Positive Economic Commentary
Saved? Are The Finances Of Americans In Better Shape Than Feared? No!
June 21, 2001
This title is a takeoff on an article appearing in the latest issue (June 23rd) of The Economist. The article cites various studies suggesting that the decline in the US household saving rate is the result of a faulty definition of saving and/or has little economic significance because of a skewed distribution. The message of the article is: Cheer up. Things could be worse. My message in this commentary is the punchline to the old joke: So, I cheered up. And sure enough, things got worse.
Before I get started, all you have to do is look at the behavior of
the current account deficit in recent years to know that Americans are
spending more than they are producing. This is shown in Chart 1. In
effect, a current account deficit measures the net dollar amount of
goods and services the rest of the world is lending to the US. If an
individual runs a current account deficit, it means that she is spending
more than she is earning or producing. What enables her to do that?
Borrowing. If a country runs a current account deficit, it means that
the country is borrowing from the rest of the world so that it can spend
in excess of its production. In the four quarters ended 2001:Q1, the
US borrowed from rest of the world on average an amount equal to about
4-1/2% of our nominal GDP -- the highest absolute and relative borrowing
from the rest of the world in over 40 years. This, my friends, is prima
facie evidence that no matter how you cut it, the combined American
saving rate for households, businesses, and any other group you want
to include not only has gone down in recent years, but it has gone deeper
into negative, or dissaving, territory. Now, this is not necessarily
an economic "bad thing." If we have been using the goods and
services the rest of the world has lent us to enhance our ability to
produce enough in the future to pay the rest of the world back what
it wants and to, at the same time, increase our standard of living,
then all of this national borrowing will have turned out to be an economic
"good thing." Let's hope that those miles and miles of fiber
optic cable that have been put down pay off!
Now, I want to turn to alternative measures of household saving that purport to show we should cheer up. Household saving in the National Income and Product Accounts (NIPA) is a residual. It is what is left over after you subtract from personal income personal taxes, interest payments on non-mortgage debt and consumer expenditures, including spending durable goods (e.g., cars, furniture, etc.). The full amount of the purchase of house is not subtracted from personal income. Some have argued that taxes paid on capital gains should not be subtracted from personal income when figuring personal saving. All right. Let's not only add back in capital gains taxes paid, but all taxes paid by households. In effect, we are going to be calculating personal saving as a percent of personal income rather than disposable personal income (i.e., personal income less taxes). Some have argued that the purchases of consumer durable goods should be added back into saving for the same reason that house purchases are -- they yield a service over time. So, let's add back in purchases of consumer durable goods less the depreciation on the stock of consumer durable goods previously purchased.
Having made these adjustments, let's look at the behavior of this amended
definition of the saving rate in comparison with the NIPA definition.
These different definitional saving rates are displayed in Chart 2.
Indeed, the level of the amended-definition saving rate is not as low
as that of the NIPA saving rate. The amended-definition saving rate
still is in positive territory whereas the NIPA saving rate has dropped
below zero. But notice that just as the NIPA saving rate has fallen
to post-war lows in recent years, so has the amended-definition saving
rate. So, apples-to-apples, orange-to-oranges, we households just aren't
saving like we used to.
Now, there is one recommended adjustment I have not made to the saving rate. I have not added in realized capital gains to income. Why not? Because realized capital gains do not represent current production or income. Saving means to defer spending of current income or production. When households save on net, they are temporarily relinquishing control over resources to entities that will use these resources to produce goods and services that are expected to enhance the production of consumer goods and services later. If households "consume" their capital gains rather than re-investing them, future production of household consumables is not enhanced. Therefore, it is not in the spirit of the term "saving" to include realized capital gains as household income.
The Economist mentions a study by the Fed that shows that the richest two-fifths of the population accounted for the decline in the US household saving rate. The poorest two-fifths increased their saving rates significantly. Interesting, but so what? The fact remains that the household saving rate, in the aggregate, fell.
If you still are feeling cheerier, I offer the data in Chart 3 to depress you. It shows the degree of leverage in the US economy -- total debt outstanding as a percent of the nominal capital stock. The debt includes debt issued by the private sector as well as debt issued by the government sector; debt issued by the nonfinancial sectors as well as debt issued by the financial sectors. The capital stock includes that of the private sector as well as the government sector.
From 1952 through 1982, total debt as a percent of the total capital stock ranged from approximately 42% to 51-1/2%. But national leverage started on an uninterrupted upward trend in 1983. Debt as a percent of the capital stock has moved up from about 48-1/2% in 1982 to 92% in 1999. Bear in mind that we are finding out that a lot of the capital stock produced in the late 1990s is not worth very much in this new century. Though the value of the capital may go away, the debt will stay -- stay until it is written off as uncollectible, that is. The mid 1980s were the era of leveraged buyouts in Corporate America. The late 1990s were the era of leveraged buybacks in Corporate America. "Financial engineering" began to be all the rage in the mid 1980s. Re-packaging and transformation of various kinds of debt instruments from mortgages to credit card receivables has led to layer upon layer of financial intermediation. Financial risk can more easily be shifted today. But risk shifting is just that -- shifting. The amount of risk is not reduced. The mortgage markets have become so "efficient" and competitive that households can very easily "monetize" the equity in their houses. Perhaps that is why homeowners' equity as a percent of the value of their houses has in recent years fallen to its lowest level in the post-war period. Easy credit terms on asset-based loans lead to escalating asset prices. Leverage is terrific when asset prices are rising. But it's oppressive when credit terms tighten and asset prices start to fall. Have you noticed the increased frequency of financial market crises since the mid 1980s? Mexico/the oil patch/Continental Bank, the US stock market, banks and S&Ls, Mexico again, Asia, Russia, Brazil, Long-Term Capital Management, the US stock market again, Turkey, Argentina. What's the trigger for the next financial market crisis? The bursting of the housing market bubble? And have you noticed what the palliative for these crises has been? The Fed cuts interest rates, which encourages the creation of even more credit. That's why the leverage ratio in the US economy is the highest it has been in the post-World War II period -- maybe even the highest in the post-World War I period. Deflation is anathema to debtors. (Like George Costanza, I've been waiting a long time to use that word.) Inflation is music to debtors' ears. (What's the antonym of anathema?) There are more voters who are debtors than who are creditors. As a result, expect increased political pressure for the Fed to keep inflating. Chart 4 shows that the difference between the Fed's funds rate target and the monthly Cleveland Fed median CPI (seasonally adjusted at annual rates) has fallen to just 10 basis points in May. On June 27, the funds rate target almost assuredly will fall below the Cleveland Fed median CPI. As I said, it's politically correct now to inflate.
Paul Kasriel The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
Director of Economic Research