Last year’s Great Panic abruptly reminded US baby-boomers how ill- prepared they are for retirement. Following that Panic, there would now seem to be a number of compelling reasons to expect the US saving rate to steadily increase over the next few years from its presently low level by historic standards.

 

            The most compelling of these reasons is that US household balance sheets have been seriously impaired by years of unusually low saving rates and by the ravages of the financial crisis. In this context, one has to be struck by the fact that US household debt today amounts to approximately 135 percent of US household incomes, or more than double the ratio that prevailed in the late 1980s. At the same time, despite the substantial bounce in equity prices from their March 2009 lows, US household wealth is some US$12 trillion, or around 85 percent of GDP, lower than it was at the start of 2008 as a result of substantially lower US home and equity prices.

 

            A second reason for expecting US households to attempt to increase their saving rate is the high degree of job insecurity that presently characterizes the US labor market and that is widely expected to continue characterizing that market in 2010 as the economy experiences a very sub-par recovery. Including part-time workers unable to find full-time employment, the US unemployment rate has already risen to a staggering 16 ¾ percent. At the same time, the extraordinarily large gaps in the US labor market are resulting in an extraordinary squeeze in household income growth as illustrated most vividly by declining wages over the past year.

 

            A third reason for expecting higher US household savings is that the US consumer is now highly credit constrained. Mortgage Equity Withdrawal, which in the housing market’s boom years reached a peak of 8 percentage points of US household income in 2005-2006, has now totally evaporated as a direct result of the US housing bust. At the same time, consumer card credit and home equity lines have been reduced substantially and there is every expectation that consumer credit will continue to be cut in 2010 as part of the financial system’s ongoing attempt to strengthen its capital position.

 

            An increase in US household income is to be welcomed as part of the adjustment process of the large US external payment imbalances. It is also to be welcomed as an important source of financing for the extraordinarily large US budget deficits that are in prospect for many years to come. However, if a higher US household saving rate is not to thwart the nascent recovery in the US and world economies, it will need to be accompanied by policies promoting higher consumption in China, Germany, and Japan, the world’s high savings countries. If recent history offers any guide, one would not want to hold one’s breath waiting for those countries to promote household consumption.

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I think there is a good case to be made for a protracted period of above-average savings from disposable income. As I pointed out the last time we discussed this topic, savings behavior is a forward-looking decision about building (or rebuilding) wealth. Therefore, it will depend crucially on employment, income growth, and asset prices. If the economy grows slowly coming out of the recession, and job growth is delayed, and asset prices remain flat, savings out of disposable income will remain high as workers protect themselves from the unknown and try to rebuild their retirement wealth through savings from disposable income. I see this as a likely scenario for the next several years (say, 2% real growth on average, a stock market that trends upward at a similarly low rate, and job growth that is weaker and slower than the recoveries from the past two recessions). The reason for this forecast is simple: the current Administration is pursuing anti-growth policies that will keep the economy weak. These include higher income tax rates, wasteful spending that does little to promote growth, new carbon taxation, new healthcare taxation, and anti-free trade policies that have gone from a neutral posture to an aggressively negative one. Even if the Administration only ends up winning on half of its agenda, that will produce devastating consequences for growth. There may be high income growth in 2010 (an adjustment to more normal levels of construction and inventories could raise growth to above 3% in 2010), which will be financed mainly by corporate profits, but the recovery will not have legs. Small businesses, already suffering from a lack of credit, will be especially vulnerable to the new taxes. Small businesses are the bulk of the economy and they are already lagging behind large businesses in job creation and growth -- a trend that is likely to gather more steam over the next months and years. Beyond the next three years, it is reasonable to expect the political pendulum to swing back, as it did in the 1980s, but it will take time for that to happen, and in the meantime slow growth in income, jobs and asset prices, combined with the all-but-inevitable acceleration of inflation, will encourage people to save at much higher rates than in the past.  

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