The Savings Culture Returns

In my Money Week column this week, I've been looking at how savings rates will have to rise in both the UK and the US. Here's a taster....

In the US, the most interesting economic statistic right now is not the bullish stock market, the bottoming out of the housing market, or the gradual emergence of the ‘green shoots’ of recovery.
It is the savings ratio.
American consumers, who for more than a decade were the shop-till-you-drop, maxed out, credit-hungry motors of the global economy, have suddenly decided to start doing something their baby-boomer parents had probably forgotten all about but which their grand-parents might just dimly remember. Saving money.
Along with other over-indebted consumers around the world, they are putting a rising chunk of their monthly pay packet aside for a rainy day. That may well turn into the most significant financial trend of the next five to ten years – and one that has the potential to significantly re-shape the global economy.
It will skewer any chance of a strong domestic recovery, support the stock market, lower trade deficits, and, over time, strengthen the currency. In the medium-term, it will no doubt be a good thing – but in the short-term it is going to cause a huge amount of disruption.
There is no disputing the raw data.
In April, the latest date for which statistics have been published, the U.S. savings ratio rose to 5.7% of GDP, its highest monthly rate for 14 years. Earlier this decade, when the housing boom was at its peak, the savings ratio went all the way down to minus 2.7% (meaning the average American spent nearly 3% more than they earned, which even Gordon Brown might struggle to describe as prudent). Many analysts now expect it to get back towards its long term average. For most of the 1970s and 1980s, Americans saved roughly 10% of their income, and in 1975, at the peak of the last financial crisis, it hit 14.6%.
Much the same can be expected in other over-indebted countries. The British are tucking their credit cards back into their wallets as well. The latest quarterly figures show the UK’s savings ratio up to 4.7%, compared with only 1.7% in the final quarter of 2008. Like the US, the British saving ratio turned negative last year, the first time that had happened since Harold McMillan was Prime Minister in 1958. Over time, we can expect the other over-extended, over-indebted economies to follow the same trend.
There is no great mystery about why that is happening. A zero savings ratio was never going to be sustainable in the long run. But soaring house prices temporarily lulled many people into an unrealistic sense of financial security. When the average house was going up in value by £10,000 or £20,000 a year, struggling to save £2,000 out of average salary of around £20,000 looked pretty pointless. Now with house price stagnant, there is little option.
Consumers know their personal balance sheets are a mess. The only way they can get them back into shape again is by saving more. Nothing else is going to rescue them. And with rising unemployment, the alternative of remaining over-indebted doesn’t look very attractive.
Once they start saving, however, the sums involved are vast. The GDP of the US is close to $14 trillion. If it gets back to a long-term average of saving 10%, that would amount to $1.4 trillion, or roughly the GDP of Spain. Shifting that vast quantity of money from consumption to investment is going to have three big consequences for the global economy.
First, domestic demand is going to stay subdued for years. It doesn’t matter how many billions President Obama or Prime Minister Brown throw at their economies. Or how many dollars or pounds the Federal Reserve or the Bank of England command their printers to roll of the presses. When roughly a tenth of the economy is being switched out of day-to-day consumption then growth is going to be sluggish.
As the global economy starts to re-cover, it is going to have to find some other engine apart from Anglo-Saxon consumers. And investors should steer well clear of companies that depend on consumer spending – such as retailers or leisure -- anywhere in the UK or the US.
Next, expect a wall of money to hit the stock market. All that freshly-saved money has to go somewhere. With interest rates close to zero and likely to stay there for the foreseeable future, there isn’t much point in putting it in the bank. Much of it will find its way into the stock market, creating a wave of money that is going to sustain the rally in stock prices we have already seen over the last three months.
At the same time, it will rescue the battered financial services industry in both the US and the UK. Steeply rising levels of deposits, and the fees to be earned from steering that money into the stock market, will make banking profitable once again. Over time, it will even bail out the banks from all the crazy loans they made at the height of the bubble.
Lastly, it is going to lift the pound and the dollar – eventually. As the Anglo-Saxon economies start to re-balance themselves away from consumption and towards investment, their huge trade deficits are going to narrow. They may not hit a surplus, but they will get closer to balancing than they have for twenty years. Over time, that is going to strengthen their currencies.
In reality, ordinary consumers in both the US and Britain have figured something their political leaders are still to nervous to tell them. They have to lower their living standards, and start re-building capital for the future. That is long overdue. Individuals can’t spend more than they earn for more than a very short period of time without running into big problems, and neither can countries.
Over time, the new ‘savings economies’ of Britain and the US will emerge in much better shape. But it is going to be a rough ride, and will shift the global economy dramatically.