Random Walk
Rob Peebles
The economists, whoever THEY are, got it right in December. Incomes rose 0.5%, just as predicted. And spending rose by 0.7%, just as predicted. So, based on those numbers, consumers spent more than they earned, just as predicted.
A person might think correctly forecasting that an entire nation would spend more than it earned shows incredible foresight. But really the economists did nothing more than what they do best. And no, that does not mean eating a free lunch in a fancy hotel while predicting that GDP will grow 3% next year. Rather than taking a shot in the dark, they extrapolated a trend. There was a trend to extrapolate because December was the 21st month in a row that the savings rate came in negative.
But that’s nothing. Here’s a stat to make Robert McTeer (of hand holding and SUV buying fame) happy enough to cartwheel through a flaming hoop: The savings rate was negative for all of 2006. And 2005 too. Two consecutive years!
Okay, you probably guessed 2006 was negative because of the 21 months, and since there are only 12 months in a year…
But two years of negative savings (or “extra-positive spending” as McTeer might have put it) shows impressive consumer resiliency. However, while the stats are noteworthy, they are not unprecedented. There are two other years when consumers spent more than they saved. But those years were 1932 and 1933, way back in the Depression when it was much easier not to save, particularly if you were the one of the one in four people out of a job. Consumers are far bolder today. Those Depression Era years should get an asterisk in the record books.
There are those, of course, who think consumers are acting rationally by spending more than they’re saving. “Behold,” the optimists say (who else would use the word “behold”?), “consumer wealth has been rising like a rocket. Why shouldn’t Americans leave behind them a trail of credit card receipts as long as a Ford Expedition?”
Well, if you are accumulating wealth by growing your business it can make perfect sense to spend more than you make. Or if your portfolio of municipal bonds is churning out an income stream wider than the Ohio River, it might be okay to outspend your wages. That the market value of a residence has increased, however, is not necessarily a compelling reason to buy a flat screen TV. That’s because unless you sell out and move to a hut in the Amazon forest, there’s no monetary windfall to justify more spending or debt service. Still, that’s how the optimists justify the plunging savings rate. In economic jargon, the argument goes like this: The price of your house is going up! You will have to pay more property taxes and insurance! Go spend some money! Yeah!
As the accompanying chart shows, all that borrowing to support all that spending has become increasingly difficult to service. But is the savings rate really negative?
There are normal people--people who can witness a car crash without arguing that the economy is better off because the demand for cars just increased--who think that a more meaningful measure of the savings rate, while pitiful, is actually positive.
Andrea Coombes of MarketWatch did actual research on this topic for an October news story. She interviewed Alice Munnell, director of the Boston College Center for Retirement Research (CRR), who figures that the savings rate appears to be negative because baby boomers are beginning to spend down their retirement plans rather than contribute to them. So Munnell and her cohorts came up with a savings rate that throws out the retirees (just as their children will do at some point), and comes up with a personal savings rate of 5.4% for the year 2003 – the latest data they had crunched at the time. Still, Munnell acknowledges that even the adjusted savings rate has been declining.
(For the record Munnell and crew didn’t do any number crunching to account for savings through 401(k) plans. That’s because contributions to those plans are already included in the government’s savings figures, as are contributions to defined benefit plans. In other words, the savings rate isn’t understated because retirement plans are off the radar screen.)
So are Americans saving enough?
That’s one thing Munnell and the CRR are trying to figure out. At least on the surface, our retirement years are less secure because of the transition from defined contribution to defined benefit plans over the last 25 years. Other factors affecting the prospects for retirement identified by the CRR include:
- Longer life expectancy mean more funds are needed at retirement
- Modest 401(k) balances
- Increase in age at which Americans earn full Social Security benefits.
- Relatively low interest rates reduce cash flows available from annuitizing wealth
In fact, the CRR found that a higher percentage of Americans in 2004 were at risk of a substantially lower standard of living in retirement than in 1983. That’s despite a 20-year bull market and a run-up in real estate. What they call the National Retirement Risk Index indicates 43% of households “at risk” in 2004 vs. 31% in 1983. The CRR blames the legislated changes in Social Security as well the mechanics of how Social Security replacement rates have declined with more two-earner households. The shift toward 401(k)s and less generous benefits generally, were second only to the Social Security effects in increasing retirement risk.
But perhaps just as telling as the long term study is the 2004-2006 update. Most of the factors making retirement a riskier proposition didn’t affect the most recent calculations. For example, stock prices, changes in Social Security, and pensions didn’t alter the index enough to be noticed. However, housing prices did change. In fact, between 2004 and 2006 there was a dramatic increase in housing wealth. That’s good news because retirees can tap home equity through a reverse mortgage and have the executor of their estate sell the house to payoff the debt. Still, the retirement risk index hardly budged. That’s because the change in housing wealth was offset by surging mortgage debt. So at least as far as the Center for Retirement Research was concerned, all that wealth creation was just cocktail party chatter.
And now, housing wealth is shrinking but the mortgage debt is still there. Bummer.
All is not lost, however, according to Munnell and friends. While they really do believe that the higher level of their risk measurement “continues to raise serious concerns for future retirement security,” they argue that “Changing retirement and savings behavior can have a major impact.”
That is, if we work a little longer and save a lot more, we can make retirement work.
And that gets back to turning around the savings rate, however it’s defined.