Notes on a society in crisis (8): Why Americans save so little, and consume so much
On April 1st 2012, my book,” Dagbok från USA”, came out in Sweden. It will also soon be published in English (as an e-book for Kindle and for other readers) with the title: “Diary from the United States – Notes on a society in crisis“. As an appetizer for English speaking readers, I will the coming weeks publish some excerpts from the book.
Leave it to the markets!
The personal savings ratio, the proportion of disposable income that a person saves, has been falling in the U.S. since the early 1980s, which this graph from FRED Economic Data, Federal Reserve Bank of St. Louis, shows. Americans save too little, everyone seems to agree on that, but what does it actually mean? It’s no coincidence that the savings ratio began to decline around the time when the U.S. trade with the outside world began to show a minus around 1980. The current account was thoroughly negative for the first time a few years into the 1980s (and so it has been with some dips in the curve ever since). A negative current account balance in a given year means, in simple terms, that the country must borrow from abroad to balance its books. An economist would say that the domestic savings are insufficient to finance the domestic investments.
There were several reasons why the average American household began to save less than before in the 1980s:
First, households’ disposable income, measured in nominal dollars, has increased for each year that passed. For example, it was becoming increasingly common for a family to have two incomes. In the 1960s, only 12% of married women with children under six had a job. By 1990 that figure had risen to 50%. Having two wage earners in the family could be seen as an insurance arrangement that decreased the need for an economic buffer.
Americans also worked more hours per year. A graph of actual working hours in OECD countries would show that the curve for the United States bends upward from about 1980 with a tendency to rise throughout the period leading up to the crash a few years ago. For the European OECD countries, the picture is quite different. In the same period, Europeans worked significantly fewer hours per year with a falling trend. The actual annual working time for full time, e.g. in Germany, was in 1980 1,751 hours. In 2010 a German worked on average 1,409 hours compared to an American working 1,778 hours. According to one report (Reich, 2011), the average American household today works 500 more hours than in 1979. This is equivalent to twelve weeks of full-time work.
Second, interest rates have been low during the last 2-3 decades compared to what they had been during the high-inflation years in the 1970s, and it was easy to borrow. The percentage of the U.S. household’s disposable income used for debt service was relatively constant from the early 1980s until the mid-1990s, at around 11-12%. Then it rose to a high of 14% just before the financial crisis in 2008-2009. Even so, it wasn’t a very high figure. One understands that the U.S. households felt that savings could be kept down. In case of an emergency, one could always borrow.
There was an even more important factor. The U.S. household’s wealth began to increase, and households got a taste of borrowing to increase their wealth further. Stock prices continued to rise during the 1990s, especially towards the end of the decade, and more and more American households borrowed to buy shares. But most of all, households borrowed to buy their own homes or to buy a bigger house than the one they already had. This was true for the entire period from 1980 up to the crash of 2008. It was a seemingly safe, lucrative business. Although prices rose rapidly, it was more or less “guaranteed” that a house, even an expensive one, could be sold at a profit. And if the house was not sold, the equity, the difference between the house’s market value and the value of the mortgage, rose. And equity could be borrowed against. Especially in the last decade up to the crises, American households made extensive use of their houses as a kind of ATM with seemingly inexhaustible resources.
Against this background, one cannot blame U.S. households for not saving as much as before. In essence, it was rational behavior, not least because they felt richer. For each year that went by, households saw the gap between the market value of what they owned in real assets and what they had borrowed to acquire these assets, increase. They felt confident about the future. The good times during those decades, from 1980 until 2008, were also evident. Corporate America earned more money for each decade that passed, and unemployment went from levels around 8-10% in the early 1980s to a low of around 4% during the early part of the last decade.
A falling personal savings ratio is, in simple terms, an indication of increased consumption, and U.S. consumption did increase over the years – as a share of GDP from the level of just over 60% in 1980 to just over 70% today. This is a very large increase. Most Western countries have not increased their consumption share since 1980. In addition, the level of consumption as a percentage of GDP is much lower in other OECD countries. Germany and France consume today just under 60% of their GDP, Sweden only 48%.
High consumption, and corresponding low savings, is problematic for the U.S. economy partly because the country must borrow from abroad to financially balance its books as I mentioned before, in fact the current account deficit has tended to increase with time. Partly due to the existence of domestic imbalances. The U.S. federal budget does not balance. Since the early 1980s, the federal budget has more or less regularly had a deficit of 2-4% of GDP. This year, 2011, the deficit will be in the range of 10% of GDP.
If you cannot blame households for saving less and consuming more, who does bear the responsibility? The short answer is – the politicians. Ever since Ronald Reagan’s presidency in the 1980s, economic policy has been strongly market-friendly. Reagan introduced an important paradigm shift in economic policy, a kind of return to classical economics. The market was put first in a new way. Specifically, this new paradigm has meant a generous monetary policy with low interest rates (which has been excellent for anyone who must borrow), and no attempt by the authorities to offset speculation and bubbles. Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, held the view that it’s not the responsibility of politicians or the central bank to try to deal with the overheating of the stock market or housing market (although, as he said, the market was characterized by “irrational exuberance”, another way of saying “unreasonable risk”). The new market-friendly paradigm has meant deregulation, particularly in the financial markets. The repeal of the Glass-Steagall Act in 1999, which since 1930 had kept U.S. banks and investment banks organizationally separated, is a concrete example of deregulation.
“Leave it to the markets!” has become the motto of the new paradigm. In addition to falling savings and rising consumption, the price of this policy was the severe financial crash in 2008-2009.
Literature:
Reich, R. B., 2011, Aftershock, Vintage Books, New York;
First published (in Swedish): September 28, 2011
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