When U.S. Secretary of Treasury Tim Geithner traveled to the G20 summit in Toronto a few weeks ago the agenda in his briefcase was one for growth, even if it meant extending government aid a while longer to ensure that the world collectively has escaped the grips of recession. Not all foreign governments at the G20 saw eye to eye on this matter. Others facing larger budget deficits in Europe were focused much more on austerity measures to get their balance sheets in order opting for some short term pain to ensure longer term health. Much of this has been publicized and is common knowledge but it surprised me how many parallels can be drawn between this and the U.S. savings rate.
As recently as 2005 American’s were saving only 1.1% of their personal disposable income. This would turn out to be a trough in the savings rate after a long and gradual decline from roughly 10% in the early 1980’s. Going into the recession, market pundits complained Americans were spending too much and saving too little as no one was prepared to handle the layoffs that ensued. In the courses required to become a financial planner I had it drilled into me class after class to always have an emergency fund to fall back on. This is found by taking your total liquid assets and dividing them by your total monthly non-discretionary expenses; an answer of 6 to 9 months is generally considered a safe and desirable level to have on hand. This made certain that you could support yourself for at least 6 to 9 months while searching for employment. This is effectively what many European countries with debt troubles are trying to do right now. They are cutting back expenses in order to build up that emergency fund so they will be better equipped to handle future economic cycles. Our banks are doing this right now as well. Unfortunately, that means higher restrictions and fewer loans to small businesses at the moment.
Coming out of the recession, now that the savings rate has climbed almost fourfold to 4% in the U.S., many are now worried that Americans are saving too much and need to start spending more in order to prop up GDP. As we have written in previous letters, consumer spending makes up roughly 70% of our GDP. This is similar to the argument Tim Geithner brought to the G20 meeting that looks like it fell on deaf ears.
Could we get all the way back to a 10% savings rate? Maybe. What is more likely to happen is that we will fall some place in between the current 4% rate and the 10% rate of the early 1980’s. State pensions and what is left of pensions in the corporate world are beginning to retool requirements and calculations. One of the ways they are doing this is by requiring new entrants to pay a higher % of their pay into the pension. Effective July 1st, a state workers union in Mississippi covering over 3,300 workers will now be requiring employees to contribute 9% of monthly earned compensation into their pension up from 7.25%. This in itself raises the savings rate. Those future retirement hopefuls not in pensions have also realized what a recession can do to their nest egg and could potentially start saving/investing increased amounts in order to make sure they avoid outliving their retirement assets. Total U.S. consumer credit is down over 5.5% since reaching a peak in mid-2008 and for the month of May the drop in consumer credit was $9.1 billion versus a much smaller expectation of $2.3 billion. U.S. consumers are getting their houses in order just like the US banks and just like many European countries.
What could pick up the slack in consumer spending for the US GDP? We can think of one possible answer. In China the last two months have been filled with strikes by workers fed up with their salaries. It seems like once a week a story is published about a Chinese manufacturer raising their salaries by 30%. This is evidence of a growing middle class. Match this with the recent announcement that China is going to slowly let its currency start to appreciate and even more buying power is created. This increase in Chinese demand could eventually filter through to U.S. products and replace some of the gap created by the increase in U.S. savings rate.
U.S. Savings Rate as a % of Disposable Income
~Ryan Comstock, CFP®
