Are Americans driving themselves into bankruptcy, or raiding their retirement income with too much current spending and too little saving? Some analysts consider that Americans are afflicted by ‘affluenza,’ an insatiable spiral of spending focused on keeping up with the Joneses (who are also overspending, as the story goes).
The concern over spending vs. saving usually arises in the context of the debt burden the average American family bears, in concerns over bankruptcy, and in Americans’ financial worries about their ability to afford the retirement they envision.
To address the question of whether Americans are saving too little and spending too much, it helps to know what the nature and purpose of saving is. Saving essentially is postponed consumption, a future-oriented activity. Consumption, or spending on goods and services, is a present-oriented activity. Neither is entirely more virtuous or valuable than the other per se. We need to engage in both, both personally and as a society.
Saving is transformed into investment through financial institutions, and since investment is the engine of long-term capital growth, some thrift is obviously necessary. But what about the virtues of spending?
The spending route to prosperity, highly praised during the Great Depression, has long been discredited as a means to economy-wide prosperity. Due to a Keynesian idea, starting in the 1930’s governments were urged to create programs and to spend specifically to stimulate employment, even if they went into debt to get the funding dollars. Thus spending generated prosperity. This became a comfortable and even expected course whenever policy makers wanted a quick boost in employment. The long run effects of the Keynesian legacy have, unfortunately, been an economy that lurches between growth and recession.
What about debt-financed household spending? Doesn’t that generate prosperity? The fallacy in this thinking becomes clear once we realize that everyone in the economy cannot simultaneously be net borrowers. If no one saves, where do the loanable funds come from? Unlike the Federal Reserve, households don’t have the ability to print extra dollars when they need them. Nor can they lower select interest rates, another Fed prerogative.
Since individual consumers can’t be net debtors indefinitely, someone—perhaps one’s heirs or estate—will have to pay off personal debt eventually, or declare bankruptcy. So what appears to be affordable and affluent living now may be luxury borrowed against tomorrow’s income—and a seemingly alarming lack of saving out of that income. Most alarming may be the slowing of capital formation, a trend that will reduce the potential for future economic growth.
In consumer debt-to-disposable-income terms, the ratio of total American consumer indebtedness—DSR, or debt service ratio—grew from about 11.2 percent in the first quarter of 1980 to 13.86 percent in the 4th quarter of 2005. These ratios include an estimate of required payments on mortgages, in addition to consumer debt. When auto lease payments, rental payments, homeowners payments and property tax payments are included, the ratio over that time period jumps from 15.88 percent to 18.62 percent.
Over roughly the same period, dollar savings as a percentage of disposable income has moved from 10.9 percent to -.6 percent. Total consumer debt at the beginning of 2006 was roughly $2.2 trillion dollars. This trend has caused many observers to raise an alarm about Americans’ overspending habits.
And perhaps they should. But because households now typically hold much of their wealth in the market value of their home, some consumers may be counting on the growing value of their real estate wealth to provide a retirement income and substitute for saving out of disposable income. Many of these individuals are house-rich but cash poor, and that has implications for their retirement plans.
As a practical strategy, real estate values have grown in recent years about one or two percentage points faster than overall prices have increased. In the first quarter of 2006, average home prices were 12.5 percent higher than a year earlier. Real estate appreciation has now slowed a bit, however, moderating to a little over 8 percent on an annualized basis. By comparison, average price inflation moved from 4 percent earlier in the year to 5.1 most recently. For families that are banking on homes and properties as a retirement nest egg, trends are less favorable on both fronts.
Do aging homeowners actually plan to liquidate their real estate to pay off debt or support themselves in retirement? Although 87 percent of 55-64 year-olds own their primary residence and another 20 percent own a second residence or property, about half have no plans to liquidate their real property—barring dire circumstances. With relatively little savings, the plan to hold on to (or pass on) assests and afford the retirement they desire may be frustrated. For some it will lead to reliance on public assistance at the end of their lives.
Some would argue that it is just too difficult to save these days, especially for low-income households. True, it is difficult. But evidence suggests that even very low-income individuals, if sufficiently forward-looking, can manage to accomplish their financial objectives. Going for broke is neither a necessary nor an inevitable strategy.