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America, Land of the Frugal -- And Why That's Bad News

After years of spending at breakneck speed, Americans have resumed the quaint practice of saving money. Although it might be uplifting to think of the shift as a newfound personal virtue, and it's true that spending on lots of things is down, the numbers suggest the lower spending may be as much the result of the inability to borrow as general consumer frugality.

The NYT's ace economics writer Catherine Rampell says that Americans are cutting back to rebuild their retirement accounts and college funds -- not just to be thrifty. She also reminds us of the complications that result from the U.S. economy being highly geared to consumer spending:

Add the decline in consumer spending to the planned expiration of government stimulus spending, and a painful readjustment in demand for goods and services could occur, economists say. The effect would be felt here and abroad, as many developing economies also depend on America's big-spending ways.
The Obama Administration is insisting on this sort of structural change, Christina Romer, chairwoman of the White House Council of Economic Advisers said on C-SPAN Sunday, as reported by the NYT:
The economic recovery, Ms. Romer said, will be driven by business investment in sectors like renewable energy rather than consumer spending. She echoed the views of other economists who expect a long-term economic shift.

"The chance that consumers are ever going to go back to their high-spending ways is not very plausible, nor do I think they should," she said. "We were a country that needed to start saving more."

Americans saved eight or nine percent of their income, on average, during the 1960s, 1970s and 1980s, but then put aside less and less, saving next to nothing for the past five years (see the disappointing graph below). Other developed countries have been on a downtrend too, but our record has been below average: the average OECD country's savings rate was about eight percent in 1994 (versus four percent for the U.S.) falling to five year percent in 2007 (when we were at 0.6 percent).

Kevin Lansing, an economist at the Federal Reserve Bank of San Francisco, has explained the decreasing thrift with economic logic, and quantified the phenomenon with a regression model. Quite simply, people saw the rise in the prices of the stocks and homes they owned as a substitute for of saving.

This graph shows how closely he was able to predict the rise and fall of the savings rate from 1960 to 2005. (For those readers who are not fans of statistics, it's a great model - he gets really close.) We will hear from him later this week on the leveraged U.S. consumer.

Looking at the situation from the angle of what people are buying, there's reason for concern over the sudden onset of parsimony. Personal consumption expenditure is currently about $10 trillion a year, made up of about 60 percent services, 30 percent nondurable goods, and 10 percent durables.

Compared to the first quarter of 2008, spending on services is up three percent (in current dollars, not adjusted for inflation). Much of this category consists of rent, electricity, phone bills, and medical care.

Nondurable spending, on food, clothing, and the like, is up about one percent -- very weak, but positive -- if you take into account the sudden 40 percent drop in what we have to pay for gasoline and heating fuel.

The real weakness is in durable goods spending -- down 10 percent, including a 20 percent drop in motor vehicles and parts (that's the dollar value, rather than the number of vehicles), and a four percent drop in furniture and appliances.

This comment from the Financial Times addresses the weakness of the U.K. economy, but it's equally applicable to the U.S.:

Mervyn King, governor of the Bank of England, has acknowledged that while in the long term Britain needs to save more, right now monetary policy must encourage consumption.

"In the short term, if it [the national savings rate] were to rise now we'd be in an even deeper recession," Mr King said in February. "That is the paradox of policy: we are doing things that we will not want to do in the medium term precisely in order to dampen the strength of the recession."

A close look at what is not being bought is instructive -- while small-ticket items such as food and clothing are rising, car sales are down 30 per cent from 2008 levels. To reinvigorate Britain's hard-pressed manufacturing sector, consumers will need to begin buying the types of goods that generally require access to credit.

Greater saving would help reduce our dependence on foreign sources capital, and improve our long-term economic outlook by increasing investment spending. But in the meantime, both the U.S. and U.K. economies are hooked on credit, and to get things going again in their old proportions, we won't be able to wait until we can pay cash for that new car. We'll need to start borrowing again, and soon. For now, it looks like thrift is the last thing America needs.
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