Consumers’ New Found Embrace of Savings Will Make for a Nasty Downturn

The blow to many Americans’ net worth via diminished home values and shrunken retirement accounts has lead to a new found insecurity and conservatism. Not only have consumers reined in spending, but they are reported to be suddenly worried about the debt levels and financial buffers. This change in sentiment is aided and abetted by credit card companies, banks, and auto lenders getting more stringent and, where applicable, cutting back on credit lines. Thus, consumers suddenly (at least for now) want to be savers (note that paying down debt is a form of savings) and even for those who still want to borrow, banks are not particularly keen to extend credit to them.

We have long warned that America’s debt-fueled consumption, at over 70% of GDP, was unsustainable and that bringing it down to a healthier level would lead to an economic contraction. Having consumers get the savings religion during a downturn will make the recession more severe.

While we think that the pain of increasing savings is salutary (akin to lancing and cleaning out a festering wound), the powers that be want to keep demand up via another stimulus package. I’d be much happier if measures like that went to well-targeted infrastructure programs and other investments in the future productivity of the economy, rather than trying to keep the consumer spending bubble aloft. Moreover, analyses of the $150 billion stimulus package earlier this year concluded that most of it was saved, meaning it did not yield much in the way of stimulus. Any “stimulus” program intended to lead to more consumption would need to target groups with a high propensity to spend (e.g., the unemployed).

From Bloomberg:

The U.S. may be on its way to becoming a nation of savers, whether Americans like it or not…That is bad news for companies catering to them, which will have to retrench as well…

The big concern is that households, spooked by the turmoil in financial markets, will cut back rapidly and sharply, plunging companies into bankruptcy and deepening a recession that many economists say has already begun.

“If we did have a quick cut in spending, it could turn a pretty nasty recession into possibly the worst downturn we’ve seen in the postwar period,” says Michael Feroli, a former Federal Reserve official now at JPMorgan Chase & Co. in New York. Even without a collapse of consumer spending, Feroli expects the economy to contract by 2 percent in both this quarter and the next.

There are signs that consumer spending is already giving way. U.S. retail sales fell in September for the third straight month, the longest slump since the government began keeping records in 1992. And consumer confidence as measured by the Reuters/University of Michigan index fell by the most on record this month…

“We are going through a quantum downward shift in consumer spending,” says Allen Sinai, chief economist at Decision Economics in New York. “Any industry that is tied to the consumer will have to downsize and consolidate.”

From 1960 until 1990, households socked away an average of about 9 percent of their after-tax income, Commerce Department figures show. But Americans got out of the saving habit starting in the 1990s as they saw their wealth build up in other ways, first through surging stock prices and later through soaring home values.

Meantime, looser credit standards made it easier for people to afford major purchases without having to save up to pay for them. The result: Since 1990, they have set aside less and spent more, pushing the savings rate down to an average of 3.5 percent. It was less than 1 percent in each of the last three years.

That may be about to change as wealth and credit evaporate. Household net worth, as measured by the Fed, fell $2 trillion in the second quarter from a year earlier — and that was before the stock market’s nosedive wiped about $3.9 trillion off investors’ portfolios in the past month and a half.

Credit is also harder to get. Borrowing by U.S. consumers fell in August by $7.9 billion, the most since statistics began in 1943, to $2.58 trillion as lenders curbed access to loans, according to Fed data.

Add to that a cyclical rise in the unemployment rate — it already stands at a five-year high of 6.1 percent and could increase to 9 percent, according to Microsoft Corp. co-founder Bill Gates — and it is no wonder households are retrenching.

“Consumers are starting to realize that they’ve been living in a fantasy world,” says Lyle Gramley, a former Fed governor who is now senior economic adviser at Stanford Group Co. in Washington. “They will have to begin salting away money for retirement, their children’s education and other reasons.”….

In the long run, higher savings would be good news for the U.S. economy, because the extra money would help put household finances on a sounder footing and lessen U.S. dependence on investment by China and other foreign countries to finance economic growth.

In the shorter run, though, it will likely mean wrenching changes for companies that have become reliant on rapidly growing consumer spending. Some firms have already begun cutting back to bring operations in line with lower demand….

More trauma is likely. The Washington-based National Retail Federation says this may be the worst holiday selling season in six years, with sales rising 2.2 percent in the last two months of the year from the same period in 2007.

“The consumer is dead in the water,” says Howard Davidowitz, chairman of Davidowitz & Associates, a New York- based retail-consulting and investment-banking firm. “We expect to see 10,000 to 12,000 stores shut next year,” on top of almost 8,000 this year.

The tourist industry faces tough times as well. Host Hotels & Resorts Inc., the largest U.S. lodging real-estate investment trust, said third-quarter profit fell 44 percent after cash- strapped consumer and corporate groups cut back on trips to Hawaii. U.S. hotels revenue per available room fell 8.1 percent in the week ended Oct. 11 from a year earlier, according to Smith Travel Research, a Hendersonville, Tennessee-based marketing firm that tracks lodging data…

`The economic and financial crisis will have long-lasting effects on the consumer,” Gramley says. “The personal-savings rate is going to increase over the next five to 10 years.”

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  1. Anonymous

    The US is going to default on it’s debt and the dollar is going to collapse no other path seems reasonable at this point we simply do not have to income to support the massive government sending on all levels.

  2. Art

    Dollar might collapse, but not right away. Thats why they talking about Brenton Woods 2, to remove dependence of other currencies on dollar. And the amount of dollars world wide, and our foreign debt, it is unlikely that this will happen right away. So yes dollar is bound to collapse, but it wont be happening any time soon. Most of global reserves in US$, if it collapses what do those reserves worth? Its money weigh. So to flush out dollars out of the system is a gargantuan undertaking in itself.

  3. EvilHenryPaulson

    I agree with the article, save for the implied surprise

    Perhaps this crisis will be known in the future as “the 2008 you’re not special financial crisis”

  4. Don

    “Having consumers get the savings religion during a downturn will make the recession more severe.”

    It’s one thing to have the religion, it’s another to act on it. I’m wondering how much saving can occur in a downturn. Doesn’t saving, or even paying down debt, necessitate being able to pay your current bills, etc., and having a little extra besides. Has any work been done on the ability to save in a recession?

    Don the libertarian Democrat

  5. rahuldeodhar

    Fantastic post again! It is funny how we forget the basics.

    Only when people are comfortable with the future they spend a lot. They even borrow against this “comfortable” future and spend it.

    But when the future looks bleak – everyone goes in self-preservation mode. They save! Banks dont lend. They start fattening up (recapitalising)

    We often start digging the well when we get thirsty!

    So Mr. Ben and Mr. Hank should realise that no stimulus is going to help. It back to good old Keynes proposal – infrastructure, public spending – just dig a hole and fill it up!

    P.S – just wanted to know if the word verification is getting beyond human sensory capabilities or am I being targeted for weird comments ;-)

  6. Anonymous


    I imagine that you are speaking in jest.

    The U.S. is not going to default on its debt. It will just ramp up the $$$ printing presses.

    The dollar has a reprieve right now. Nevertheless, you are right, the dollar will eventually plunge. There is no other way out of this crisis.

    On a positive note, Hank and Ben finally have seen the light and are putting ideology aside and doing what needs to be done (i.e., pump money into the economy). I think that we dodged the bullet.

  7. Brad

    Jackson Brown did a great a song entitled “The Pretender” and I find it aprapos to the articles general route of the consumer malaise. As Jackson Brown concluded in his lyrics, true love is forsaken for legal tender. Money — the desire of material possessions — always triumph’s over all else, except true faith. You think consumerism won’t return, you think they won’t be able to reflate in short order — you think wrong.

  8. Jojo

    And this is why Q4 and [at least] Q1 2009 earnings are going to go into the dumps.

    Many people investing in stocks seem to lose the connection that companies exist to sell a product or service. If the consumer stops buying, it creates a cascading effect all the way up the chain to every company that sells not only to the consumer, but all the companies that provide raw materials/services to these companies, all the companies that provide advertising, etc. Further, companies that provide to the providers are hurt, ad infinitum until all are consumed. In other words, to quote an old maxim, nothing happens until the sale is made.

    It is this effect that TPTB are so worried about stemming and why they are desperate to somehow get the consumer to spend again.

    Eventually, some fool(s) is/are going to propose loosening lending standards [temporarily, of course ;)] again out of frustration and desperation. Mark my words.

  9. Anonymous

    Haven’t spent money on anything but food, gas and housing expenses this year. I’m fine with this and can go on like this for the next 5 years. YOU go on and waste your money for the economy…

  10. Anonymous

    Yves, what does this mean for the many, many countries that now live off of tourism? All the people who run tours, preserve parks, build hotels, manage restaurants, make arts and crafts… increased emigration and brain drain.
    – Drew

  11. Anonymous

    Love to see a link to the analyses that show that the last stimulus package was saved and not spent.

    Given the talk of a special session of Congress to pass another stimulus package, it would be a pretty timely discussion topic.


  12. Anonymous

    Is consumption 70% of GDP ie consumption contributes 70% to GDP or is consumer debt 70% of GDP?

    I have read both of the above here in the last few days or so?

    Can someone please clarify?

  13. locust

    Bit hard to get out there and go shopping for crap you don’t need nor really want to impress people you don’t know nor care about when you’re unemployed.

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