“In a fundamental shift, consumers are saving rather than spending,” notes the Los Angeles Times.
This is the shift we’ve been talking about for months. The great credit expansion of 1945-2007 is over. Now cometh the great credit contraction.
During the bubble years, more and more credit produced less and less real prosperity. It was as if you were borrowing more and more, to invest in your business or merely to increase your standard of living, but your income didn’t rise fast enough to keep up with the interest payments.
In 2005, Americans saved nothing. Not even aluminum foil or string. Now, the savings rate is approaching 5% of disposable income – a big turnaround.
We know from logic and experience that saving money – not spending it – is the key to getting wealthier. Saving money gives you capital. And it’s capital accumulation – in the form of factories, roads, ships, buildings, machines…and raw savings – that gives people the ability to produce more. It may take a man with a shovel a whole day to dig a decent grave. Give him capital – in the form of a backhoe – and he can bury everyone in town. That’s why capitalism works. It rewards the fellow who saves his money.
Yet every yahoo economist in the year of our Lord 2009 takes news of rising savings rates like the death of Michael Jackson. If households don’t consume, they reason, how can a consumer economy grow?
The problem is that you can’t really grow an economy by borrowing and spending.
Recent history proves it. Despite the biggest splurge of borrowing and spending in history, the US consumer economy barely grew at all.
“In the five years to December 2007,” reports Grant’s Interest Rate Observer, “America’s credit market debt climbed by nearly 57%, to $18 trillion. However, in the same half-decade, nominal GDP was up by only $3.3 trillion.”
For every five dollars people borrowed, they only increased their incomes by $1. Imagine that the borrowing had an average effective interest rate of 10% (credit card debt can be much more expensive). At that rate half of the additional income earned between 2002 and 2007 had to be used just to pay the interest.
This was not the kind of growth that was likely to last. In fact, it didn’t. The whole thing came crashing down in ’07 and ’08. And now, the consumer has had a cup of coffee. He’s looked at himself in the mirror. He’s sorted through his pile of bills. And he’s made up his mind: that’s enough of that!
“The ratio of cash held by households as compared with assets has been rising sharply,” says James Saft in The New York Times.
“Companies, households and banks all want to pay down debt and…prefer to hold cash rather than assets, partly because the outlook for those assets is poor and partly because after a decade of excess, everyone now looks a bit over-extended.
“This is exactly what happened in Japan during its lost decade, when a balance sheet recession, one characterized by the paying down of debt and liquidations of assets, was self-reinforcing and very difficult to stem.”
And now this from David Rosenberg:
“The ultimate question is where all this cash is going to be deployed, and we believe it will ultimately be diverted toward debt repayment.”
Let’s see. We can figure this out from the numbers above. American consumers must have added about $7 trillion in extra debt during the Bubble Epoque, 2002-2007. Now, instead of buying things, they use their money to pay it down. The average household has about $43,000 worth of income. Let’s keep the math simple by saying there are 100 million households in the United States…and that they save 5% of their income. And let’s say they use every penny of savings to pay down debt. Hey…it will only take about 30 years to pay it off! Get ready for a long, long slump.
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