“Annual Income twenty pounds, annual expenditures nineteen six, result happiness. Annual income twenty pounds, annual expenditures twenty pounds ought and six, result misery.” - Charles Dickens, David Copperfield
It is generally accepted that financial stability for an individual, family, or business rests on generally having lower expenses than income. It is this margin that leads to savings and investment, personal and professional opportunities, financial security and peace of mind. Unfortunately, this perception often changes when talking about economics and the larger society. When a large population reduces spending - increases savings - it can lead to lower economic output in the short run. It is for this reason that many “experts” believe it is bad for consumers to be savers and lower spending (higher savings) is often said to be “dangerous” for the economy. Is it actually the case that overspending at the micro level is bad but doing so at the macro level is good? Many seem to think so.
It is generally accepted that financial stability for an individual, family, or business rests on generally having lower expenses than income. It is this margin that leads to savings and investment, personal and professional opportunities, financial security and peace of mind. Unfortunately, this perception often changes when talking about economics and the larger society. When a large population reduces spending - increases savings - it can lead to lower economic output in the short run. It is for this reason that many “experts” believe it is bad for consumers to be savers and lower spending (higher savings) is often said to be “dangerous” for the economy. Is it actually the case that overspending at the micro level is bad but doing so at the macro level is good? Many seem to think so.
Recently there was news of strong consumer spending in the U.S. during the month of April. What strong consumer spending often means is that consumers' collective spending (on what, it doesn't usually seem to matter to media and financial pundits) increased significantly compared to the prior period. Increasing spending more than increases in income seems to be seen even more positively than spending increases matching income increases. So for example, in April average incomes were said to be up 0.3% for the month, while consumer spending was up 0.4%. The previous month saw an even larger spending gap as income was reported up 0.2% while spending was up 0.5%. The fact that spending has increased more than incomes during these periods was celebrated by those on Wall Street and the media as evidence of a strong economy. That's because people generally won't voluntarily increase their spending more than their income unless they are confident in their jobs and the economy. Of course, the flip side of such consumer (over)spending is a declining rate of savings. If it is assumed that an economy where spending is going up even higher than income is good, then declining savings rates must also be a good thing.
One can make the argument that occasionally savings rates are actually too high. Especially during the midst of a recession or depression, savings rates may become very high as the fear from consumers and business result in lower spending and higher saving. Taken to an extreme, this can lead to even weaker economic conditions and a negative economic spiral. (However, in an economy with market-set interest rates, weak economic conditions will naturally result in lower interest rates that will eventually create its own demand for higher economic activity. This natural feedback loop has of course now been nearly entirely eliminated by central bank manipulation.) However, the argument that today's savings rates should go even lower seems a difficult one to make given the very strong economy America is said to be experiencing and American savings rates already near historical lows.
Below is a graph of the personal savings rate in the U.S. based on statistics from the Bureau of Economic Analysis, which covers a span of almost 60 years, from the beginning of 1959 to April of 2018. As of this past April, the average U.S. savings rate was down to 2.8%. That figure is calculated as the ratio of average personal savings in the U.S. to disposable personal income.
One can make the argument that occasionally savings rates are actually too high. Especially during the midst of a recession or depression, savings rates may become very high as the fear from consumers and business result in lower spending and higher saving. Taken to an extreme, this can lead to even weaker economic conditions and a negative economic spiral. (However, in an economy with market-set interest rates, weak economic conditions will naturally result in lower interest rates that will eventually create its own demand for higher economic activity. This natural feedback loop has of course now been nearly entirely eliminated by central bank manipulation.) However, the argument that today's savings rates should go even lower seems a difficult one to make given the very strong economy America is said to be experiencing and American savings rates already near historical lows.
Below is a graph of the personal savings rate in the U.S. based on statistics from the Bureau of Economic Analysis, which covers a span of almost 60 years, from the beginning of 1959 to April of 2018. As of this past April, the average U.S. savings rate was down to 2.8%. That figure is calculated as the ratio of average personal savings in the U.S. to disposable personal income.
Sources: Federal Reserve Bank of St. Louis; Bureau of Economic Analysis
During this span of 712 months, there were only 12 months (1.7% of the entire timespan) in which the personal savings rate was calculated to be below the level of today: October 2001, April 2005, June-November 2005, August and November 2007, and November and December of 2017
Of the twelve month of savings rates below those of today, eight of them were in 2005. That year had the lowest average savings rate for any year since the depression of the 1930s. The more than three-year span from the beginning of 2005 to April 2008 was the first time over the last 80 years in which the average savings rate in the U.S. fell below 4% and stayed there for more than a year. We are in the midst of another such period. Since November 2016, the average U.S. savings rates has fallen below 4% and has been there for 18 months and counting.
The next graph below, from the Peter G. Peterson Foundation (pgpf.org), extends the definition of U.S. savings to include government and corporate savings as a percentage of national income. This is called Net National Savings. As with consumer savings rates, we see a similar downward trend with the country's collective savings rate.
During this span of 712 months, there were only 12 months (1.7% of the entire timespan) in which the personal savings rate was calculated to be below the level of today: October 2001, April 2005, June-November 2005, August and November 2007, and November and December of 2017
Of the twelve month of savings rates below those of today, eight of them were in 2005. That year had the lowest average savings rate for any year since the depression of the 1930s. The more than three-year span from the beginning of 2005 to April 2008 was the first time over the last 80 years in which the average savings rate in the U.S. fell below 4% and stayed there for more than a year. We are in the midst of another such period. Since November 2016, the average U.S. savings rates has fallen below 4% and has been there for 18 months and counting.
The next graph below, from the Peter G. Peterson Foundation (pgpf.org), extends the definition of U.S. savings to include government and corporate savings as a percentage of national income. This is called Net National Savings. As with consumer savings rates, we see a similar downward trend with the country's collective savings rate.
These low rates of national savings have averaged below 3% over the last 15 years, and help to explain the long period of generally low economic strength and increasing vulnerability to financial stress. Compare these rates to the much higher national savings rates in past decades in the U.S. as well as currently in higher-growth countries (see graph below) in Asia (and Switzerland) who routinely see rates of Net National Savings rates above 10% or 15% (except for Japan, who has seen its savings and its growth fizzle to near zero in recent years. More on that in a moment.)
Government/central bank “sophisticated” (and transparent) plan to discorage savings: below-inflation interest rates
In a country with central bank-controlled interest rates, lowering interest rates is a rather easy way to create a low national savings rate. Lowering interest rates to the level of inflation, and below, will skew savings toward spending, and long-term investing toward speculation. While Japan and the U.S. have led the train of declining interest rates, other countries, such as Australia, South Korea, Hong Kong, Singapore and nearly all the countries of Europe have sharply reduced interest rates over the last decade. And not surprisingly, many of these countries, certainly most of Europe, have seen lower economic growth. Because of the lag effect and the cycle of savings, investment and long-term economic growth, the experiment of these countries following the lead of Japan and the U.S. will likely continue to lead to lower growth and more financial weakness over the longer term. (Thankfully, some of these countries have started to raise interest rates in the last couple years, but the extended period of extremely low (or negative) interest rates has already done much damage to their economic potential.)
Looking just at the U.S., below is a chart comparing U.S. interest rates (using the Fed Funds Rate) to stated inflation (CPI). The green area represents average interest rates and the dark red represents average inflation. When the green area is above the red area then potential interest rates for savers is higher than inflation. This creates a potential reward and motivation for earners to save some of their income and generally leads to fairly high savings (and investment) rates. Conversely, when the green area is completely hidden behind the red (creating a lighter shade of red), those are periods in which inflation is higher than available savings rates. During these periods, earners will be discouraged from saving their income and savings rates will generally be low.
Government/central bank “sophisticated” (and transparent) plan to discorage savings: below-inflation interest rates
In a country with central bank-controlled interest rates, lowering interest rates is a rather easy way to create a low national savings rate. Lowering interest rates to the level of inflation, and below, will skew savings toward spending, and long-term investing toward speculation. While Japan and the U.S. have led the train of declining interest rates, other countries, such as Australia, South Korea, Hong Kong, Singapore and nearly all the countries of Europe have sharply reduced interest rates over the last decade. And not surprisingly, many of these countries, certainly most of Europe, have seen lower economic growth. Because of the lag effect and the cycle of savings, investment and long-term economic growth, the experiment of these countries following the lead of Japan and the U.S. will likely continue to lead to lower growth and more financial weakness over the longer term. (Thankfully, some of these countries have started to raise interest rates in the last couple years, but the extended period of extremely low (or negative) interest rates has already done much damage to their economic potential.)
Looking just at the U.S., below is a chart comparing U.S. interest rates (using the Fed Funds Rate) to stated inflation (CPI). The green area represents average interest rates and the dark red represents average inflation. When the green area is above the red area then potential interest rates for savers is higher than inflation. This creates a potential reward and motivation for earners to save some of their income and generally leads to fairly high savings (and investment) rates. Conversely, when the green area is completely hidden behind the red (creating a lighter shade of red), those are periods in which inflation is higher than available savings rates. During these periods, earners will be discouraged from saving their income and savings rates will generally be low.
Source: Federal Reserve Bank of St. Louis
Savings rates in the U.S., and elsewhere, are highly correlated to the ratio of interest rates on potential savings compared to the rate of inflation. When consumers can earn a high return on their saving compared to the rate of inflation they will save more. When they earn low or negative returns on their savings compared to the rate of inflation they will spend more and save less. When the potential return on safe investments in the U.S. has been as low as it has been the last 15 years or so, consumers have been heavily incentivized to spend instead of save. Consumers do not have to be financially sophisticated to understand that earning 1% a year in the bank while losing 3% or 4% a year to inflation does not increase wealth. Better to spend the money now than have a guaranteed loss of spending power. Since the year 2000, these rate differentials have given American consumers little incentive to save their money. It was only the shock of the 2008 financial crisis that prompted Americans to increase their savings rates (for a time, which seems to be over), for their own financial security, despite the below-inflation interest rates on potential savings.
Lower savings do not lead to higher long-term economic growth
Governments and central banks use low interest rates, and their financial cousin, low savings rates, to cover up structural weakness in the economy by spurring higher consumption in the shorter-term. This has been the primary influence behind the very low rates of savings in the U.S. over the last two decades. (Though another significant advantage of ultra-low interest rates for governments is the large reduction in interest costs for governments to service their debt.)
For a case study on the dangers of using low interest rates to manipulate consumers into spending less, we can look at Japan. Until interest rates were dramatically lowered in the early 1990s, Japanese consumers had one of the highest savings rates in the world. Not coincidentally, they also enjoyed high prosperity and economic growth. In response to the onset of the 1990 recession, central bankers there sharply lowered interest rates and have now kept them there for more than 20 years (see graph below).
Savings rates in the U.S., and elsewhere, are highly correlated to the ratio of interest rates on potential savings compared to the rate of inflation. When consumers can earn a high return on their saving compared to the rate of inflation they will save more. When they earn low or negative returns on their savings compared to the rate of inflation they will spend more and save less. When the potential return on safe investments in the U.S. has been as low as it has been the last 15 years or so, consumers have been heavily incentivized to spend instead of save. Consumers do not have to be financially sophisticated to understand that earning 1% a year in the bank while losing 3% or 4% a year to inflation does not increase wealth. Better to spend the money now than have a guaranteed loss of spending power. Since the year 2000, these rate differentials have given American consumers little incentive to save their money. It was only the shock of the 2008 financial crisis that prompted Americans to increase their savings rates (for a time, which seems to be over), for their own financial security, despite the below-inflation interest rates on potential savings.
Lower savings do not lead to higher long-term economic growth
Governments and central banks use low interest rates, and their financial cousin, low savings rates, to cover up structural weakness in the economy by spurring higher consumption in the shorter-term. This has been the primary influence behind the very low rates of savings in the U.S. over the last two decades. (Though another significant advantage of ultra-low interest rates for governments is the large reduction in interest costs for governments to service their debt.)
For a case study on the dangers of using low interest rates to manipulate consumers into spending less, we can look at Japan. Until interest rates were dramatically lowered in the early 1990s, Japanese consumers had one of the highest savings rates in the world. Not coincidentally, they also enjoyed high prosperity and economic growth. In response to the onset of the 1990 recession, central bankers there sharply lowered interest rates and have now kept them there for more than 20 years (see graph below).
Sources: Federal Reserve Bank of St. Louis; International Monetary Fund
Not surprisingly, Japanese savers responded to the low interest rates by saving less...
Not surprisingly, Japanese savers responded to the low interest rates by saving less...
Have lower interest rates, which have spurred lower saving and higher consumption led to abundant long-term growth for Japan? Below we see the answer. Economic activity in Japan has hardly increased in the two decades of its near-zero percent interest rate experiment.
Source: Federal Reserve Bank of St. Louis; JP Cabinet Office
Rates of consumption above income may provide some short-term “stimulus” to the economy, but do not lead to strong economic growth over the long-term. In fact, low interest rates correlate to lower savings rates and low long-term economic growth. Comparing countries, we see that those with the highest rates of net savings generally have higher rates of economic growth. We have also seen that in the history of the U.S. Like Japan, America used to be a country with high savings rates. Even during the very difficult decade of the 1970s, Americans were still willing to save (as consumers, but also when including the U.S. government and corporations, as the earlier graph on Net National Savings shows).
In fact, it was the high rates of interest that consumers were offered in the 1970s, even higher than the high rates of inflation, which propelled consumers to save and invest and keep its economy growing. Looking at the graph below we see that the decade of the 1970s still saw real economic growth increase at a higher rate the U.S. has experienced since their own experiment with ultra-low interest rates began. Since the year 2000, more or less the beginning of the end of America's economic might and greatness around the world, economic growth in the U.S. has generally been weak, probably even weaker than published GDP figures might suggest. (In 2018 median inflation-adjusted household income is still below the level of 2000.)
Rates of consumption above income may provide some short-term “stimulus” to the economy, but do not lead to strong economic growth over the long-term. In fact, low interest rates correlate to lower savings rates and low long-term economic growth. Comparing countries, we see that those with the highest rates of net savings generally have higher rates of economic growth. We have also seen that in the history of the U.S. Like Japan, America used to be a country with high savings rates. Even during the very difficult decade of the 1970s, Americans were still willing to save (as consumers, but also when including the U.S. government and corporations, as the earlier graph on Net National Savings shows).
In fact, it was the high rates of interest that consumers were offered in the 1970s, even higher than the high rates of inflation, which propelled consumers to save and invest and keep its economy growing. Looking at the graph below we see that the decade of the 1970s still saw real economic growth increase at a higher rate the U.S. has experienced since their own experiment with ultra-low interest rates began. Since the year 2000, more or less the beginning of the end of America's economic might and greatness around the world, economic growth in the U.S. has generally been weak, probably even weaker than published GDP figures might suggest. (In 2018 median inflation-adjusted household income is still below the level of 2000.)
Source: streettalklive.com
Low savings: bad for the economy; really bad for individuals and families
Perhaps an even more significant impact of interest rate manipulation is the effect on individual households. It is not the case that every family in America saved 2.8% of their income in April. Some Americans are net savers, some are net spenders. If we think about this decline of the U.S. savings rate from about 6% in mid-2015 to about 3% now, as well as the wide range in savings rates, positive and negative, it's clear that a lower national savings rates reflects an increasing percentage of families experiencing negative cash flow each month. While such statistics are hard to come by, the variability around savings rates suggests that perhaps 25%-30% of families already had a negative savings rate in mid-2015.
Since then, the decline in the average savings rate suggests millions more families have swung from being net savers to net spenders over the past three years. Since savings is the fuel for future financial accumulation and security, lower savings rates and negative cash flow simply make future goals and retirement even more difficult. Encouraging individuals to spend more than they make, to build up their debt (even as interest rates are rising), does not lead to financial security. Tens of millions of Americans are already carrying high debt, living paycheck to paycheck, or have monthly budgets high on fixed expenses and low on discretionary spending.
A large segment of the U.S. population has little to nothing saved for retirement, or any other long-term goal. A couple articles ago I talked about the misinformation regarding savings required to retire. My intention was not that people don't need to save for retirement or security, but that having millions of dollars was not necessary for most Americans to have a modest retirement. However, because of a long period of low savings rates, there is now a large segment of the American population that has little or nothing saved for retirement or anything else. According to Federal Reserve data compiled by dqydj.com the median net worth in the U.S. (not including home equity) for a household led by someone age 50-54 was about $50,000, with a quarter of age 50-54 households having less than $6,000 in financial net worth. Clearly, for such a large share of households on the edge of retirement with little in the way of net financial assets, saving more and reducing debt should be the goal, not the opposite.
The graph below from Bankrate.com is a survey made last year of the respondents biggest financial mistakes that Americans regret. As we look at the questions respondents agreed with, we see that the regrets revolve around either not saving enough – for retirement, emergencies, education – or taking on too much debt. Not saving for retirement early enough was the regret cited the most by those age 50-64, with 37% citing the affirmative. Except for the 7% who said “something else” and the 20% who listed no regrets (and there were other responses not shown), every regretted financial mistake was some variation on either spending too much or saving too little. I suspect that many Americans could answer the affirmative to most of those.
Low savings: bad for the economy; really bad for individuals and families
Perhaps an even more significant impact of interest rate manipulation is the effect on individual households. It is not the case that every family in America saved 2.8% of their income in April. Some Americans are net savers, some are net spenders. If we think about this decline of the U.S. savings rate from about 6% in mid-2015 to about 3% now, as well as the wide range in savings rates, positive and negative, it's clear that a lower national savings rates reflects an increasing percentage of families experiencing negative cash flow each month. While such statistics are hard to come by, the variability around savings rates suggests that perhaps 25%-30% of families already had a negative savings rate in mid-2015.
Since then, the decline in the average savings rate suggests millions more families have swung from being net savers to net spenders over the past three years. Since savings is the fuel for future financial accumulation and security, lower savings rates and negative cash flow simply make future goals and retirement even more difficult. Encouraging individuals to spend more than they make, to build up their debt (even as interest rates are rising), does not lead to financial security. Tens of millions of Americans are already carrying high debt, living paycheck to paycheck, or have monthly budgets high on fixed expenses and low on discretionary spending.
A large segment of the U.S. population has little to nothing saved for retirement, or any other long-term goal. A couple articles ago I talked about the misinformation regarding savings required to retire. My intention was not that people don't need to save for retirement or security, but that having millions of dollars was not necessary for most Americans to have a modest retirement. However, because of a long period of low savings rates, there is now a large segment of the American population that has little or nothing saved for retirement or anything else. According to Federal Reserve data compiled by dqydj.com the median net worth in the U.S. (not including home equity) for a household led by someone age 50-54 was about $50,000, with a quarter of age 50-54 households having less than $6,000 in financial net worth. Clearly, for such a large share of households on the edge of retirement with little in the way of net financial assets, saving more and reducing debt should be the goal, not the opposite.
The graph below from Bankrate.com is a survey made last year of the respondents biggest financial mistakes that Americans regret. As we look at the questions respondents agreed with, we see that the regrets revolve around either not saving enough – for retirement, emergencies, education – or taking on too much debt. Not saving for retirement early enough was the regret cited the most by those age 50-64, with 37% citing the affirmative. Except for the 7% who said “something else” and the 20% who listed no regrets (and there were other responses not shown), every regretted financial mistake was some variation on either spending too much or saving too little. I suspect that many Americans could answer the affirmative to most of those.
Is it a sound economic “plan” to central banks to set savings rates far below inflation rates, to encourage Americans to spend more, save less and go into more debt? It's certainly not good for most American consumers, who generally already wrestle with higher debt than they would like. And it's not good for economies over the long term as it trades saving and investing for consumer spending and sends money out of the country. In the short-term, governments and the economy might prosper from lower savings as more Americans consume more, save less, and go deeper into debt. In the long run, low savings rates result in weak economic growth, and more financial vulnerability. And every tick down in the national savings rate means even more individuals and families who will suffer and have a future of looking back and regretting their past willingness to overspend.
