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December 17, 2004

Saving for a Rainy Day

You know the old expression about saving for a rainy day.  Well, in the economy it turns out to be just the other way around.  We should save instead for the day the rain stops falling.  Because, in America at least, our lack of saving has all of the characteristics of a drought.  Every day the sun shines brightly and we bask in the glow of our runaway spending, yet the cumulative effect of all that free spending in the sun may be a disaster.

At least that’s how some experts are sizing things up.  The savings rate of American consumers – defined as the fraction of each dollar of current income that is not spent – fell to a rock-bottom low of 0.2 percent in October.  Twenty years ago we set aside 11.4 cents as savings out of every dollar earned.  Today the federal government borrows more than a billion dollars every day just to operate.

In fact, the only sector of the economy that has been setting a respectable amount of money aside in the U.S. economy is the business sector.  With profits at very high levels, it’s been hard for them to do anything else.  It’s also a little ironic, because private sector businesses are supposed to be the recipients of our savings, used to finance investment, and not the other way around.

If you think this situation is unsustainable, you are undoubtedly correct.  But if you think that consumers are acting irrationally, then you’d better think again.  Because from the individual consumer’s point of view, there really aren’t a lot of good reasons to save right now.

After all, one reason why we save is to accumulate assets that we can tap into some time in the future, right?  It turns out that the economy is doing that for us already, thank you very much.  Thanks primarily to continued appreciation in housing prices, household net worth has been soaring.  We’re spending almost every cent we earn, yet the 46.6 trillion dollars that is our collective net worth is about 10 percent higher today than it was a year ago.

It’s not a rise we can safely depend on continuing.  The volatility of financial assets has increased in recent years, and many of our portfolios are dominated by items that are not easily converted to cash.  But the rise in household wealth is a form of savings that statistics on the disposition of current income fails to capture.

The incentive to save gets even more diluted when you consider what’s been happening to interest rates.  When inflation is taken into account, yields on CD’s and short term investments are practically zero.  Can American’s really be blamed for not snapping them up? 

Indeed, the reason why current savings rates are so low is that many of us are looking at low interest rates and doing precisely the opposite.   We’re borrowing.  We’re taking out loans against our homes and other assets, buying everything from furniture to college educations for our children.  That borrowing shows up in the current accounts as negative saving, since it lets us spend more than we earn.

But even if saving for us individually isn’t very attractive right now, an economy where we collectively spend every cent we earn isn’t viable.  Capital investment by businesses and governments needs a constant flow of new money to regenerate itself, and right now the American consumer is contributing precious little to the pot. 

Those contributions are largely coming from foreign investors right now, in response to what they perceive as an attractive climate for investment.  When that assessment changes, as it most certainly will, interest rates and savings rates could undergo some significant changes.

Link to this commentary: https://commentaries.cberdata.org/289/saving-for-a-rainy-day

Tags: finance


About the Author

Pat Barkey none@example.com

Patrick Barkey is director of the University of Montana Bureau of Business and Economic Research. He served previously as Director of the Bureau of Business Research (now the Center for Business and Economic Research) at Ball State University, overseeing and participating in a wide variety of projects in labor market research and state and regional economic policy issues. Note: The views expressed here are solely those of the author, and do not represent those of funders, associations, any entity of Ball State University, or its governing body.

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