Breathe Deeply
Last month’s issue addressed the popular belief that Americans are struggling under a mountain of debt. After reviewing some metrics and research, I suggested it was time for a deep breath. The burden is not now, nor is it likely to soon become, as onerous as is generally thought. But other risks to consumer spending certainly exist, and the low personal savings rate is among them.
As now reported, the savings rate was -0.7 percent during the month of January and averaged -0.4 percent during all of 2005. This means consumer spending exceeded disposable income earned over that time. More generally, a declining savings rate means that consumer spending is growing faster (or declining more slowly) than is disposable income. Hence, one factor underpinning the strength of consumer spending during the past 20 years has been the decline in the savings rate from 10 percent to zero.
Perhaps the most important reason for this decline is the large increase in household wealth. Net worth stood at 4.3 times income in 1985 but now stands at 5.5 times income. While some of the wealth came from thrifty behavior, much came from rising stock and real estate values. Think of it this way: If the savings rate held steady at 10 percent for the past 20 years instead of declining as it has, Americans would have accumulated an additional $7.2 trillion in savings. But the rising wealth-to-income ratio over the same time means Americans are $10.8 trillion richer than if it stayed at its 1985 level. Why save when existing assets are appreciating so nicely?
This gets to the heart of the concern. The next 20 years aren’t likely to enjoy the 16 percent returns stocks delivered between 1985 and 2000 or the 9 percent appreciation rate that house values have delivered since. And with less spectacular asset appreciation, saving is likely to become more aggressive. Still, two things suggest the reversion to historically normal savings rates should not be problematic.
First, the change is likely to be gradual. Just as the 10-point decline in the savings rate took two decades to unfold, any move in the opposite direction is also likely to be slow.
Second, the current savings rate might not be quite as low as we think. In fact, it seldom has been. Compared with initial reports, the savings rate has been revised upward for 37 of the 40 years between 1965 and 2004. At the time, for example, 1979 posted the lowest savings rate in the postwar period – 4.5 percent. Now, however, the savings rate for 1979 is recorded as an impressive 8.9 percent. On average, savings rates were revised upward by 2.4 percent.
Don’t be tempted to believe that these revisions are getting smaller. Even though recent revisions to savings rates have been small by historical standards, that’s most likely because the largest revisions typically come several years after the fact, as more complete information comes to light.
So, even though today’s low savings rate presents a plausible drag on consumer spending going forward, the risk of any abrupt consumer retrenchment is low. Please, take a deep breath.
