Earn What You Spend

We should be roundly surprised at the number of individuals who spend more than they earn, but living within your means has gone distinctly out of fashion in the past decades.  So when we hear of the massive credit card, auto, and mortgage debt accrued by friends and family alike, we aren’t surprised in the least - it is simply par for the course. 

That is, of course, changing. 

We view the holidays, usually the most commercial season of the year, differently: 

Certainly many are recasting these pared-down celebrations as a return to the true meaning of the holidays. And although railing about commercialism has been a fine American tradition since at least 1965, when Charlie Brown first rescued that flimsy little evergreen, this is the year that hand- wringing and reality may finally meet.

Why the hand-wringing?  From a recent Op-Ed in the NYTimes:

Since the mid-1990s, vigorous growth in American consumption has consistently outstripped subpar gains in household income. This led to a steady decline in personal saving. As a share of disposable income, the personal saving rate fell from 5.7 percent in early 1995 to nearly zero from 2005 to 2007.

In the days of frothy asset markets, American consumers had no compunction about squandering their savings and spending beyond their incomes

But living beyond our income level is not only no longer desirable, it’s impossible.  Consumer credit, the fuel to this fire, is drying up, despite a $800 billion bailout devoted to this sector. 

M.P. Dunleavy explores living within one’s means in her latest article for the NYTimes- exploring the ever-appropriate example of the Jones family, who continuously lived beyond their means, fueling their consumption on their we-thought-it-couldn’t-go-down home values.  The story ends in a now-familiar way: their home’s value finally collapsed, and with it, the whole deck of cards came crashing down. 

There are a plethora of finance blogs out there, many of them quite excellent.  Just read through this list of articles to get an idea of both the depth and breadth of those striving to understand what it now means to live within our means.  

As I first saw this crisis unfolding, I thought the pullback in consumer spending - the giant deleveraging happening in the consumer sector, was only a good thing.  Spending more than you earn can be fine in the short term, but it is always a recipe for disaster in the long term, so the sooner the American consumer took this lesson to heart, the better. 

But if there is one fact that has consistently stood out in my mind, it is this: that over 70% of our GDP is from consumer spending.  The logic, then, is simple: a pullback in consumer spending, whether necessary or not, will cause a contraction in our GDP.  It will cause a recession.  It’s the Paradox of Thrift.  

If the consumer spending pullback had happened in 1999, during the heyday of the dot com era, I think it could safely be seen as a positive thing.  If it happened two and  half years ago, during the height of this credit bubble, it would similarly be seen as a necessary pullback.

But not now.  Our financial system is teetering on the edge - each time we think we’ve pulled away, we watch while another bank requires massive government intervention to keep from going under.  The pullback in consumer spending has come at the worst possible time.

So what do we do next?  Continue to encourage consumer spending with the full knowledge that we simply cannot afford it, pushing the bound-to-happen pullback further into the future?  Or do we face the ramifications of this pullback, and finally put the consumer on a more sustainable trajectory? 

I, for one, just don’t know.