Americans: Save, but not too much

By Money Matters Editors

This is not a polemic against saving. Americans – and others for that matter, but especially Americans – need to save. And how.

A decade of unsustainable over-consumption fueled by home equity loans and refinancings has left the United States with too little saved.

Americans reversed the above trend during the recession, with the nation’s savings rate rising to about 5 percent of gross income.

The paradox of thrift

But now there’s an equally difficult problem: the U.S. is saving too much, all at once. The great economist John Maynard Keynes said saving is a good thing, but if everyone saved everything, all the time, it would be a disaster. Keynes called it the ‘paradox of thrift.’

That’s because some consumer spending is needed to stimulate the U.S. economy. In fact, in recent decades consumer spending has accounted for 60-65 percent of U.S. GDP, and in some years the figure was closer to 70 percent. During the recession the U.S. has entered the ‘frugal consumer’ era and it remains to be seen whether consumption will account for as much of GDP as it has in the past, but one constant remains: some consumer spending must occur for U.S. GDP growth to approach historical rates.



But will it occur? We’re still too early in the post-financial crisis age to know if consumer spending will approach previous levels, but the early indicators suggest that it will not. And, similarly, the early data suggests Americans will continue to save at least 5 percent of gross income. If anything, they might save even more, in order to rebuild nest eggs and make-up for asset destruction in the housing and stock markets.

If that occurs, it will almost guarantee lower GDP growth than would typically occur in the U.S. economy following a recession, and it’s an inevitable consequence of a society that amassed too much debt in all spheres (individual, corporate, government) this decade. In other words, there are just so many dollars in an economy and it appears dollars deployed can achieve an impressive rate of savings or consumer spending, but not both.

How will the U.S. emerge from the above quandary? Well, after awhile the United States will have amassed enough savings and capital such that high spending won’t represent as large an opportunity cost: American citizens will have saved enough to meet future life goals. But economists say that day is 5-7 years off.

In the meantime, the danger of Keynes’ ‘paradox of thrift’ exists. Hence, the adage here is: if you over-consumed this decade, and need to increase your savings, then do save. However, if your financial status is strong, you have little debt, and you can afford to spend a little, then spend a little.