Responding to "What about Savings?"

Last year's Great Panic abruptly reminded US baby-boomers how ill-prepared they are for retirement. Following that Panic, there would now seem to be a number of compelling reasons to expect the US saving rate to steadily increase over the next few years from its presently low level by historic standards.

The most compelling of these reasons is that US household balance sheets have been seriously impaired by years of unusually low saving rates and by the ravages of the financial crisis. In this context, one has to be struck by the fact that US household debt today amounts to approximately 135 percent of US household incomes, or more than double the ratio that prevailed in the late 1980s. At the same time, despite the substantial bounce in equity prices from their March 2009 lows, US household wealth is some US$12 trillion, or around 85 percent of GDP, lower than it was at the start of 2008 as a result of substantially lower US home and equity prices.

A second reason for expecting US households to attempt to increase their saving rate is the high degree of job insecurity that presently characterizes the US labor market and that is widely expected to continue characterizing that market in 2010 as the economy experiences a very sub-par recovery. Including part-time workers unable to find full-time employment, the US unemployment rate has already risen to a staggering 16 ¾ percent. At the same time, the extraordinarily large gaps in the US labor market are resulting in an extraordinary squeeze in household income growth as illustrated most vividly by declining wages over the past year.

At the same time, consumer card credit and home equity lines have been reduced substantially and there is every expectation that consumer credit will continue to be cut in 2010 as part of the financial system's ongoing attempt to strengthen its capital position.

A third reason for expecting higher US household savings is that the US consumer is now highly credit constrained. Mortgage Equity Withdrawal, which in the housing market's boom years reached a peak of 8 percentage points of US household income in 2005-2006, has now totally evaporated as a direct result of the US housing bust. At the same time, consumer card credit and home equity lines have been reduced substantially and there is every expectation that consumer credit will continue to be cut in 2010 as part of the financial system's ongoing attempt to strengthen its capital position.

An increase in US household income is to be welcomed as part of the adjustment process of the large US external payment imbalances. It is also to be welcomed as an important source of financing for the extraordinarily large US budget deficits that are in prospect for many years to come. However, if a higher US household saving rate is not to thwart the nascent recovery in the US and world economies, it will need to be accompanied by policies promoting higher consumption in China, Germany, and Japan, the world's high savings countries. If recent history offers any guide, one would not want to hold one's breath waiting for those countries to promote household consumption.

Desmond Lachman is a resident fellow at AEI.

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