LONDON (Reuters) - Rapid technological advances are propelling the U.S. economy into a new paradigm, unemployment is the lowest in decades, corporate debt is rising, inflation is dormant and the expansion is one of the longest on record, even if growth isn’t that hot.
Much of that growth is being driven by consumer spending fueled not by rising income, but by borrowing more and running down savings, which have slumped to historically low levels.
Sound like the U.S. economy today? Yes, it does. It’s also the U.S. economy of July 2000, when economist Wynne Godley warned in the London Review of Books that the house of cards was in danger of tumbling down.
As it turned out, the tech bubble was already in the process of bursting and the economy duly slid into recession the following year, as consumers battened down the hatches.
Godley’s warnings from 18 years ago, especially on the potentially “horrendous” impact on growth if consumers start saving again, should be kept in mind today. How long can consumers, who account for around 70 pct of the U.S. economy, simultaneously continue to fund spending and run down savings?
The International Monetary Fund published a working paper earlier this month looking at the U.S. personal savings rate since 1961. It is now around 2.5 percent, approaching the historic low of just above 2 pct that preceded the 2008 crash.
It’s a similar picture in Britain, where the household savings rate is 5.3 pct, languishing near last year’s 54-year low of 3.9 pct.
Most U.S. recessions since 1961 have been preceded by a record low savings rate, the exceptions being 1973-75 and 1981-82. But the savings rate preceding the latter of those two recessions was still low relative to anything that had gone before.
“This issue has implications for the outlook for U.S. consumption and GDP growth, financial market stability, and external imbalances,” the paper’s authors Sam Ouliaris and Celine Rochon wrote.
The mathematical flip side of dwindling savings is increased debt. The housing market has recovered from the crisis and Wall Street is booming, encouraging consumers to borrow against these rising asset prices.
“Savings” locked into rising house prices isn’t included in the savings rate, which itself is an average rate and masks the fact that consumer spending can power on even if income growth is weak because most of it is driven by the richest 10 pct.
Ouliaris and Rochon found no structural change in U.S. consumer behaviour since the financial crisis. That is to say, after retrenching for a few years, they reverted to type: borrow more, run down savings, and carry on spending.
The paper calls into question the “secular stagnation” theory supported by Larry Summers. The former Treasury Secretary argues that sluggish growth is in large part due to a substantial and structural increase in savings, which coupled with a decrease in investment keeps interest rates low.
But Ouliaris and Rochon find that savings are projected to fall further, potentially back to the pre-crisis lows. This will happen if asset markets keep rising, increasing consumers’ net worth and encouraging them to borrow and spend more.
On the one hand, this would extend what is already the second-longest expansion in U.S. history. But on the other, it would also put “negative pressures” on the current account deficit, which would be a drag on growth.
As Godley noted in 2000, it is difficult to disentangle consumer savings from the performance of the stock market and the economy in general. Relying on rising equity prices being the glue that holds it all together is a risky game.
“Everything should be all right so long as the stock market holds up,” he said. “An increase in private debt relative to income can go on for a long time, but it cannot go on forever.”
If consumers do decide to save more, both the economy and Wall Street would be vulnerable.
“It is easy to imagine, with a recession or even a prolonged stagnation, that there would be a large fall in the stock market, which would make matters infinitely worse,” Godley wrote.
The Dow and S&P 500 have yet to revisit their record highs from late January, although both are close. The Nasdaq rose to fresh peaks earlier this month. Markets and the economy appear to be humming along for now.
So consumers can carry on spending, and the savings rate may fall further. But how much further is debatable.
“The toxic mix of rising interest rates, falling savings, low or falling incomes and high levels of corporate debt is a train crash waiting to happen,” said Ann Pettifor, director at Policy Research in Macroeconomics in London.
IMF Working Paper: The U.S. Personal Saving Rate
What If They Start Saving Again? Wynne Godley on the U.S.
Reporting by Jamie McGeever, editing by Larry King