January 31, 2020

Most Americans are familiar with the old advice that “a penny saved is a penny earned” or “the sooner, the better”. This is just one way of describing the power of compound interest, where interest is earned on principal plus interest already earned. In contrast, whatever gets consumed today cannot be used to make more money tomorrow. Perhaps the most important part of successful retirement planning is simply saving as much as possible, as soon as possible, and having the discipline to keep it up. While this is generally agreed upon, what represents a “penny of savings” is not always clearly defined and this can have personal and public policy implications.

The personal savings rate in the U.S. is about half of what it was in the mid-Seventies, but then again, it is well above the generational lows hit earlier this century. It stands at about 8% these days.¹ The credit crisis of 2008 sparked a mini renewal in better savings, but that has since fallen off somewhat. In aggregate, consumers still spend considerably more than they earn, and it is possible they might someday be forced to sharply cut spending in order to rebuild savings. If this were to happen, it would adversely impact the economy, because consumption is such an important component.

However, there are issues defining what actually constitutes income and spending. For example, benefits paid by pensions to individuals are not treated as income in official calculations because they are considered transfer payments. Moreover, spending by individuals on consumer durable items, such as automobiles, should probably be treated as investment and capitalized over many years, rather than expensed annually, because they are long-lived assets that depreciate over time. Realized capital gains—widely available to many investors given the decade-long bull market—are not officially included in income because they do not relate to current production; and yet, most people realistically think of realized gains in terms of current income and pay taxes on them. Making these types of adjustments would alter the reported savings rate and influence its value as an indicator.

Part of the problem in measuring the savings rate occurs in the allocation of income between sectors. For example, deducting capital gains taxes reduces personal income, but increases government revenue. By combining all sectors, the total national savings rate is more in line with long-term averages. Even if the actual long-term trend regarding savings is debatable, consumer debt is nonetheless rising again. Still, the personal debt to income ratio has been generally increasing for decades, so it is difficult to determine if it is getting to levels that once again threaten consumer solvency. Besides, most household debt is accounted for by home mortgages, which are collateralized by real property; hence, mortgage payments encourage forced savings. Debt also represents one side of the personal balance sheet. The general recovery in real estate values alone is the other positive side of the ledger.

None of this is meant to suggest that personal savings are not important. Indeed, despite the averages, too many Americans consume too much and save too little. Some consumers have taken on too much debt and potentially face serious consequences. Furthermore, the positive wealth effect from the sustained stock market boom of the last decade could conceivably reverse if there are declines, causing likely reductions in spending. However, most consumers probably react to overall trends in share prices in terms of their spending habits, and not the extremes of market tops or bottoms. Record low unemployment also helps, boosting confidence in personal finances. Of course, if general employment were to suffer, that would surely threaten consumer incomes and spending decisions, and increase debt problems. Overall though, at this stage, personal indebtedness is not a major concern, and the “new normal” single digit national savings rate may not be as alarming as some believe.

_{1. fred.stlouisfed.org/series/PSAVERT}