Consumers Don't Care About Savings Rates

LA Times details the (lack of) savings:

Consumer spending last month grew faster than people’s take-home incomes as households cut their savings rate a bit to support their purchases of cars and other goods and services.

The government said Friday that the personal saving rate — the percentage of after-tax income that’s not spent — fell to 3.5% in November from 3.6% in October. As recently as June, the rate was 5% after being consistently at about that level or higher since late 2009.

I'm not sure why it took me so long to realize the below relationship (I have been looking over this data for years now), but the savings rate broadly does not matter to consumers. In fact, over the past 50 years (as the chart below shows), it hasn't mattered at all.

What has mattered for the average American is simply that a specific amount is saved, which has been around $100-$200 a month in real (after-inflation) terms, irrespective of the amount they have actually earned. So while real disposable income and consumption have roughly tripled over the past 50 years on a per capita basis, savings is up a less-than-whopping 13% (0.25% annualized growth).

The other thing to notice in the above chart is the declining level of real per capita disposable income, something that will have to reverse to keep the concept that we can grow our way out of our debt alive.

Source: BEA

Can Negative Interest Rates Cause Savings to Increase?

At current interest rates, an individual will lose purchasing power in their savings account if there is even an inkling of inflation. A common assumption is that the Fed has done this (i.e. pushed interest rates to historic lows) to increase aggregate demand (i.e. if you are earning nothing, you might as well spend it) or to move investors to riskier investments that might provide better momentum for the underlying economy (i.e. an investment in a corporate bond that makes it cheaper for corporations to borrow).

But what if low to negative interest rates in fact causes the opposite... an increase in the savings rate and derisking by investors? This post is based on a very quick and dirty framework I've been thinking about and focuses on the savings rate, but the same framework could (in my opinion) justify why investors may choose to derisk as well. Any feedback would be greatly appreciated.

Getting to $100 Saved

Let's assume our saver knows that in ten years they will need to have $100 saved (for retirement, college education for their kids, a new car, etc...). Earning 0% on their savings, they would need to save $10 / year. If they were to earn a rate of return on that $10 saved each year, by the tenth year they would have excess savings (i.e. the blue and yellow lines).

As a result, if an investor can earn more than 0%, they do not need to save $10 / year, but a smaller amount. The chart below shows how much that $10 can be reduced based on various rates of return on their savings.

Assuming the individual earned $200 / year, the original $10 was 5% of their income (i.e. a 5% savings rate). The various amounts needed to save each year is converted to a savings rate below. It clearly shows that if a saver can earn a rate of return greater than 0% (i.e. if interest rates were higher), they can save less to get to their goal.

Unfortunately, savers aren't currently able to earn 0% on their checking / savings accounts. With any inflation, an investors is faced with negative interest rates. So, to get to a $100 real level of savings, an investors will need to save more than the $10 / year.

I know some readers will point out that an individual can always choose to add more risk to increase their returns, but what happens if that investment doesn't work out? An even higher level of savings, which they may not be willing or able to do.

So there's the very basic framework. What am I missing?

You Take the Good. You Take the Bad.

A few data points from today...

The Good

This morning's Chicago PMI showed that delivery times have slowed. How is this possibly a good thing? Well, if corporations are slowing delivers due to a lack of capacity, they are more likely to invest in more capacity, add (or at least stop laying off) employees, or in a perfect world... both.



The Bad: Sustainability of Consumption

Also released this morning was personal income and consumption for March. The chart below shows personal income, personal consumption, and personal consumption less transfer payments (defined as money given by the government to its citizens). Excluding these payments, which includes unemployment benefits, the savings rate is... wait for it... negative (good over the short run perhaps, but without hiring this hardly seems sustainable).



Source: ISM / BEA

National Savings Rate Negative

The chart below shows the national savings rate (net savings of individuals, corporations, and the government). What we see is that for the first time since the Great Depression the aggregate savings level turned negative and is still negative.



What does this mean? It means the economy has been reliant on external sources of financing for our current level of consumption, which is sustainable… until it isn’t. Put another way, maintaining our current level of growth isn't completely in our hands at the moment.

This will either reverse at some point in the future with:

• Absolute savings increasing through a higher savings rate, which will cause the economy to slow (all else equal) as we get our balance sheet in check (i.e. what is going on in Europe)
• The growth of the private sector, which will allow the absolute level of savings to increase without a large increase in the savings rate as a percent of GDP; the denominator will grow, rather than the numerator in the savings as a percent of GDP ratio (i.e. the goldilocks scenario)

Source: BEA

How Individuals are Saving

Savings are building up per Marketwatch:

Incomes grew faster than spending in August, pushing up the nation’s personal savings rate, the Commerce Department estimated Friday.

Real consumer spending increased by a seasonally adjusted 0.2% for a second straight month, the government’s data showed. In nominal terms, income rose 0.5% in August, after a 0.2% gain in July. Nominal spending rose 0.4% in August for the second straight month.

Real after-tax incomes rose 0.2% in August, after falling 0.2% in July. Incomes rose more than the 0.3% that had been forecast in a survey of economists by MarketWatch.

Here are the longer term components of savings. It looks like the growth in both income (increasing savings) and incremental spending (decreasing savings) are both bouncing back... but slowly.



Source: BEA

Personal Savings on the Rise

Peter Boockvar (via The Big Picture) with the details:

The Savings Rate is now approaching the 50 year average of 6.9% and will very likely head above that over the next few years as the pendulum swings in the other direction as it got as low as .8% in Apr ‘05. One hand, higher savings will put a crimp on consumer spending which of course makes up a majority of US GDP but on the other, higher savings is the fuel for investment which helps to finance businesses everywhere that are getting crowded out in their borrowing by the enormous needs of the US gov’t and some European ones.

Source: BEA

Are Americans Already Back to Their Old Ways?

Financial-Planning reports:

While 63% of Americans said they were concerned about the overall state of financial markets in 2009, just 45% said they were concerned in 2010.

Nervousness and fear about retirement dropped from 55% who were nervous or afraid last year to just 40% this year. American's concern about having enough money to retire has fallen from 56% in 2009 to 51% this year, the same as in early 2008, the study found.

“Americans appear more relaxed about retirement and are far less worried about their finances overall,” said Craig Hogan, Scottrade’s director of customer intelligence. “The number of people who reported being concerned about issues such as day-to-day expenses, education costs, paying off credit cards, and saving for big ticket purchases didn’t just decline – each category hit a four-year low.”

Which leads us to this morning's personal consumption and expenditure report. To the NY Times:

U.S. consumer spending rose as expected in February for a fifth straight month, while stagnant incomes pushed savings to their lowest level since October 2008, a government report showed on Monday.

The Commerce Department said spending increased 0.3 percent after rising by a slightly downwardly revised 0.4 percent in January. Consumer spending in January was previously reported to have increased 0.5 percent.

Source: BEA

Is the Consumer Relevering?

Sure looks like a possibility based on Friday's consumer credit release. Marketwatch details:

In an encouraging sign for the economy, U.S. consumers increased their debt in January for the first time in a year, just the latest hint that household demand may be on an upswing.

Although the economy has picked up steam lately, many economists don't believe it will be on a sustainable path unless consumers restart their spending.

This wasn't too big a surprise following last week's downturn in savings (paying down debt counts as savings), but maybe we should not be counting out the consumer in the short run. We shall soon see... later this week we get February's retail sales figure.

Source: Federal Reserve

Why Save?

One reason for the continued low savings rate (and continued spending)?

No place to store it (unless you want limited return).

The below chart details the historical savings rate vs. the three year Treasury yield (I used three year yields as this is a relatively safe investment on the duration side).



Coincidence or a legitimate relationship?

Source: Federal Reserve / St. Louis Fed

Long Term Trend in Personal Savings

Ahead of tomorrow's personal savings release, lets be reminded of the longer term trend...

While the savings rate has turned up to ~5% since bottoming in early 2008, we are still a long way off from the 8-10% level seen from the early 1960's to mid-1980's. It is also important to note that paying down debt liabilities is included in the above savings rate, thus the actual amount "saved" has not actually been this high in recent months as the consumer delevers.

Source: St. Louis Fed

Where's the Investment?

I have heard from a number of readers that the lack of consumption in the current environment is not as troubling as one might expect. The thought is that rather than consume, individuals are increasing their level of savings, which is just a form of future consumption (and the opportunity to consume MORE later outweighs the benefit of consuming LESS now).

Which makes sense, except the data does not support this theory. Looking at the data, we see a HUGE decline in investment (and thus a HUGE decline in savings if you assume I = S). How large? Investment is down massively from its 2005 peak across the board and is now below the level of investment seen in Q2 1997.

Twelve years of growth in investment gone? What is happening? Well, the savings that has been reported is not occurring as the numbers imply. Savings is calculated as the difference between income and consumption. What is missing is interest payment / debt repayment. As described by reader Angry Saver in a previous post:

The C+I... formula is simplistic and rests on flawed assumptions. It is an accounting identity that does not always reflect the facts in the real world. End demand by consumers is the key. When end demand shrinks, so does the pie. When future income shrinks, so does the pie. Adding gov't debt will create false demand and may keep the debt system from imploding, but it will also limit future end demand.

(We've) spent too much based on misperceptions of future wealth (wall street lies). Much of the so-called investment/savings were borrowed from abroad and were actually malinvestments as they exceeded ability to pay and were not based on end demand. The bills for all that excess/mis-spending are now due. A rude awakening. Debt repayments and debt defaults at the household level will accelerate.

Despite propaganda to the contrary, U.S. consumers are now realizing that their future incomes will be less than previously thought. Lower savings/investment is to be expected as our economic future will be smaller than previously assumed.

Source: BEA

Income Down, Savings Up = Consumption Down = Stalled Economy

WSJ reports:

Without government support, personal income is under pressure as the U.S. workweek gets shorter. In a report showing the U.S. unemployment rate rose to 9.5% in June, the Labor Department said the average workweek for production and non-supervisory workers on private non-farm payrolls fell by six minutes to 33 hours -- the lowest since records began in 1964.

The bad job market is endangering a U.S. recovery. A key report last week said the economy slumped April through June by 1.0%, much less than over the winter. But the data showed consumer spending decelerated in the spring. Spending is a big part of the economy. While analysts foresee the economy rising in the current, third quarter, fear for jobs will likely keep wallets tight and hinder the expected growth the rest of the year.

The data Tuesday showed personal saving as a percentage of disposable personal income was 4.6% in June, the Commerce Department said. It was 6.2% in May, 4.7% in April, and 3.7% during March.

Below is a chart of personal vs. disposable personal income (notice the spike in disposable income from last years rebate check... didn't last for long).

Now, the money shot. Real personal consumption per capita vs. national savings.

Catch-22 alert. How do we get a recovery without the return of the consumer... how does the consumer return without a recovery?

Source: BEA

Update:

There seems to be some confusion (in my opinion) over this post over at Reddit. User Shenpen states (and has a lot of support from the Econ crowd) that:

This makes no sense. If savings are up, they are in the bank. If they are in the bank, they need to pay interest. They can only pay interest on it if they invest it. Investment creates demand for capital goods i.e. it simply diverts the jobs from making consumption goods to making capital goods.

True, in normal circumstances. Ignoring the practically zero cost of deposits, the issue lies when EVERYONE tries to save at the same time. Call it the "paradox of thrift". In a given moment it is in each participants best interest to save, but IF ALL SAVE AT THE SAME TIME then the overall income pie decreases as the economy slows (i.e. GDP decreases).

Thus while savings is rising as a percent of income, the overall level of income (thus savings) is actually decreasing. We can see this in the actual data. Savings as a percent of income has risen, but overall savings (i.e. investment within GDP) has fallen dramatically.

I will agree that this is one way out of the Catch-22. If investment towards capital goods (with actual use) does increase, then we don't necessarily need consumption to spring back for growth to return.

The Paradox of Thrift

Okay, don't argue with a Nobel Laureate economists. As soon as I posted this under the heading "I Think Paul Krugman is Wrong", I realized he is of course... correct in his interpretation. The overall thought of whether this is the reason for the decline in savings is up for interpretation.

First, I'll let Paul summarize what the paradox of thrift is:

The paradox of thrift is one of those Keynesian insights that largely dropped out of economic discourse as economists grew increasingly (and wrongly) confident that central bankers could always stabilize the economy. Now it’s back as a concept. But is it actually visible in the data? The answer is, and how!

The story behind the paradox of thrift goes like this. Suppose a large group of people decides to save more. You might think that this would necessarily mean a rise in national savings. But if falling consumption causes the economy to fall into a recession, incomes will fall, and so will savings, other things equal. This induced fall in savings can largely or completely offset the initial rise.

Which way it goes depends on what happens to investment, since savings are always equal to investment. If the central bank can cut interest rates, investment and hence savings may rise. But if the central bank can’t cut rates — say, because they’re already zero — investment is likely to fall, not rise, because of lower capacity utilization. And this means that GDP and hence incomes have to fall so much that when people try to save more, the nation actually ends up saving less.

In other words, if ALL consumers increase their savings in a consumption based economy, the overall pie (i.e. economy) shrinks. Thus, while individuals save more as a percent of income, overall savings decrease as the pie decreases at a faster rate.

Paul then shows a chart, which is similar to the following (his is just the difference in each of these categories from Q4 '07 --> Q1 '09) pulled from the same BEA database.

He sees the data and declares:

Sure enough, the sharp increase in personal saving has been accompanied by a decline in overall national saving — partly via reduced corporate savings, largely via increased public deficits.

What matters for the economy is the aggregate savings (my mistake, my point was that the individual consumer still has the incentive to save as they have been able to raise their "personal" level of savings). Since savings must equal investment (the I in C + I + G + NX = GDP equation), the decrease in savings has impacted the size of the overall economy, thus income. The issues that Paul details (and again, I missed) is that even though individuals have increased savings rapidly, overall investment is STILL down.

Of course, the counter-argument is that we need government spending to take the place of personal spending until the consumer is able to bounce back.

Update:

Reader Matt Stiles with an alternative view:

Saving is investment. The very act of saving is nothing more than a postponement of current consumption in exchange for future consumption. While in between, the money is used to lend to entrepreneurs. The rate of interest is what regulates this process.

Of course, if you throw in government tampering with 200 year old property laws. (GM, Chrysler) and allow banks to operate without traditional legal accounting principles then sure, savers will be less likely to invest where they otherwise would (early stages of production).

Additionally, Krugman take the Keynesian approach and advocates for enormous deficit spending. And subsequently, when this pulls down the "overall" level of investment in the economy, this somehow supports his "paradox of thrift?" Seems suspect to me...

Personal Consumption Holding Steady

WSJ reports:

Americans spent at a slower rate in February as their income fell and they saved money at a historically elevated level to cushion against the recession. Personal consumption rose 0.2% compared to the month before, the Commerce Department said Friday. Spending had increased a revised 1.0% in January; originally, spending was seen up 0.6%.

Personal income in February fell at a seasonally adjusted rate of 0.2% compared to the month before. Income increased a revised 0.2% in January; originally, income for that month was seen 0.4% higher.

Personal saving as a percentage of disposable personal income was 4.2% in February, the Commerce Department said. It was 4.4% in January. The last time the saving rate exceeded 4.0% two straight months was August and September 1998, up 4.3% and 4.2%, respectively.

How is it possible to spend more, save more, all the while earning less? Taxes paid down and social benefits up...

Source: BEA

Personal Savings Bounce

Source: BEA

Personal Consumption Down... No More "Borrowing" Buffer

Marketwatch reports:

Personal incomes and consumer spending fell in the United States in December from November, the U.S. Commerce Department reported Monday. Incomes dropped 0.2 percent, while disposable income also fell 0.2 percent, the government said. In the previous month, incomes fell 0.4 percent, while disposable income fell 0.3 percent. Consumer spending, meanwhile, fell faster, dropping 1 percent, the report said. Consumer spending, which drives a lion's share of the U.S. economy, fell 0.8 percent in November and 1.1 percent in October.

In other words, the savings rate increased (if spending drops more than income, that means it is going to savings). Looking at the chart below whichs details the savings rate going all the way back to 1948... it's about time.



This increase in savings was expected for those trying to get their personal balance sheets back in order (and required when the savings rate actually turned negative in 2006). However, just because it is needed, doesn't mean it won't be the cause of significant pain for an economy made up ~70% by consumption.

As can be seen below, we are entering a new secular phase for the U.S. economy. For the past 16 years we have had unbelievably "smooth sailing", with personal consumption growing a steady 1-4% per capita in real terms over that entire period. What I found interesting is what I will refer to as the "borrowing buffer". That is, when disposable income didn't increase (the blue line), the U.S. consumer was able to borrow to keep up the spending pace (the red line).



Until now. With the turmoil in consumer credit, lack of supply (and in many cases demand) for cheap credit, the "borrowing buffer" is no more. Personal consumption broke through the 1-4% range and is now down almost 2% in real per capita terms over the past year. In other words, personal consumption like most other economic data, has fallen off a cliff.

This is why the government has and will continue to pick up the private sectors slack.

Source: BEA

Defined: Unsustainability

Source: BEA

Nation of Debt

Government
Below's chart shows social benefit payments made by the government against the amount of personal taxes collected. As can be seen, individuals have been receiving significantly more in the form of benefits than they have paid for since 2000.


In real terms (further below), we can see that the nation has never received more benefits, YET real taxes collected by individuals are lower than when they peaked in 2000. In fact, we have never experienced a longer period of time (at least as far back as 1948) when more has been spent on social benefits than collected by personal taxes.


Individuals
As a nation, we have never saved so little (and for such a long period of time). The chart below shows the aggregate dollar amount saved by individuals since 1948 in nominal terms.

Since U.S. savings peaked in the early 1990's at ~$350B per quarter (in nominal aggregate, not real per capita terms), savings has collapsed to negative territory for the first time since the great depression.

Conclusion
You learn in Economics 101 that Automatic Stabilizers should be in place to raise tax revenue during the good times to pay for government benefits during the bad. With all the tax cuts we've experienced and a continued increase in benefits paid during the past 8 years, we are now moving into unprecedented times.

In fact, we've never spent this much on benefits relative to personal taxes at the beginning stages of a recession. The government is bloated and loaded with debt, while individuals are in a similar situation. Much of the "wealth" accumulated by individuals in place of savings is under pressure by a declining equity market, high inflation, and a deflating asset bubble.

With financing becoming more expensive and harder to come by for the government and individuals alike, tax revenues under pressure, and an economy which needs a debt laden and broke consumer to spend in order to grow, we're in rough shape.

Update
Below is the nominal chart shown on a logarithmic scale as requested. Compounding is an amazing thing and it shows how what may appear to be a small difference can create such significant issues over time.

If at First You Don't Succeed... Stimulus Package Edition

Since the rebate checks were sent out:

• Personal Savings is up
• Real Personal Consumption is Flat

Should we admit failure? No... lets try another!