WILLIAM GALSTON JUNE 10, 2009
Whatever the pace and shape of the recovery may be, the U.S. economy faces a decade of fundamental--and probably wrenching--change. Among the most important shifts: A quarter century of relentless personal consumption will give way to a new era of saving.
There simply is no choice. Households have taken on more debt than they can afford and will have to set aside a larger portion of their income to reduce it. Middle-aged workers have suffered massive losses in their retirement plans and are facing a bleak future unless they use more of their earnings to replenish their assets. Moreover, we cannot count on the rest of the world to lend us money on terms we can afford indefinitely.
The path we were on (until very recently) was simply untenable. In 1982, Americans saved twelve percent of their disposable personal income. At the beginning of the Clinton administration, that figure was still around eight percent. By 2005, however, personal savings had hit minus one percent: Americans were actually spending $1.01 for every dollar they earned.
The collapse of savings, not surprisingly, coincided with a surge in consumption. In 1982, personal consumption amounted to 63.8 percent of GDP. In 2008, it was 70.5 percent. Which means that in the last year alone, households spent about $1 trillion more than they would have if consumption had remained at Reagan-era levels.
How did such dramatic changes in consumer practices come about? Debt. In the early 1980s, household debt amounted to a bit more than 60 percent of disposable income. At its peak in the first quarter of 2008, this ratio had more than doubled, to 133 percent.
During the past quarter century, Americans had come to believe that old-fashioned saving was no longer necessary. Steady rises in asset values--especially housing and equities--would take us to the Promised Land, sufficing not only to maintain consumption, but also to provide for retirement as well. The past two years have shattered this confidence. Households have lost almost $13 trillion in net worth since the summer of 2007, and housing (the largest component of household worth) hasn't yet hit bottom.
In response, average Americans have abruptly changed course. For the first time since World War Two, personal consumption (not adjusted for inflation) has declined. The savings rate has surged to 5.7 percent, the highest it has been since 1998, and many analysts believe it will go higher. If it reaches eight percent and stays there, if housing stabilizes, and if the value of equities increases at about seven percent per year, households could expect to rebuild their net worth to pre-recession levels by the middle of the next decade.
But the process of bringing debt down to sustainable levels has barely begun. The household debt-to-disposable income ratio, which peaked at 133 percent, has declined only slightly, to 130 percent. At this pace, it could take the better part of a decade to get it down to where it was when George W. Bush took office.
Basic arithmetic tells us that if households increase savings and shed debt, consumption must decline. If it returned to the average rate of the 1990s (about 67 percent of GDP), personal consumption would be about $500 billion per year lower than it would have been if 2008 patterns had persisted. In the short run, anyway, the effect might well be to slow the pace and vigor of economic recovery and growth. If so, we will have to accept this as the unavoidable consequence of sustained excess.
There may be social and moral compensations, however. The next generation will be less likely to view shopping as entertainment. They (and the rest of us) will have to put more aside for the purchases we decide are necessary, and for the kind of retirement we hope to enjoy. We could see a new seriousness about investment--public as well as private. We will produce more and import less. And who knows: Thrift might make a comeback, not just as a practice, but as a socially prized virtue as well.