The Age of Frugality takes a holiday

April 1, 2010

That whole Age of Frugality thing didn’t last long, did it?

U.S. real personal consumption grew in February at a respectable 0.3 percent clip, the fifth straight such monthly rise, a fact widely greeted as news that the recovery is on course. The fly in this tasty soup, however, is income, which in real terms didn’t increase at all, not even by one tenth of a percent.

American’s did this neat trick — spending more while earning the same — the old fashioned way: they cut back on luxuries … like saving.

Savings as a percentage of disposable personal income fell to 3.1 percent from 3.4 percent the month before and down from a recent peak of 6.4 percent in May 2009. In fact, the last time the savings rate was lower was October 2008 when a market maelstrom was convincing so many people, apparently falsely, that something rather dangerous and important was wrong with the economy. In real terms, consumption is only very slightly below where it peaked in 2007.


What happened? Well, from a certain point of view the medicine of reflation worked. Low rates punished savings and also drove the stock market and other risk assets higher. The fall in housing prices abated, leaving many personal balance sheets in better shape. Given the shape of the job market, I think we have an answer to the question of whether asset price inflation drives spending. It did during the boom and it is again now.

Government transfers helped too. They hit $2 trillion for only the second time in history, as payments from the common coffers such as social security and unemployment insurance now comprise more than 18 percent of income.
This does not have to end terribly, but it most certainly does have to end.

As strategies to head off a depression, reflation and social insurance have real merit but in the absence of sustained jobs growth and the income gains it brings, they lack something critical: sustainability. At a certain point, and it needs to be relatively soon, the money that finances the easy rates and high transfers needs to be assured that this is in transition to something else. That is why the recent uptick in Treasury yields is troubling. Not because it denotes inflation — that is not a threat — but because it might just show a waning of faith in the United States as a borrower.


It is just about possible that Americans’ stopping savings is some sort of a bellwether of a better economy. Perhaps the jobs picture looks better on the ground and people are willing to spend in anticipation of better income growth in the future. Certainly some of the consumer confidence data continues to show a bit of optimism about the future.

The data as it comes out, though, is less reassuring. Private U.S. employment dropped in March by 23,000, according to a report by payroll processing firm Automatic Data Processing Inc. While the ADP does not include government employment, which is getting a temporary boost from the census, the outlook for Friday’s nonfarm payroll data, which does, is a lot less rosy than should be expected for a country in a recovery from an extremely sharp recession.

Another possibility is that the savings data shows the effect of another part of the huge baby boomer cohort moving into a somewhat premature and somewhat involuntary retirement. Many of them may have decided, encouraged by stock market valuations that may not be sustained, to partly fund themselves by running down their assets. Many boomers may well have plenty of assets, but the effects on financial markets of them moving from the asset accumulation to the asset eating stage of life would be very large and not positive for stocks.

Even if consumers don’t know it, the savings rate in the U.S. has to and will rise. There are two basic ways this could happen. The Federal Reserve and policymakers are hoping that it will gradually as employment revives and income recovers. That too would allow government transfers to fall, helping to reassure holders of Treasuries.

A less benign scenario starts with a crisis in the bond market. This drives interest rates up and also collapses the stock market, causing a panicked rise in savings that could make the blip we saw last year look tame.

In the end the information about how it plays out will come from one of two places; the job market or the bond market.

One way or another, frugality’s holiday has to end.

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