Is Saving More a Good Thing?

Last Updated Apr 6, 2009 6:18 PM EDT

A recent store visit underscores just how dramatically spending
habits have changed in the past few months. A woman dressed in cashmere,
accented with a whisper of Hermes, stood in a long line of customers at
Jack's 99-Cent Store in Manhattan. After asking a neighbor to hold
her place, she rushed back with a 10-pack of disposable razors.

Half-apologetically, she commented, "I never used to shop at places
like this before, but these days..." There was no need for her to
finish the sentence.

Clearly, Americans have started ratcheting back their
consumption in response to the new economic realities. But is reduced spending
and higher levels of savings, which many have encouraged Americans to do for
years, really that great for the economy? The answer is complicated.



Where We Are Now


Except among desperate housewives on unreality shows,
conspicuous consumption is out; Americans are hunkering down. Consumer spending
fell more than 3.5 percent in the last half of 2008 — the equivalent
of about two weeks’ pay. That’s the first drop in spending
since 1991 and the biggest since 1980.

And when Americans do go shopping, they are heading down-market, even when they dress in (presumably last
season’s) Hermes. Luxury retailer href="http://finance.bnet.com/bnet?Page=QUOTE&Ticker=jwn">Nordstrom saw same-store sales drop
by 12.5 percent in the last quarter of 2008; mid-market href="http://finance.bnet.com/bnet?Page=QUOTE&Ticker=m">Macy’s is
cutting thousands of jobs. Meanwhile, href="http://finance.bnet.com/bnet?Page=QUOTE&Ticker=cost">Costco managed to eke out a bit of growth
in the U.S., and href="http://finance.bnet.com/bnet?Page=QUOTE&Ticker=wmt">Wal-Mart’s U.S. operations are busy, busy, busy,
reporting 6.2 percent year-over-year sales growth through the end of January.


The flip side of less spending is, of course, more saving.
Instead of assuming that they could always tap into the rising values of their
homes and stock portfolios to finance this week’s shopping spree,
Americans are living within their incomes again. Debt actually declined in the
second half of 2008, while savings rose from less than zero in 2006 to about
1.7 percent for 2008.

And as 2008 went on, Americans got even thriftier. The
savings rate in August, before the stock market tumble, was 0.8 percent; it
rose to 2.8 percent in November and 3.6 percent in December. For 2009,
economists are guessing the savings rate will be at least that high, and
potentially much higher.



What a Higher Savings Rate Means Today


That increase would seem to be good news. After being
browbeaten by earnest types for years over their profligacy, surely Americans
are helping themselves by saving more money, right? On an individual level,
maybe. For the economy as a whole, though, not so much.

After all, the result
of that big pullback in spending has been that retailers from the Sharper Image
to Foot Locker to Wickes Furniture are closing down stores by the hundreds.
href="http://finance.bnet.com/bnet?Page=QUOTE&Ticker=tm"> Toyota is cutting production. And when href="http://finance.bnet.com/bnet?Page=QUOTE&Ticker=gm">GM owners decide to drive their 2002
minivans for another year, as many of them are doing, it hurts dealers and
suppliers all over the country.


Consumer spending accounts for 71 percent of U.S. economic
activity; when that takes a hit, it has to have an effect. James Grant of Grant’s Interest Rate Observer figures that a
savings rate of 3.3 percent translates into $346.5 billion of deferred
spending. That is, as an economist would say, a nontrivial sum.

When consumer
demand is lower, business expansion is necessarily slower. Remember, it was the
great American consumer who pulled the U.S. out of the mini-recession of
2000-01. But that won’t happen this time — households just
don’t have enough income and savings to keep consumption going.


But isn’t saving supposed to be a good thing? Of
course it is, and of course being buried in debt is a bad thing —
something all too many families are now learning the hard way. But in a
downturn, higher savings can lead to an ever-worsening spiral of economic woe
in which companies shed more workers, causing spending to drop even further,
and so on.


“You cannot save yourself to prosperity during a
recession,” says Keith Leggett, senior economist at the American
Bankers Association. “Higher saving will further dampen aggregate
demand, leading to lost output and more job destruction.” Economists
have a phrase for the fact that higher levels of savings can prolong a
downturn: the paradox of thrift. “The higher savings right now is bad
news,” says Dana Johnson, chief economist of Comerica Bank in Dallas.
“It’s inhibiting recovery.”

What Higher Savings Means Long Term


While Johnson’s comment may be true, it is also
beside the point. With incomes falling, unemployment rising, credit
contracting, and many families still up to their eyeteeth in debt, it is only
rational for people to put away cash.

What was irrational, in retrospect
— and, yes, these things are always easier to see in the rearview
mirror — was to assume that asset prices would always rise fast
enough to cover purchases for which there was no income to match. It is not so
much a matter of whether the higher savings rate is good or bad; it simply is what
it is.


That said, good things could well emerge from the most
painful economic time in most Americans’ memories. Take credit. In
the 1990s and early 2000s, there were few safeguards to what boosters liked to
call “the democratization of credit.” Well, it was
democracy gone amok. Ill-prepared individuals took out mortgages they
couldn’t afford and signed up for credit cards whose terms they
didn’t understand. And there was always someone willing to let them do
it.

No more. The majority of banks that responded to a recent query from the
Federal Reserve said they were continuing to raise lending standards; that
means they are reducing the availability of credit. Greg McBride, senior
financial analyst at Bankrate.com, told The New York Times recently that even when conditions improve, “Lenders won’t
go back to giving out credit like candy anytime soon.” Too much
credit, the U.S. has learned, can be as economically damaging as too little.


Then there is savings. Yes, it’s true that right
now higher savings are likely hurting the economy and that this is driving the
federal government into ever-greater debt in an effort to increase aggregate
demand. “You need to get demand coming from somewhere,”
explains David Wyss, chief economist at Standard & Poor’s.
Even if it’s borrowed from future generations.


Stimulus, however, is like a jolt of triple-espresso:
There’s a definite kick, but it doesn’t last. For long-term
economic growth, a higher savings rate would be a blessing. Savings help to
finance business investment and to fund long-term obligations like Social
Security. Used productively, they are a form of legitimate alchemy, turning
deposits into a higher standard of living.

And it certainly beats handing over
our economic destiny to, say, China, whose thrifty populace has been financing
U.S. investment for more than a decade.



No Pain, No Gain


More philosophically, hard times bring self-evaluation.
Limits force choices; priorities must be set. It’s not the worst
thing in the world for children to be told, "No, darlings, you can’t
have everything you want all the time." And if they learn from their
parents’ mistakes — i.e., don’t bet the house,
literally — then they will act in more economically sensible ways
when they become adults. Recklessness can be fascinating and a few people will
win big, but Ozzie-and-Harriet-style economic stability makes for broader
prosperity.


Like wolves among caribou, downturns thin out the weak,
leaving the rest of the economy stronger and more efficient. If that is matched
with a higher savings rate, the U.S. economic engine could rev up nicely (see
Life in a Thrifty Future). There is no intrinsic
reason why this could not happen; after all, Americans saved more than 8
percent of their incomes as late as 1994. That was the year of the tipping
point — when the incentives to spend, in the form of cheap and easy
credit, began to outweigh the incentives to save.

That balance has tilted back
again, and so has behavior, in the form of lower credit card balances and
higher savings. Ultimately, that will be a very good thing.


Right now, we’re suffering the pain, but the gain
is there for the taking.



  • Cait Murphy

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