Savings Goes Negative

The Wall Street Journal is reporting that according to the Commerce Department, the savings rate in the US went negative in July. While personal income continues to rise, personal spending continues to rise at a faster pace.

In July Americans spent $59 billion more than they earned, a savings rate of negative 0.6%. A negative savings rate may not be the end of the world, but it is a very bad thing.

The US consumer is the engine of the global economy. For years producers world wide have counted on US consumption in the face of stagnant growth in Europe and Japan. The fear is that debt laden US consumers with stop consuming, or even reduce consumption, leading to a global recession.

I don't think we will see a big pull back from the consumer until long term interest rates rise. A lot of the fuel for consumption comes from consumers tapping their home equity. In July, housing prices rose 13.4%, while this increase isn't uniformly distributed, it does mean that new home equity was created in July, meaning that new fuel is available for the fire.

The problem is that a low, now negative, savings rate indicates that the US is not only failing to save and invest for the future, but actually consuming the wealth it has created in the past. In the long term, a low savings rate is very bad and will have a huge impact, however I doubt we see an immediate impact.

People want to keep up with their peer group. People will buy houses they can't afford with mortgages banks shouldn't issue, people will buy new cars, TVs, clothes and Ipods until it gets to the point that they can't afford the monthly payment. I think that rising rates will be the catalyst that reduces US consumer spending. Rising energy prices are a good second candidate for that catalyst, but as long as you can pay for gas with credit, my money stays on interest rates. My money also stays on companies that make a product people either can't or won't do without.

The standard criticism of the savings rate figure is that it doesn't take into account the "savings" created by rising asset prices. The idea is that houses and investments are going up, so American consumers are perfectly rational in spending all the money they get from income. There are two problems with this criticism.

First, most Americans aren't prepared for long term liabilities like retirement, education, and long term health care. Rising investment values are supposed to help make these burdens more manageable. Most people don't have enough saved to take care of these responsibilities, thus the need for a positive savings rate. The size of these burdens also continues to grow each month, and that doesn't show up in the savings rate either.

Second, asset prices have, and will in the future, decline. The decline in stock prices from 2000 to 2003 were not figured in the savings rate, and future declines in asset values won't be figured into the savings rate either.

On the brighter side, the jobs numbers were good today, and unemployment is below 5%.

Timothy Burger
timothyb(at)timothyburger.com