Savings: It’s Not Different This Time

The S&P500 slipped 0.6% last week mostly on fears that the much anticipated bounce back in corporate earnings this fall may not be such a sure thing.  New data sparked concerns that consumers may not resume their old buying habits–just as they did in most of the previous U.S. recessions.

First some data.  Productivity skyrocketed for corporations in the first quarter of 2009.  The good news for firms–it helps them prop up profits, even as sales drop.  The bad news for workers and consumers–it reduces the need for labor (unemployment goes up), so incomes fall; this means people can’t consume as much.  The Treasury deficit in July was a record $181 billion, up from $103 billion in July 2008.  Retail sales fell–when they were expected to rise.  The same thing happened with consumer sentiment.  Initial claims came in higher than expected (558,000) and continuing claims also remained near record highs.  And CPI fell 2.1% on a yoy basis, the largest drop in inflation in 59 years (since 1950).

Rebecca Wilder presented an observation about the savings rate during this recession (in the RGE Monitor).  She noted that the current trend in savings, starting at the beginning of the recession in October 2007, was UP and pointing upward for the near future.  Then she observed that the savings trend during the last seven recessions (since 1960) was down and continued downward during the subsequent recovery periods. 

She concluded that this is odd, representing perhaps behavior that is different–this time.

But what Ms. Wilder did is make the same mistake that almost every analyst makes when comparing the current recession to ANY recession since the Great Depression.  They’re comparing apples to oranges.

All of the post-Great Depression recessions were of the inflation control type where demand exceeded supply in a cyclical fashion, causing inflation to rise.  The government (usually the Fed) would slow down the demand with counter-cyclical measures (such as interest rate hikes) causing the overheated economy to slow down (mild recession), paving the way for resumed growth.

This recession, much like the Great Depression, resulted from the bursting of a credit bubble, which developed over a secular 25+ year period.  The root causes and many of the outcomes are not similar to those in typical inflation control recessions.

From this perspective, it makes a lot of sense that savings are soaring today.  In past recessions, credit remained plentiful and household wealth was not severely impaired, so people saved less–temporarily during the recession–to maintain lifestyles until the inevitable recovery arrived and unemployment fell.  And household debt to GDP was typically between 40% and 60%–a manageable level.

In this recession, consumer credit is being curtailed (more stringent criteria for mortgages, credit cards, student loans, auto loans, home equity loans, etc.) and household wealth is being obliterated (home equity depletion is growing and retirement savings lost in the stock markets are still down 30%).  Households are sensing (correctly) that this is a permanent shift–not something that will recover in the near future.  And household debt to GDP is 100%–a crushing debt level that must be reduced (through savings).

So today’s savings uptrend is not surprising.  Households will increase their savings rate (perhaps back to the 10% levels maintained over many decades in the mid 20th century) and reduce their spending–prolonging and deepening the very recession that caused this savings to rise in the first place.

This IS what happens in credit bubble recessions.  It happened in the Great Depression; it’s happening in Japan today. 

It’s not different this time.

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