’t need and you’ll find the $1,000 (and maybe a lot more) a month.

Ignorance of the concept of opportunity cost can mean, after 35 years of well paid employment, having a negligible net worth at 60 and parking cars under the direction of a high school kid at 70. You can be young in this country and be without money but it’s really tough being old and in that shape and much worse to realize it needn’t have turned out that way. James’ brother advised saving “until it hurts.” What did he know that you don’t?

Richard E. Savoy

14 Pat Yoe 01.17.10 at 6:17 pm

Patently absurd. Businesses and products dedicated to savings are thriving.

In fact I save a lot on my monthly phone. I have Straight Talk. I previously had Verizon then switched to AT&T but the bills were CRAZY!.

When I heard about Straight Talk I couldn’t believe it but have had it now for 2 months and it is just sick! I’d heard that it was on Verizon and the coverage is rock steady, so yeah.

15 Pat Yoe 01.24.10 at 2:27 pm

Just as the IRS has said that it’s our responsibility to arrannge our affairs to minimize tax liabilities, so too is it our reponsibility to minimize expenditures and maximize value received.

For example. I killed my contract with AT&T as soon as I could. I also sold my iPhone. I have Straight Talk on the Verizon network. Bought it at Walmart and it’s an amazing deal. The Samsung Finesse is a very cool smartphone and paying only $45 a month for unlimited everything is the best deal going!

16 tracy 05.31.10 at 2:56 am

Of course you have to save in this economical climate. I bought a Net10 phone which came with 300 minutes to use and thereafter costs 10 cents per minute, now why would I spend my money on something else that is not going to give me a good deal.!!

17 bankruptcy Ben 06.20.10 at 4:21 pm

Manard Keens talks about this. The problem of saving because the money is taken out of the ecconomy. However there is a difference between saving and investment but both ultimately improve the ecconomy. GDP = private spending + public spending + business spending + investment. So by investing you’re creating jobs and demand, but investment might be borrowed funds (eg bonds or money borrowed from banks) as well. Where does that money come from… That’s right savings! At the moment the money is comming from China better it comes from us I say.

18 Moneyedup 07.21.10 at 7:28 pm

To me, saving is good for the economy. People are generally saving in order to make purchases in the future or for their retirement. With a good interest rate on a savings account, your money will grow and eventually you will have more to spend in the future.

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