Believe it or not, US consumers have pulled off a dramatic U-turn. Addicted to debt in the boom years, the world’s biggest consumers are pinching their pennies at a rate few thought possible just a year ago. This deleveraging process is weighing on the economy now, but paving a path to recovery.
The descent into indebtedness did not happen overnight. Back in 1994, the US savings rate was a respectable 5.3%. Prosperity lulled consumers away from the piggy bank consistently over the next 5 years, and then they raided the piggy bank in 1999 and again in 2005 to supplement their spending – at the height of the boom, no less. The economy liked it, but the trend wasn’t sustainable.
It sounds irrational, but there were good reasons for the change in behaviour. Interest rates were very low in the post-2001 period, discouraging saving activity. Also, house prices were on a tear, rising yearly by an average 7.5% in the 2000-2006 period. Consumers saw this partly as savings, and partly as a source of ready cash. At the same time, the stock market was on a roll, raising average wealth and creating an overall sense of well-being. Extraordinary prosperity became the ‘new normal.’
Suddenly, those positive factors vanished, exposing the dire state of true consumer savings. Moreover, millions of jobs have been lost, creating an instant and urgent need for prudence. Between April 2007 and May 2009, the savings rate leapt from 0.8% to 5.9%, a rapid and remarkable improvement. Progress was interrupted by the cash-for-clunkers program, but the savings rate is expected to rebound in the final months of the year.
Increased prudence improves long-term stability, but is very painful in the moment. Every percentage increase in the savings rate removes about $100 billion from current spending, which as it happens is also a full percentage point of consumer spending. As forecasts for spending were already modest, the effect of this extra withdrawal of cash has hurt retailers, and indeed the whole economy.
America is not alone. Its consumers make up 70% of the domestic economy, and given that the US accounts for roughly 20% of world GDP, the effects have ricocheted everywhere. The 12% tumble in international trade this year was both directly and indirectly related to US consumer retrenchment.
US consumer-bashing is a popular sport today, and many analysts have given up on this mighty spending machine as a source of renewed world growth. That is likely a big strategic mistake. First, in this period of retrenchment, spending activity levels have fallen far below what can be sustained in the longer term future, suggesting strong growth when the economy begins to recover. A second, and related, point is that the savings rate will not rise forever. US consumers will reach a level that is comfortable for them, and the rate will likely hover at that level for some time – a sign that the lessons of the recession sunk in. When that happens, spending will automatically start to grow again at the same pace as income – instantly improving the global economic picture.
The bottom line? US consumers are in saving mode, which is improving their balance sheets, but weighing against overall economic growth. When savings rates rise to a level that begins to boost confidence – probably within the next 6 months – spending statistics should start to improve.