Here's a puzzle. But not a very enjoyable one.
Americans need to save more. They also need to spend more because no recovery can take place with consumers on the sidelines.
That's the nub of one of the many challenges facing the battered, reeling economy. For some 20 years, Americans said no thanks to thrift. We consumed at a prodigious rate — big houses, powerful vehicles, enticing electronics, and convenient, frequent travel — all made affordable (or at least that's how it seemed) by low interest rates, easy access to credit and fast-rising home equity that we used as an irresistible piggy bank.
At the same time, we deposited less and less of our income into real savings accounts. For decades until the early 1990s, personal savings — after-tax income minus expenditures — averaged in the neighborhood of 9 percent. That's when our collective bender kicked in. Socking cash away for a rainy day became an afterthought. In 2005, at the height of the real estate boom, the personal savings rate dipped into negative territory. Clearly that was not sustainable.
Worried And Scaling Back
Now, with credit stalled, layoffs mounting and fear permeating the country, Americans are saving once again. In January, the savings rate hit 5 percent of disposable income, the highest level in nearly 14 years.
"People have seen their house prices collapse, the value of their 401(k)s collapse," says Harvard economist Kenneth Rogoff. "And if they're not unemployed, they're worried about being unemployed. People are really hunkering down."
That means they are paying off credit card debt, scaling back spending and shopping for discounts — a new frugality that's been imposed by harsh economic reality. "A recession of this magnitude redefines what necessities are," Rogoff says. "You see it in a place like New York, where a high-end clothing store like Barney's is empty, a midrange place like Macy's is more crowded, and Wal-Mart and its equivalents are really packed."
Years before the financial meltdown, Rogoff had been warning of a severe imbalance in the global economy that essentially came down to this: Rich countries like the United States were bingeing on credit, while developing countries like China had surplus savings and used it to enable American borrowers.
Easy credit is now a thing of the past. Rogoff expects the savings rate to climb as high as 10 percent of income or more, levels that have not been reached in 25 years. Other indicators of consumer retrenchment to look for: plummeting imports and a continued drop in retail sales.
An Unavoidable Adjustment
Rogoff says that will make the recession deep and painful because consumer spending makes up nearly 70 percent of the U.S. economy. But in the absence of a magical turnaround in home prices and the stock market, it is unavoidable. The debts are due, personal wealth has been demolished, and people are uncertain about the future.
Rogoff says the adjustment should have happened earlier, when a stronger economy could have absorbed a pullback by consumers. "It's unfortunate that policymakers in the 2000s and even before didn't take measures to raise our savings rate," he says.
The timing of it all makes everything precarious.
Americans tightening their belts is good medicine for the country's long-term health. But when everyone starts saving at the same time, you have an economy in free fall. That's why economists across the ideological spectrum agree that stimulus spending by the government is necessary.
But weatherizing homes and building roads on the government dime can only do so much to fire up the world's largest economy. At a certain point, consumers have to regain confidence and get back in the game.
So will Americans regain the shopping bug when they get some extra cash from the Obama tax cuts? Rogoff thinks they'll be more inclined to bank it or pay down debt than head to the malls. That's what largely happened with the Bush tax rebates.
He doesn't expect consumers to regain their footing until the banking system is repaired and new rules are in place to make capitalism more stable — 2011 at the earliest.