Wikinvest Wire

The paradox of thrift

Monday, September 21, 2009

We're all going to be hearing a lot about the "paradox of thrift" in the months (and probably years) ahead, the well worn maxim that economic growth suffers when more people save, due to the fact that more saving means less spending.

This report in the LA Times covers the topic quite well.

After the most punishing downturn in half a century, the U.S. economy has finally begun showing signs of renewed life. Stock prices and factory orders are up. The housing market appears to be stabilizing. Job losses are moderating. Overall, the economy has begun to grow, officials believe.

Welcome as all those developments are, many analysts worry that they may not be enough to offset another trend: the continuing refusal -- or in many cases the inability -- of millions of U.S. consumers to go out and spend money the way they did before the crash.
Yes, conventional economic "wisdom" has it that there was nothing fundamentally wrong with an economy where more than 70 percent of all activity came from personal consumption.

As formerly spendthrift consumers all across the country begin to rebuild their personal balance sheets, now realizing that their home equity isn't going to fund their kids' higher education and their own retirement, more traditional methods of saving (e.g., spending less than you make) are becoming popular again.

No less an economic expert than former Fed chairman Alan Greenspan feared this development not long ago, noting that a higher personal saving rate (after tax income minus spending) could make an economic recovery difficult.

He seems to be right about a lot more things in retirement than when he ran the central bank.
When American Express asked a sampling of 2,032 people late last month what they would do if they found $500, the answers were like a pitcher of ice water in the face of retailers. Survey respondents were offered a list of possible spending choices that included splurging at a restaurant, going on a shopping spree and taking a trip.

But a mere 10% or fewer marked one of those items. Most went down the list and checked off paying regular bills, reducing credit card debt or simply saving the money.

"What we see consumers doing is exhibiting a level of discipline that we didn't know," said Gail Wasserman, a spokeswoman for American Express, which like other card companies has reinforced the reduced- spending trend by issuing fewer cards and slashing credit lines to lower their own risks.

"It's very clear consumers have hit the reset button. They've reevaluated their priorities and separated their wants from their needs," Wasserman said.
Apparently, that's what happens when you reach the maximum level of debt that a system can sustain and asset prices can be pushed no higher - you hit the reset button.

That is an odd analogy - hitting the reset button.

For example, when computers are functioning properly, there is no need to reboot. Normally, it is only when things go awry that a restart is needed. It seems that if the system had been designed a little better, there would be no need to reset it...


Anonymous said...

Over and over again, with wringing of hands, I hear that 70% consumer content of GDP is unsustainable. But I never hear what level is sustainable? Nor even what is the historical consumer content of GDP.

Can you provide any context to this number?

Tim said...

China has been at 40 percent for some time. If memory serves, up until the late 1980s, the U.S. was somewhere between 60 and 65 percent.

Adam said...
This comment has been removed by the author.
Adam said...

Hi Tim, I agree that our consumerist country has gotten out of hand but you are missing something. The income inequality argument.

Debt has replaced income and exasperated the problem.

Anonymous said...

I truly don't understand why we don't see more about this 70% statistic. No one dares to say what it really means.

To make it clear, let's start with 100%. Divide 100% into three parts and you get three times 33% (plus a bit but who cares). Now, 70% is roughly two times 33% (one-third of 100% you will recall from about five seconds ago).

Why all the fifth grade math?

Because an economy running on 70% consumption is an economy that consumes TWICE what it produces.

yes, that is correct. Imagine spending twice what you earned. This is what we do as a nation.

If you ignore stockbuilding and stockdraws (reasonable over the long term), a global economy MUST be balanced with consumption equaling 50% of the economy. Any other ratios lead to inflation, deflation, or the disappearance of segments of the economy.

Yes, you! Fat, Cheez Doodle eatin' Yank! You eat twice as much as you make!

p.s. One day I will learn to log in

Alan said...

Easy fix, just give everyone a big fat raise, then they can both save and spend!

Anonymous said...

The US consumes too much, and several other nations consume too little. The US can't go on being the consumer of last resort for the entire world forever. Private debt is already too high to repay, and private citizens can't borrow much more now that this has become obvious to saving nations.

The formulas the Fed uses assume a closed system, which is why the Fed keeps trying to force US citizens to borrow/consume what other nations don't. This cannot work in the long run, and there is no exit strategy.

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