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.