Earn What You Spend

A collapsed economy has many implications, one of which is a rather drastic uptick in the personal savings rate of most Americans.  This is entirely logical: unemployment is up, wages are down, virtually every asset we own has lost value, so Americans are spending less than they used to.  We are, collectively, at last living up to one of the basic maxim’s of personal finance: spend less than you earn.

The personal savings rate in May was 6.9%, the highest percentage we have seen since 1993.  This is a welcome and needed change for the long-term sustainability of the American consumer.  But in the short term, we can see the effects of the Paradox of Thrift at play here:

Although saving money helps individuals repair their finances and pay debts, a sharp rise in overall personal saving can actually deepen a recession and hurt the people who are saving more. As people save money, fewer dollars circulate through shopping malls, Main Street businesses, and large employers and subsequently back to workers through their paychecks. This thrift pulls the economy lower.

Economists say the recent spike in personal saving is likely to fall back slightly as the effects of government stimulus fade, but they have said that Americans are becoming thriftier and are not likely to return to the free-spending patterns that fueled much of the growth of the last nine years.

With consumer spending making up a significant percentage of our GDP, our economy is still looking for a sector that can pick up steam and pull us out of the recession.  Yet consumers are shell-shocked from watching the economy deteriorate as quickly as it has, and it is unlikely we will forget this lesson anytime soon.

Despite the obvious downside of consumer spending no longer being able to pull the economy out of a downturn, most economists agree that a personal savings rate at or near our long-term average is undoubtedly beneficial. According to one economist:

My hope is that the uncertain economic times many Americans will be finding themselves in will be an opportunity to rethink their values regarding the use of money at a deeper level… They would embrace thrift not because we have to, but because we want to. And not just for a few months, but as a long-term proposition.

There are, after all, many things more important than money.

I recently bought TIPS - Treasury Inflation-Protected Securities - for the first time.  All the talk about looming hyperinflation was beginning to alarm me, and given a recent conversation with a friend who professionally manages money, it seemed justified.

Alan Blinder’s article in the NYTimes was all the more interesting: inflation, he contends, is the least of our worries.  Our primary worry is still deflation, not inflation: it is amazing how until recently virtually every economist was worried about a Great Depression-style deflationary cycle.  But with deficits as far as the eye can see, interest rates as low as they can possibly go, oil prices coming off their lows, it does seem like inflation could make a quick comeback.

Blinder informs us, though, that we can already see what the market is forecasting for inflation. And it isn’t that bad:

The market’s implied forecast of future inflation is indicated by the difference between the nominal interest rates on regular Treasury debt and the corresponding real interest rates on Treasury Inflation Protected Securities, or TIPS. These estimates change daily. But on Friday, the five-year expected inflation rate was about 1.6 percent and the 10-year expected rate was about 1.9 percent. Notice that the latter matches the Fed’s inflation target. I don’t think that’s a coincidence.

Perhaps my timing of a TIPS purchase was off.  But it still seems like a smart hedge.

Just out from the AP: total unemployment insurance claims fell for the first time since January:

The Labor Department said the total unemployment insurance rolls fell by 148,000 to 6.69 million in the week ending June 6, the largest drop in more than seven years. The decline is a sign that layoffs are easing.

The drop also breaks a string of 21 straight increases in continuing claims, the last 19 of which were records. A dip in continuing claims several weeks ago was later revised higher.

This could signal a “slowing of the rise” in unemployment claims.  That is, things are not getting better, but rather not getting bad as quickly as they were before.  I imagine calculus teachers across the country are glad that the notion of the second derivative is finding such broad adoption.

CNBC outlines how credit card default rates are rising above record levels:

Bank of America—the largest U.S. bank—said its default rate, those loans the company does not expect to be paid back, soared to 12.50 percent in May from 10.47 percent in April.

In addition, American Express, which accounts for nearly a quarter of credit and charge card sales volume in the United States, said its default rate rose to 10.4 percent from 9.90, according to a regulatory filing based on the performance of credit card loans that were securitized.

[via Calculated Risk]

Bennington College president Liz Coleman gave my favorite talk from this past year’s TED.  Her call to action: we need to reinvigorate the liberal arts education.  There is a trend that says a deep specialization in a single subject is the best way to learn.  However, without a broad and fundamental understanding of the world around us, we cannot adequately address the problems we face.  

It reminds me of Tim Brown’s description of IDEO’s recruitment of T-shaped individuals: 

Regardless of whether your goal is to innovate around a product, service, or business opportunity, you get good insights by having an observant and empathetic view of the world. You can’t just stand in your own shoes; you’ve got to be able to stand in the shoes of others. Empathy allows you to have original insights about the world. It also enables you to build better teams.

We look for people who are so inquisitive about the world that they’re willing to try to do what you do. We call them “T-shaped people.” They have a principal skill that describes the vertical leg of the T — they’re mechanical engineers or industrial designers. But they are so empathetic that they can branch out into other skills, such as anthropology, and do them as well. They are able to explore insights from many different perspectives and recognize patterns of behavior that point to a universal human need. That’s what you’re after at this point — patterns that yield ideas.

A T-shaped individual is the product of a liberal arts education: we have the ability to empathize with the world around us.  And as Tim Brown states, empathy is a powerful tool. 

To watch the rise and fall of Alan Greenspan’s stock with the public is nothing short of spectacular.  The former Federal Reserve chairman was revered as a savant gracing us with his unparalleled intellect that could keep the economy running strong.  Then, in the lightening fast manner that only public opinion is capable of, he was roundly condemned for not doing enough to prevent the current economic downturn.  He is currently accused of fueling the real estate and stock market bubbles by keeping interest rates too low for too long.

Enter an unlikely hero: Ben Bernanke.  Here is a man who spent his career studying the event we have been so fearful of repeating: the Great Depression.  It would seem that few people, then, would understand the mistakes of the past as well as Bernanke, and would thus be able to keep our economy away from the brink of disaster.  But studying a subject and facing it in the real world are frequently distinct phenomenon: the translation of professorial knowledge to policy implementation is not a sure bet. 

Thus Jim Kramer’s article in New York Magazine praising Chairman Bernanke as one of the saviors of the economy is all the more interesting: here is a soft-spoken intellect who, according to Kramer, just might have saved us from tipping into the Great Depression Part II: 

I’ll just come right out and say it: Ben Bernanke will go down as the greatest Federal Reserve chairman in history. The soft-spoken academic who has toiled in the shadows of his legendarily self-promoting predecessor, Alan Greenspan, will be known as the man who averted the Great Depression Two, a sequel that could have eliminated the United States as a world financial superpower and reduced us to this century’s Britain …

The moment of crisis has passed, the parallels to the Great Depression are gone, all because Bernanke learned the lessons of history and refused to let it repeat itself. Bernanke once seemed Lilliputian compared to Greenspan. Now their statures have been reversed.

There is something pleasing about a professor leaving academia to save the economy.  Knowledge - all too often shunned in our political system - turns out to be quite valuable in the end.