Personal Finance: Americans try to delay the day of financial reckoning

Personal Finance: Americans try to delay the day of financial reckoning

November 2nd, 2011 By Chris Hopkins in Business Diary

Markets in the United States last week cheered the news that the economy grew at an annual rate of 2.5 percent in the third quarter. That was the best pace in a year, and was hailed as evidence that the U.S. economy was unlikely to slip back into recession.

While the gain was insufficient to contribute to job creation, it was a decidedly welcome improvement over the previous two anemic reports.

However, a deeper look into the makeup of the report highlights a disquieting trend.

Much of the gain came from households dipping into their piggy banks to finance consumption spending. Real disposable personal income declined 1.7 percent, while consumption spending rose 2.4 percent, perpetuating a notable reduction in savings over the past several months that has some economists rightly concerned.

Americans already save too little and spend too much. This trend briefly showed signs of a modest reversal

during the recession, but is now sliding back in the wrong direction. September data revealed that we saved just 3.6 percent of disposable income. By contrast, Germans typically sock away 10 percent, while the French routinely save 15 percent of their income.

Between 1960 and 1985, the average savings rate in the U.S. held relatively steady at 8 percent. Then began a persistent decline over the next 20 years until by 2005, Americans were barely putting aside 2 percent of their incomes. This erosion of thrift was particularly problematic since the baby boom generation was careening toward retirement and should have been stashing cash and forgoing consumption.

This dearth of savings, combined with a doubling of household debt, fueled a relentless expansion of consumption spending as a percent of the nation's overall economy.

By the onset of the recession in 2007, 71 percent of U.S. output was accounted for by consumption. By contrast, it comprises less than 40 percent of Chinese economy.

With the onset of the financial crisis, household savings briefly increased, averaging about 6 percent throughout the recession. However, the rate has resumed its decline since 2009 and it continues to trend in the wrong direction. And there are signs that some of the lessons of the pre-meltdown spend-a-thon are being forgotten.

Over three-fourths of the increase in durable goods expenditures by households last month was for so-called "recreational goods": RVs, ATVs, motorcycles and personal watercraft. Let's hope the Jet Ski holds it resale value.

The status quo is unsustainable; the question is whether the necessary adjustments are made purposefully or are imposed by the implacable forces of the market.

Efforts to inject short-term stimulus aimed at pumping up spending merely serve to forestall and exacerbate the inevitable reckoning. American households need to improve their balance sheets, and there is no painless substitute for reducing consumption, paying down debt, and increasing savings.

Current tax policy that serves to amerce saving and investment should be reformed, while individual households must alter their consumption patterns to consume less and save more. The unpalatable alternative is a permanent reduction in the standard of living for the next generation.

Christopher A. Hopkins CFA is a vice president at Barnett & Co.