Friday, November 28, 2008
Stephen Roach, the chairman of Morgan Stanley Asia, sees a silver lining in the collapse in personal consumption:
The good news is that lines should be short for today’s “first shopping day” of the holiday season. The bad news is more daunting: rising unemployment, weakening incomes, falling home values, a declining stock market, record household debt and a horrific credit crunch. But there is a deeper, potentially positive, meaning to all this: Consumers are now abandoning the asset-dependent spending and saving strategies they embraced during the bubbles of the past dozen years and moving back to more prudent income-based lifestyles.
This is a painful but necessary adjustment. Since the mid-1990s, vigorous growth in American consumption has consistently outstripped subpar gains in household income. This led to a steady decline in personal saving. As a share of disposable income, the personal saving rate fell from 5.7 percent in early 1995 to nearly zero from 2005 to 2007.
In the days of frothy asset markets, American consumers had no compunction about squandering their savings and spending beyond their incomes. Appreciation of assets — equity portfolios and, especially, homes — was widely thought to be more than sufficient to make up the difference. But with most asset bubbles bursting, America’s 77 million baby boomers are suddenly facing a savings-short retirement.
The harsh reality is that the changing attitude of American consumers toward thrift is one of the major causes of the current global financial crisis. Millions of Americans borrowed more money than they could afford to repay in reliance on rising asset values. Sure, the financial services industry abetted the borrowing by lowering standards to accomodate the ever-greater ambitions of American consumers, but at the end of the day nobody can force you to borrow and spend too much. You do that yourself, to yourself. The return of thrift will force us to recognize that inconvenient truth, even if we do not often say it out loud.
Roach makes a policy argument in favor of thrift, but there is a spiritual or psychological aspect to it. There is something enormously satisfying about living well below one's means. Not only do you have choices that more fully tapped people do not have, but you know that you have it within yourself to postpone material gratification. There is power in that. You either know this or you do not. Chances are, if you are a typical American, your grandparents knew it and you do not.
Apart from its spiritual benefits, thrift permits the accumulation of capital. Capital is the foundation of your personal prosperity. When I was but a wee bearn, I proposed to my grandmother that I spend a nickel on a candy bar. She, the only economics major in her class at Vassar, observed that "a nickel is all a dollar can earn in a year." At age seven I had no idea what she was talking about, but when I finally grasped her meaning a light went off. Since then, I have not been able to spend money without automatically calculating how much capital I would need to earn what I am proposing to spend. Not how long I would need to work to earn the money I am about to spend, but how much capital I would need to produce what I am about to spend. Develop that habit and you will spend your money more carefully, I guarantee it.
All of this leads, of course, to a final obvious point: Accumulated capital is the basis not only of personal wealth, but national wealth. If you save your money and invest it productively -- not, by the way, in the house you live in or illiquid stores of wealth, such as land or specie, but actual businesses, directly or indirectly through bank deposits or the capital markets -- you are building the wealth of America and, with it, all the world.
Politicians will tell you to consume, which for most Americans means to borrow and spend. They say this because they are interested in short-term results -- illusory prosperity -- to get them past the next election. Many people will fall for this advice. You, however, do not have to join them. You can be the source of capital for permanent prosperity. You can do this because now you, too, know the essential lesson of capitalism: "A nickel is all a dollar can earn in a year."
Your grandmother was a wise one. I wonder if Vassar students today are exposed to such verities as she apparently was.
The thing most disgusting about the vast majority of politicians is how a combination of living primarily for the next election and possessing general ignorance of how markets function and wealth is created makes them exemplars of a shallow, self-centered approach to life that utterly lacks basic awareness of the concept of deferring or foregoing current consumption. And even worse, they do it with my money.
Re: "A nickel is all a dollar can earn in a year."
One of my fearless pool-hustler pals turned $100 in $107,000 playing baccarat at a casino in Las Vegas. More than a few of my bold entrepreneurial friends in business have turned nickels into millions of dollars.
But they all believed one simple rule: Make the money before you spend the money.
The bigger issue right now is that no one in political power, whether Republican or Democrat, seems to have the political will promote policies that encourage thrift. Not only does the government continue to borrow, but it also encourages the average citizen to borrow as much as they can. We no longer seem to have the political will to endure a true recession, either. As soon as it looks like the economy is tanking government encourages all kinds of policies to keep spending up, including making loans cheaper. As a result, we haven't had anything like a real recession since 1992-93, even though the dot.com bubble burst and Al Queada hit the twin towers. Without occasional corrections markets tend to get out of whack, and the longer they go without correction the worse this becomes.
Borrowing works as long as the lenders are still willing to lend. At some point in time, however, the lenders for whatever reason decide that they no longer want to do so.
This happened to our role model for international hegemony, Great Britain, in 1914-19 and also in 1941-45. In both instances, we were their primary lender. In 1916 they came close to having to discontinue WWI because they were bankrupt. In 1940 without Lend Lease they would have lost the war, and when we abruptly ended Lend Lease three weeks after Hiroshima in 1945 we touched off a recession that took years to correct and ultimately resulted in the loss of the British Empire.
Right now we are fortunate that others are rushing to buy our T-bills in the face of this crisis. But ultimately the borrowing and spending (notice we don't say tax and spend anymore,) will have a price, and that price will be a continued deflation of our currency. While I could be wrong, I think we just elected the wrong party if we want to reinstitute a sound fiscal policy. Interest rates are falling again, government is spending like crazy, and it will soon be encouraging you and me to spend like crazy. Right now, all we are worried about in the short term is avoiding a deflation, which is a legitimate concern. But ultimately there will be a price to pay. What happens when the Chinese no longer buy our T-bills, just like we no longer provided credit to Great Britain?
Our politicians are selling us down the river because no one in power has the will to tell us that we need to save and spend less.
That's why your nickel candy bar now costs a dollar and soon will cost much more.
And why we will have the aircraft carriers, but will not have the means to keep them afloat.
Yes, TH, I basically agree and yet, we must consider economies like Japan where the savings rate is high and economic growth is sluggish.
Viking, the irony is that by making lending standards stricter, and encouraging thrift, policy makers would only be making the economic downturn worse, not better. The time for locking the barn doors is before the horse has bolted, and if they are bolted, the horse cannot get back in even if he wanted to.
I have not been out, but the news on CNBC has been surprisingly positive. I'm sure that certain retailers specializing in big ticket items like large-screen TVs and computers will suffer, but that implicates a relatively small number of companies. We'll see.
Short term I agree, we have no choice. Unfortunately, I think the dems will use this to as an excuse to perpetuate the fiscal mustang syndrome, ie. no barn doors needed, which is how we got in this mess in the first place.
Amen to your Commentary, TH. You should moonlight as a preacher. I suppose you do already, in a manner of speaking. And amen to your simple rule, DEC.
The consumption habits of Americans over the past generation would amaze even Thorstein Veblen (who coined the term "conspicuous consumption").
Squealer perhaps unintentionally touches on the Keynesian notion called "The Paradox of Thrift," that the amount of saving and investment in theoretical equilibrium falls as the desire to save increases, which is a bit of a loaded weapon for the average Econ 101 student to deal with. As one of my old Econ texts phrases it:
"...an increase in the desire to save causes an increase in leakages from the spending stream. Aggregate demand and national product fall. As they fall, businesses decide fewer machines and factories. There is a decline in the quantity of investment..."
Fortunately, my Econ 101 prof during my freshman year at PU was Burt Malkiel, so I understand that all such Keynsian concepts have to be taken with a grain of salt. There is, however, probably a "sweet spot" of national savings that is not constrictive, and I am sure we have a ways to go before we reach the apex of that function curve and start sliding down the other side into P.O.T. problems. Japan may be on the other side of that curve.
The essence of the Japanese problem was that the government was forced to prop up inflated real estate prices rather than letting a natural correction occur. The result was that the economy stagnated for 8-9 years.