Sunday, December 12, 2004

For Savings, Nowhere to Go but Up?

Respond true or false to this statement: "I spend more than I should and I ought to save more money."

The official U.S. personal savings rate, as calculated by the Commerce Department, makes a strong case that the majority of Americans must plead guilty as charged — and that most of the rest are liars.

This is a long-standing issue, of course; by various measures, Americans have been saving less and less of their collective income since the mid-1980s.

It has become a hotter topic in recent months as the dollar has tumbled and the alarm has been sounded about the nation's growing dependence on foreign capital to fund its growth.

The numbers have become so extreme that there is an air of hopelessness to it all. In October, Americans saved just 0.2% of their disposable income, according to government data. In the 1970s and early 1980s, that rate of savings was between 9% and 11%.

But as veteran investors know, a market trend often changes right about the time when most people think it never will. For a number of reasons, a turn may be on the horizon for the U.S. savings rate.

First, however, if Americans deserve the label of world's biggest spendthrifts, it isn't all their fault. Although it has become all too common to scream, "I'm a victim!," instead of taking responsibility for one's actions, it's a valid argument in this case.

Start with the Federal Reserve Board. Apparently petrified about the risk of a Japanese-style deflationary bust in the United States after the stock market cracked in 2000, the central bank slashed short-term interest rates in 2001 to the lowest levels in a generation.

By mid-2003, still unsatisfied that deflation risks had dissipated, the Fed cut yet again, leaving its benchmark short-term rate at 1% — the lowest since 1958.

For many Americans, saving money has primarily meant putting it in a government-insured bank account. But by hacking rates so low in recent years, the Fed sent a clear message: Go ahead and spend, because saving (at least in the classic sense) would earn you little.

In mid-2001, the average yield on one-year savings certificates at banks and thrifts was 4.09%. By mid-2003, that average was 1.16%. What kind of savings incentive was that?

Investors who favored corporate, government or municipal bonds faced a similar situation after 2000. Long-term interest rates plunged along with short-term rates. People who relied on interest income from bonds found they were being paid ever-lower rates to lock up their money in those IOUs.

If spurring consumption was Job One for the Fed after 2000, the central bank achieved its goal. And much of that consumption has been in new homes and the things that fill them.

If you've had money to save, the housing market was the logical place to put it in the last few years. Mortgage rates were falling and by 2003 were the lowest in modern memory.

At the same time, property values seemed to have nowhere to go but up at the turn of the century — quite a different story from the stock market, which had been many Americans' favorite asset class in the late 1990s, only to leave a trail of wealth destruction from 2000 through 2002.

The Sept. 11, 2001, terrorist attacks also helped consumption win out over saving and investing.

Immediately after the attacks, the overriding concern for the economy was that Americans would stop spending and instead squirrel away whatever they could to buffer themselves and their families in a world suddenly turned dark with fear.

They did retreat from spending — for a few weeks. But the popular refrain then became that people should get on with their lives, because by cowering the nation would hand victory to the terrorists.

It was a patriotic appeal, and it registered with many Americans. Spending soon resumed. Indeed, the recession that began in March 2001 ended in November of that year, according to the National Bureau of Economic Research, the official record keeper of U.S. economic cycles.

In the last two years, Asian central banks have been on their own campaign to enable U.S. consumer spending. They've done so by taking hundreds of billions of dollars earned on the exports they sell us and reinvesting them in Treasury bonds.

That has helped keep U.S. interest rates down while supporting the value of the dollar. The buck still has fallen against the yen and other major currencies, but it might have been much worse without the central banks' investment in our bonds. And by supporting the dollar, the banks also support U.S. purchasing power.

All of this has allowed the U.S. economy to roll along seemingly without the need for a rainy-day fund.

Now, however, the economic and financial landscapes are changing in ways that seem to point to an inevitable rise in Americans' savings rate.

The Fed, confident that the economy was on a sustainable growth track, began raising short-term interest rates in June. On Tuesday, policymakers are expected to boost their benchmark rate from 2% to 2.25%, the fifth increase this year.

Higher interest rates make credit more expensive, which eventually should be a drag on consumption. Perhaps more important, higher rates give consumers more reason to think about contributing to their bank accounts. For the first time in years, you actually may earn more in interest than what the bank takes back in account fees.

(The one-year average savings certificate yield now is 1.92% and climbing, according to rate tracker Informa Research Services.)

Long-term interest rates also are likely to head up in 2005 if the Fed keeps tightening credit, most economists believe. That should slow the housing market.

If so, that could be the most important factor driving more people (particularly aging baby boomers) to save money.

Here's why: The housing bonanza, like the stock market bonanza before it, in effect allowed Americans to save without having to reduce consumption. As the value of their assets rise, people naturally feel richer.

The argument that the official savings rate understates the real rate is that wealth gains, such as in retirement-account stock assets and in housing, don't figure in the official rate.

Fair enough. But what if people begin to doubt that future gains in stocks, homes and other assets will match the gains of the last 10 or 20 years? Suddenly, the realization hits that you should be saving more now, not relying on possible asset growth.

Such a shift in U.S. consumers' attitude about their savings would have far-reaching implications for the global economy. But it wouldn't have to spell disaster. For one thing, a shift like this would certainly be gradual, not abrupt.

Are the world's greatest shoppers really ready to slow their consumption and put more money away for the future? It seems farfetched. Which is why it just might be the big surprise of the second half of this decade.


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