I have been tracking the savings rate on this blog for some time. What has been obvious to me and other observers is that the U.S. has had a declining savings rate since the secular bull market in bonds and shares began in the early 1980s. Indeed, it seems likely that there is a correlation between asset prices and savings rates in the United States.
However, we have now experienced a spectacular bust in asset prices. Many pundits including myself expect a secular shift away from consumption toward saving. However, the data do not show this shift. In fact, after peaking this past Spring at 6.4%, savings rates have plummeted to 3.1% in the last month. What gives?
Well for one, asset prices have skyrocketed since then. And it does seem that the prior correlation between asset price increases and low savings rate is intact. This has been the conclusion I draw. However, I want to offer up a few other possibilities and make a few conclusions about low income growth and industrial policy.
Here are the three possibilities I have come across. (If you have any other thoughts, please add them in the comments):
- Asset prices are increasing. The wealth effect and the decrease in debt-related stress associated with this increase has allowed consumers to resume their prior consumption patterns. This is where I have focused in the past.
- Debt-related stress is still acute, particularly because of continued high rates of unemployment. This has caused consumers to draw down savings in order meet basic material needs.
- A surge in strategic defaults has left consumers with more money to spend and is boosting retail sales.
Let’s go through each of these below.
The asset-based theory of low savings is at the centre of my own writings here. I first broached this in The US Economy 2008, a post which accurately predicted both the economic turmoil we have witnessed and the lack of political will as well as the burgeoning protectionist acrimony now at play.
All of this is the consequence of an industrial economic policy in the US which is predicated simultaneously on suppression of domestic wage growth and on consumption growth in order to boost corporate profits and increase asset prices. These two goals are at odds with one another and naturally lead to the accumulation of debt.
When the business cycle reaches its apex, the weight of these debt burdens becomes too heavy and we end up in recession. Interest rates are cut too low in order to resume the asset-based dynamic. But, what follows is a jobless recovery because, as I indicated, the goal is to increase corporate profitability and this is very much dependent on suppressing wage growth.
At some point after rates are cut to zero, this cycle must end with the US economy collapsing under the dead weight of the debt accumulation. But the cycle can continue indefinitely until then.
This dynamic can continue for a very, very long time. In the United States, by virtue of America’s possession of the world’s reserve currency, an increase in aggregate debt levels has been successfully financed for well over twenty-five years. Mind you, there have been a number of landmines along the way. But, time and again, these pitfalls have been avoided through asymmetric monetary policy and counter-cyclical fiscal expansion.
So, poor quality growth can continue for very long indeed. And it is this fact which allows the narrative of easy money and overconsumption to gain sway.
The boy who cried wolf
A soothsayer who counsels against this type of economic policy, but who warns of impending collapse will surely be seen as the boy who cries wolf. Think back to 2001 or 2002. Did we not witness then the same spectacle whereby the bears and doomsayers were let out of their holes to warn of impending doom from reckless economic policy? By 2004, unless these individuals changed their tune, they were long forgotten or even laughed at – only to resurface in 2007 and 2008 with their new tales of woe…
The fact is: low quality growth does not lead to immediate economic calamity. It can continue through many business cycles. Even today, it is wholly conceivable that we could experience a multi-year economic expansion on the back of renewed monetary and fiscal expansion…
printing money works. It does goose the economy as intended and it can induce a cyclical recovery.
Nevertheless, the recovery is likely to be of poor quality due to significant malinvestment. Debt levels will rise and capital investment will be directed toward riskier enterprises. Look at what’s happening in China. Are you telling me stimulus is not working? It most certainly is.
In the west, stimulus is also working. It is designed to stop people from hoarding cash and to consume. It is also designed to get people out of savings accounts and into riskier asset classes. it is doing just that.
–Is economic boom around the corner?, Sep 2009
In my view this accounts for much of the decline in savings. And I have stressed this as the savings rate has declined.
See the following posts from right after we started seeing a decline in the savings rate and after i believe recovery had begun:
- Aug 2009: Do the personal income data demonstrate unbalanced reflation?
- Oct 2009: Americans are not increasing savings
But then there is debt stress. I see this stress as mainly mortgage-related. In the 1930s, the savings rate went negative when things were at their worst.
Last October I took a brief look at the Asset-Based Economy at economic turns to see what debt burdens looked like across different sectors of the economy and how they responded to recessions and recoveries. What was clear to me is that, in the household sector – where most of the end consumption lies, it is mortgage-related debt which is the key stressor.
the household sector has breezed through the recessions in 1990-91 and 2001 without decreasing debt significantly. As a result, the increase in debt levels in the household sector are pretty astonishing. In 1952, it began at 24% of GDP, rising to around 40% by 1960, where it remained through the Ford presidency. Afterwards, it shot up again to its present 97%, four times the level a half-century ago.
This pattern is largely the same as the previous one.
Consumer Credit Debt
Consumer Credit seems to be much more volatile than mortgage credit. You can see the fluctuations in comparison to nominal GDP are greater. And the absolute amounts are much less than in the mortgage market. The conclusion I draw from this is that,to the degree household debt levels have increased unsustainably, it is mortgage debt which is to blame.
So, it seems logical that the massive decline in house prices of about 30% nationwide has created enough debt stress that some have had to dip into savings in order to meet their obligations. Certainly this is why Bill Gross’ formula for recovery in early 2009 was to "stop the decline in asset prices." It does seem that this has also been the purpose of the Obama Administration’s economic policy and bailouts all along (see "It’s the writedowns, stupid").
Now, if the Obama Administration and the Federal Reserve have been successful in reviving asset prices, then you would expect retail sales to be increasing. They are. So, it seems like increased consumption is leading to decreased savings. This doesn’t sound like debt stress. If anyone has counterfactuals, please provide them.
The last bit is something I got from a reader at Seeking Alpha. It is an interesting theory. He says:
The recent boost to retail sales could have come from a surge in Strategic Defaults. A recent article by Old Trader documented that for every foreclosed house on the market another 5-6 houses are in strategic default.
Assuming their mortgage was the single largest expense in their budget, they suddenly have a lot more spendable money. That additional spending money could account for both the recent drop in credit card delinquencies as well as a recent uptick in retail sales.
His thoughts certainly dovetail with the increase in retail sales. Moreover, his contention that retail sales increase when defaulting on a mortgage and relieving the debt stress of the greatest expense a household has.
You can read my post "Strategic default: In come the waves again" for more on strategic defaults. But, the long and short of it is that house prices have not reverted to mean. They are still well above their trend line and the rise in consumer price inflation. It makes sense for people, years after a large decline in prices has begun, to default, knowing that they can save by renting for much less.
I believe strategic defaults will increase as Alt-A and prime loans reset. However, this raises the prospect that banks will start pursuing recourse on these loans. My recent post "Do non-recourse loans become recourse in the new mortgage plan?" elicited some interesting comments by readers following the strategic default situation.
Tom Lindmark, who writes the blog But Then What, said:
Since mortgages are governed by state law, I don’t think that it is possible to make a blanket statement as to whether they may or may not be subject to deficiency judgments in the event of modification. I’ve had several conversations with attorneys over the statutes in
Arizona on various occasions and the bottom line has always been to forget about trying to recover anything over and above the value of the property if you’re foreclosing on residential real estate.
Here’s a link (http://www.sackstierney.com/articles/antidefici…) to a decent article on the Arizona statutes. Notice how a simple concept gets really complicated really fast. You may note that the article implies that a refinance may not enjoy anti-deficiency protection. It fails to reference an Arizona court decision that many feel extends protection to refinance transactions. I don’t have that link readily available but if I can find it again I will send it to you.
I think that the bottom line on this one is that the banks probably don’t want any part of jumping through the hoops that would be required to obtain deficiency judgments. Putting aside the bad publicity, the expense and complexity of trying to wring blood out of very dry stones probably isn’t worth it.
Another reader challenged the concept that banks will not pursue strategic defaulters, writing:
In Florida they can come after all loans even 1st mortgages and they have started doing so on some shocked people and some were even short sells where a professional didn’t verify there was no recourse for the banks for the difference.
Probably, rumor in Florida is that the banks are starting to look at the person’s credit report besides the foreclosure and their job listed to see if they are a good target to collect something on. Wouldn’t be surprised if they start selling the ones that don’t look as good to collection firms.
"When John King stopped making payments on his home in Coral Gables, Florida, two years ago, he assumed the foreclosure ended his mortgage contract, he said. Last month, a Miami-Dade County court gave collectors permission to pursue him for $44,000 stemming from the default.
King is among a rising number of borrowers who are learning that they can be on the hook for years after losing their homes. Amid a crisis that stripped $6.4 trillion, or 28 percent, from the value of U.S. residential real estate since the 2006 peak, lenders are exercising their rights to pursue unpaid mortgage balances. To get their money, they can seize wages, tap bank accounts and put liens on other assets held by debtors."
The bottom line in this for me is that, to the degree strategic defaults are increasing retail sales, this is unsustainable. Eventually, banks will take every recourse they can to pursue these defaulters because the losses from these loans are going to mount.
Note that some pundits believe the data are inaccurate and that the decline has been nowhere as large as the data now indicate. Time will tell. I take the line that America has been living beyond its means. When the housing bubble burst it was game over. Policy can reflate the economy temporarily. And savings rates have declined as a result. But the secular trend is clear. Weak consumer spending will last for years.
People like Stephen Roach opined back in November 2008 that this was a good thing. I agree. Yet, some are attempting to shift the blame for America’s problems onto other people, mostly the Chinese. As Roach wrote in the FT the other day GD II awaits if China bashing rhetoric turns into protectionism. America needs to take responsibility for its own economic policies. China has its own problems. Let them focus on these. Blaming others for a problem made in America is not going to solve anything.
Nevertheless, in my view, it is clear in part why Americans have over-consumed. I alluded to this in my recent post on overconsumption:
The challenge the US faces is how to maintain consumption growth in the face of continuing pressure on income. Businesses are enjoying a huge resurgence in profit and this has contributed to their savings and low debt levels. Yet, households remain indebted. Moreover, after the 2009 stimulus shot in the arm, disposable personal income is not going anywhere.
Unless US policymakers solve this problem – the divergence in the benefits of economic policy for business and households, consumption growth will have to slow. If consumption does slow and asset prices stall, the US will be headed back into recession.
Put more directly: At the heart of America’s problems is an economic policy which is designed to keep wages down but consumption up. That necessarily means more bubbles, more debt, more wealth and income inequality, and consequently more strife and social unrest when the gravy train ends. You cannot expect to hollow out a country’s manufacturing base, set up a bunch of McJobs to replace it, and still have consumers spend to support the economy. This is what we are now starting to realize.
Inevitably, given human nature, people start looking out for themselves when their basic needs are not being met. That is what my The politicization of economic problems post was about.
We can sit here and laugh at Marc Faber and his media-seeking hyperbole about how this whole thing is destined to end in collapse. However, he has a very far-sighted view of what is transpiring. Unless policy makers change their tune and understand that a rebalancing is in order, we are going to be in a world of trouble.
What we need are leaders who understand that, in an environment when the most basic needs on the hierarchy of needs are under threat, people will react with fear, anger and irrationality. Playing the blame game and pointing fingers will only yield unpredictable results. Rather, American policy makers should focus on the longer-term goal of increasing household income and savings. Unfortunately, this can only be done via higher interest rates and concentrated industrial policy focused on increasing wages instead of suppressing them.
Update: I failed to add a graph of real wages. I haven’t updated the data on this in a while, but you can see some charts from my June 2008 post Chart of the day: real hourly earnings, which shows how wages have stagnated.
Also,regarding economic policy in the United States, policy makers aren’t gathering around a table and asking "how can we drive down wages and goose consumption at the same time?" Rather, this is the de facto policy which is inherent in monetary and industrial policy.
On the one hand, the Federal Reserve has followed an asymmetric monetary policy that is geared toward attenuating the effects of recession on economic output. In practice this has meant reducing interest rates quickly after the peak of a business cycle, but increasing them rather slowly as the cycle ramps up.
On the other hand, deregulation in a globalized world has exacerbated the trend toward emphasizing shareholder income at the expense of domestic workers by increasingly outsourcing jobs via technological improvements and global wage arbitrage.
I do have a number of ideas how this can be reversed and will expand on it at some point. However, there really is no magic bullet that doesn’t involve some measure of economic pain.
Update 01 Apr 2010: See further ideas on this via a subsequent post, “Why the fall in the savings rate is not meaningless.”