The Fruits of Frugality

Last Updated Apr 4, 2009 3:56 PM EDT

In the wake of the worst economic conditions most Americans have ever experienced, Americans' behavior is changing. We are spending less (a 3.5 percent drop in late 2008) and saving more (a 3.8 percent increase in December, quadruple the rate earlier in the year).

That reverses a trend toward ever greater profligacy that dates back to the early 1990s — and it runs counter to the encouragement we're getting from the government to resume our shopaholic ways. But Americans haven't always been spendthrifts: from 1950 to 1992, the savings rate averaged 8.6 percent, and this new frugality might stick. What might a return to a savings rate that high mean for the future? Let's take a look.

More Nesting, Less Conspicuous Consumption

Of course, this is already happening — Wal-Mart is one of the few retailers currently posting gains, and Netflix has been signing up subscribers at a record pace — but the changes in spending habits could well become entrenched for the long haul. Economist Tyler Cowen notes that during the Depression, people gave up nights on the town to stay home and listen to the radio and play board games. “These stay-at-home tendencies,” he wrote recently in The New York Times, “persisted through at least the 1950s.” Today’s families play Nintendo Wii and watch DVDs, but the impulse is similar.

Significantly, home sizes will shrink as well. Over the past generation, Americans grew accustomed to the idea that their homes were piggy banks (delivering cash via home equity loans) and retirement accounts (to be sold before moving closer to the grandchildren). So it made sense to get the biggest, most expensive home possible, especially given the availability of so much cheap credit.

But in a high-savings environment, particularly one followed by the implosion of a real-estate bubble, house sizes will suffer. With down payments back in style and pickier mortgage lenders, people will be able to finance less; the market will adapt by offering homes that fit the new realities. Great rooms will be slightly less great; developments will squeeze in more units per acre. Big builders such as Toll Brothers, KB Home, and Hovnanian Enterprises have already started rolling out smaller models, and others are likely to follow. To be sure, though, we’re not talking about going back to log cabins or even Levittown-sized homes. The average new home today is still more than 2,400 square feet, compared to 1,760 square feet in 1978.

Lower Anxiety

This is hard to fathom in the current job market, but once the economy stabilizes, financial worries in a frugal America will be smaller than they used to be.

Think about it: living on the edge of the economic precipice is not a comfortable environment; having some protection, in the form of savings, does wonders for one’s peace of mind. In 2007, the American Institute of Certified Public Accountants did a series of studies that concluded financial well-being and competence contributed “to happiness and psychological health.” After basic needs are met, the href="">link between consumption and happiness is weak and maybe nonexistent.

A bonus: a higher savings rate would likely even out the economic cycle, since households with a cushion can maintain more of their spending when tough times hit, rather than abruptly putting on the brakes as they are doing now. Boom-and-bust is not good for either countries or individuals. Steady is better.

Greater Security

One of the most dramatic trends since the early 1990s has been the flow of international capital into the U.S.; in effect, savers in foreign countries (and especially China, which is holding more than $1 trillion in U.S. debt) have been underwriting American shopping. Indeed, foreigners now own almost half of outstanding U.S. Treasuries; in cash terms, that’s about $2.5 trillion.

While there’s nothing wrong with foreign money coming into the U.S. — it actually reflects international confidence in the U.S. economy and provides capital for American entrepreneurs — the U.S. has become so heavily reliant on foreign capital that if that money were to suddenly find some other place to go, the U.S. could be in big trouble.

In recent years, 80 percent of net domestic investment has come from non-American savers. A sharp drop in overseas investment in the U.S. without a compensating rise in domestic savings would hurt living standards — and there would be nothing we could do about it. But if we were to finance more of our own investment through domestic savings, our living standards would improve more quickly and the improvements would last.

Unfortunately, a href="">higher savings rate will do little for our current situation, and having to quickly adjust to consuming less has not and will not be easy. But once we’ve accustomed ourselves to living smaller and saving bigger, the national economy (not to mention the national psyche) will be better for it.