Savings rate still in the red: another very disturbing economic statistic

DuncanK · March 17, 2003, 17:27

Here's an interesting article from The Economist arguing that a quick end to a war in Iraq will not be the end to the economic slump. The US savings rate is still negative.

http://www.economist.com/opinion/dis...ory_id=1632261

orange · March 17, 2003, 17:34

can you please post the article?

DuncanK · March 17, 2003, 18:16

np. here it is

Mar 13th 2003
From The Economist print edition

Even without the uncertainty about Iraq, the global economy would be fragile

BEARS are supposed to hibernate all winter. This year they have had little rest. Investors marked this week's third anniversary of the Nasdaq stockmarket's peak by pushing most markets to fresh lows—some 50% or more below their levels in early 2000 (see chart 1). Some economists reckon that the outlook for the big rich economies is similarly grizzly.

The reason why markets are nervous is not just the imminence of war with Iraq, but the evidence that, even without a war, the world economy is in worse shape than many had thought. America's total payroll employment fell by a huge 308,000 in February. Some of this was due to bad weather and the call-up of military reservists, but other surveys confirm that companies have been cutting labour in response to falling profits and rising energy costs.

A weak jobs market, along with war fears, explains why in February the Conference Board's index of consumer confidence fell to its lowest in nine years. Consumer spending, the main pillar of the American economy over the past two years, seems to be stalling. Some economists are starting to fret about the risk of another recession—the second in three years. Every big oil-price increase over the past three decades has been followed by an American recession. That does not prove that oil shocks always cause recession. But with the economy already vulnerable, a sustained rise in oil prices above $40 a barrel could nudge it over the edge.

Many forecasters now expect GDP growth in America of only 1-1.5% at an annual rate in the first half of this year. Futures markets are pricing in a more than 50% chance that America's Federal Reserve will cut interest rates at its open-market committee meeting next week.

It is not only America where growth forecasts are being shaved. A year ago, GDP growth in the euro area was tipped to be a respectable 2.8% in 2003 by The Economist's poll of forecasters; now it is expected to be only 1.1% (see chart 2). This represents an even more dramatic pruning than the cut in America's expected growth rate from 3.6% to 2.5%. Germany's GDP shrank slightly in the fourth quarter, and may well have contracted again in the present quarter, meeting the popular definition of a recession. German industrial production jumped by 1.6% in January, but this followed a 3.5% fall in December, so output remains weak.

Jobs are also disappearing in the euro area. German unemployment jumped by 135,000 in January and February, close to its fastest rate of increase since the depths of the early 1990s recession. Germany's jobless rate stands at 10.5% of its labour force. In France, too, surveys show that households are more worried about jobs than at any time since the early 1990s. French consumer confidence has fallen to its lowest for six years.

Japan, for years the economic laggard, was in the unusual position of having the fastest GDP growth rate in the fourth quarter of last year (2.2% at an annual rate) of any of the 15 rich countries that are monitored each week on our Economic indicators pages. This was largely due to a jump in net exports, helped by strong demand in China. But Japan's brief spurt looks unsustainable: most forecasters expect its growth to average only about 0.5% both this year and next.

The recent rise in the yen against the dollar will hurt exports and reinforce deflationary pressures. Japan's trade surplus narrowed sharply in January. Toshihiko Fukui, who takes over as the new governor of the Bank of Japan next week, is not expected to embrace a radical easing of monetary policy to rid the country of deflation. The Japanese stockmarket fell this week to its lowest in 20 years, prompting fears of a new financial crisis, because lower share prices will erode the capital of banks and insurers when they close their books at the end of the financial year on March 31st.

Still bubbling over

To a large extent the fate of the rich economies rests on America. Stephen Roach, chief economist at Morgan Stanley, reckons that America accounted for two-thirds of total global growth since 1995. If the American economy now stumbles again, neither Europe nor Japan look ready to take over as an engine of growth.

Yet despite worries about the immediate impact of a war and higher oil prices, most economists still expect America's economy, along with its stockmarkets, to rebound once the war is out of the way and the associated uncertainty lifts. For example, J.P. Morgan Chase is predicting annual growth of almost 4% in the second half of this year. This seems to assume that the recent slump in consumer and corporate confidence is mostly related to war fears. Iraq has clearly taken its toll on the economy, but there are also deeper problems that would continue to cramp growth even without a war.

The biggest is that the economic excesses created by the greatest financial bubble in history have still not been fully purged. Ed McKelvey, an economist at Goldman Sachs, argues that the main reason why private-sector spending is weak is that households and companies are still trying to correct the huge deficits that they ran up during the stockmarket bubble.

Chart 3 illustrates the problem. America's private sector was a net saver for 40 years until 1997: the total income of households and firms always exceeded their spending, with average net saving of 2.6% of GDP. But the irrational exuberance of the late 1990s encouraged a massive boom in spending and borrowing, pushing the private sector into a deficit of 5.2% of GDP by 2000. In the year to the third quarter (the latest period for which data are available), the private sector was still in deficit, to the tune of 1.4% of GDP. In other words, says Mr McKelvey, the private sector is only halfway back to its long-term average rate of net saving of 2.6% of GDP.

Firms have done much to cut costs and restore the health of their balance sheets, but they have further to go. In the early stages of a recovery, the corporate sector usually runs a small financial surplus, investing less than cashflow. But America's companies continue to run a deficit. Worse still, profits have remained feeble. Ian Harwood, chief economist of Dresdner Kleinwort Wasserstein, estimates that profits across the whole economy, as measured in the national accounts, fell again in the fourth quarter of last year—the third quarter in a row of decline after a brief recovery. This may explain why firms are still cutting jobs.

American households have done even less to repair their balance sheets. Personal savings rose from 2% of disposable income in 2000 to 4% in the fourth quarter of 2002. But Mr McKelvey reckons that the appropriate saving rate, given the decline in households' total net worth as share prices have fallen, is somewhere in the 6-10% range.

The main reason why households have been able to postpone their adjustment is their ability to borrow—and so spend—against the rising value of their homes. But that extra cash could soon run out: even if property prices stay high and mortgage rates stay low, the scope for home-equity withdrawal will decline. Households will then have to tighten their belts. This, in turn, implies that America's growth rate could remain below potential for some time, regardless of what happens in Iraq.

The required adjustment in household saving back to normal levels can be cushioned (if not prevented) by monetary or fiscal easing. In 2002 America's economy had a fiscal stimulus worth over 2% of GDP. Without it the economy might barely have grown. This year's boost is likely to be more modest. Defence spending will increase, but President Bush's proposed tax cuts are likely to be watered down by Congress. On top of this, cuts by state governments, which are constitutionally bound to balance their budgets, are likely to offset as much as half of any easing by the federal government this year.

This increases the pressure on the Federal Reserve to cut interest rates soon. In testimony to Congress in early February, Alan Greenspan, the Fed's chairman, hinted that he would wait for a resolution on Iraq, to see if the economy then rebounds, and then cut rates if necessary. But the recent weakening of the economy argues for a rate cut now.

Another prop to America's economy is the cheaper dollar, which will boost net exports. The snag is that a weaker dollar will hurt the rest of the world. The dollar hit a four-year low against the euro of almost $1.11 this week after John Snow, America's treasury secretary, said that he was “not particularly concerned” about the dollar's decline. Europe and Japan, however, are much more concerned.

The correct response by central banks in Europe and Japan to an appreciation of their currencies is to ease monetary policy. The Bank of Japan cannot cut interest rates, which are already at zero, but it has been intervening to push down the yen. The European Central Bank, on the other hand, has more room for manoeuvre. It duly trimmed rates on March 6th, by a quarter-point, to 2.5%. But this was not enough.

Since the ECB cut interest rates in December, the euro's trade-weighted value has risen by 6%, equivalent in terms of its impact on inflation to a rise in interest rates of more than half a point. Policy has, in effect, tightened this year, even though the economic outlook has deteriorated; and the euro area's core inflation rate (excluding food, energy and tobacco) has dropped below 2%. Fiscal policy has also tightened slightly because of the straitjacket imposed by the stability pact, which is forcing Germany to increase taxes in the midst of recession. Tighter fiscal policy increases the case for monetary easing.

If the world economy does stumble, policymakers will have to act quickly. Starting from a position of ample global excess capacity, further sluggish growth, let alone a recession, could raise the risk of deflation in some countries. There is clearly a big chance of further falls in share prices: in its latest quarterly review, the Bank for International Settlements argued that, despite the war premium, America's stockmarket still looks overvalued relative to historical norms. After previous bubbles share prices have always become significantly undervalued before recovering. The economic and financial headlines could get worse before they get better.

Imran Siddiqui · March 17, 2003, 18:16

Haven't you been arguing for weeks on end that consumption is important and savings isn't? So why are you doing a 180 now?

DuncanK · March 17, 2003, 18:19

Quote:

Originally posted by Imran Siddiqui

Haven't you been arguing for weeks on end that consumption is important and savings isn't? So why are you doing a 180 now?

Sure. The point is that spending has been driving the economy for years and now people will try to pay off their debts before they resume their spending.

DAVOUT · March 17, 2003, 18:24

Usually repayment of loan are considered as savings. The figure discussed here would show that the spending has exceeded the income.

Drogue · March 17, 2003, 18:30

Isn't that a good thing? All this spending on credit can only cause a slump in the long term, as people have to pay it back eventually. Sadly in the UK, we haven't reached that point yet (IIRC) and are still borrowing more, and getting further into debt

DuncanK · March 17, 2003, 18:36

Quote:

Originally posted by Drogue
Isn't that a good thing? All this spending on credit can only cause a slump in the long term, as people have to pay it back eventually. Sadly in the UK, we haven't reached that point yet (IIRC) and are still borrowing more, and getting further into debt

Monetary policy tends to encourage people to borrow money more than it does actually increase their income. Some economist think that's bad. They say it would have been better to just let the economy slip into a recession in the late 90s instead of lowering interest rates. If you look at the graph you can see that debt has been driving spending since the mid 90s.

The problem is that wages aren't high enough to drive the economy by income alone. People have to keep going into debt to keep up their traditional spending levels.

Lancer · March 17, 2003, 18:40

My van will be paid for in May! WooHoo!

Imran Siddiqui · March 17, 2003, 18:41

Quote:

They say it would have been better to just let the economy slip into a recession in the late 90s instead of lowering interest rates.

They ignore political pressures. It ain't popular to say we'll just go into recession now, no matter if it's the smart thing or not.

DuncanK · March 17, 2003, 18:44

Quote:

Originally posted by Imran Siddiqui

Quote:

They say it would have been better to just let the economy slip into a recession in the late 90s instead of lowering interest rates.

They ignore political pressures. It ain't popular to say we'll just go into recession now, no matter if it's the smart thing or not.

hehe, true. No politicians really listen to these guys. In fact, no one really does period. Although, Greenspan might be considering their theories, which might explain his reluctance to lower interest rates right now.

Dis · March 17, 2003, 19:00

Savings are only a problem in a depression.

which we could be heading towards

.

Urban Ranger · March 17, 2003, 23:24

Quote:

Originally posted by DuncanK
Sure. The point is that spending has been driving the economy for years and now people will try to pay off their debts before they resume their spending.

I am now completely confused wrt your position.

Case · March 18, 2003, 02:53

Quote:

American households have done even less to repair their balance sheets. Personal savings rose from 2% of disposable income in 2000 to 4% in the fourth quarter of 2002.

I fail to see how increased household and business saving offers a fix to the current US economic problems. In recessions, businesses and people generally tend to over-save due to fears about their financial security, and this causes consumption to fall, resulting in the economy slowing further.

As such, the only reason to encourage increased saving in a recession is to make money available to businesses so that they can expand. However, as US interest rates are already fairly low, I really don't see this as justification for encouraging more people to sit on their pay-checks and businesses to stash their profits away in the bank.

While the US debt situation appears to be serious, IMO it would be best to wait for a genuine economic recovery before trying to tackle it.

BTW, based on the situation here in Australia, household debt figures are now considered pretty unreliable. This is because increasing numbers of people are using their credit cards as ad-hoc debit cards. While this behaviour has seen figures for personal and household debt increase dramatically, becuase people using their cards in this way generally have no trouble paying their credit card bills and are only using 'credit' as a convienient way of paying for goods which they can afford, the debt figures now greatly overstate what's really going on.

DuncanK · March 18, 2003, 02:57

UR,

Spending does drive the economy of course, but we need to actually increase real wages significantly to maintain that spending. The long run economic policy is trickle down economics which doesn't work, so the Fed has to keep decreasing interest rates to get people to go into debt. This action can only be a temporary solution.

The reason that we are going to go into a recession is because the savings rate is going to increase sharply, and if you look at the graph you can see that it already is. I'm not arguing that we are going to have a recession because the savings rate is low. I'm arguing that we will have another recession because income is not distributed in a way that will maintain high spending levels, because of trickle down economics.

DuncanK · March 18, 2003, 03:04

Quote:

Originally posted by Case

I fail to see how increased household and business saving offers a fix to the current US economic problems. In recessions, businesses and people generally tend to over-save due to fears about their financial security, and this causes consumption to fall, resulting in the economy slowing further.

As such, the only reason to encourage increased saving in a recession is to make money available to businesses so that they can expand. However, as US interest rates are already fairly low, I really don't see this as justification for encouraging more people to sit on their pay-checks and businesses to stash their profits away in the bank.

While the US debt situation appears to be serious, IMO it would be best to wait for a genuine economic recovery before trying to tackle it.

Good point. The Economist supports the Bush tax cuts, because they believe that it will increase the savings rate and stimulate spending at the same time. I disagree though. The lower income groups are more in debt and they won't be getting the tax cut. We need a stimulus that will allow the lower income groups to pay off their debt.

DuncanK · March 18, 2003, 13:40

Well housing starts are down now. I'll eat my hat if there's now recession this year.

Sava · March 18, 2003, 13:44

America is a debtor's society... it's bound to catch up with us sooner or later.

Bosh · March 18, 2003, 14:23

Quote:

Greenspan might be considering their theories, which might explain his reluctance to lower interest rates right now.

Possibly he doesn't want to get in the position that Japan is now and is trying to ensure that he can cut interest rates a lot if things get really bad.

Good article, if I wasn't an impoverished student I'd buy an Economist subsciption despite the right-wing slant. It seems like the US economy is in a bit of a bind since we had a couple years of really low savings rates but we can't get them back up to normal without dropping spending and possibly getting in a downward spiral. Its times like this that I'm happy that I'm used to a college student level of spending...

Drogue · March 18, 2003, 14:32

Quote:

Originally posted by Boshko
Good article, if I wasn't an impoverished student I'd buy an Economist subsciption despite the right-wing slant.

IMHO there are many better online magazines that are free. The Economist, as well as having a right-wing slant, is a little too political for me. If that's what you want, it's great, but if I wanted to read about economics, I wouldn't be reading that. Just my opinion though, I'm sure others like it.

DuncanK · March 18, 2003, 14:36

Quote:

Originally posted by Boshko
Possibly he doesn't want to get in the position that Japan is now and is trying to ensure that he can cut interest rates a lot if things get really bad.

After things get really bad its too late. There is at least a 6 month lag before the lower interests rates even start to work. He's too conservative.

Quote:

Originally posted by Boshko
Good article, if I wasn't an impoverished student I'd buy an Economist subsciption despite the right-wing slant. It seems like the US economy is in a bit of a bind since we had a couple years of really low savings rates but we can't get them back up to normal without dropping spending and possibly getting in a downward spiral. Its times like this that I'm happy that I'm used to a college student level of spending...

Amen to that. I'm going back to school next semester too.

Bosh · March 18, 2003, 14:45

Quote:

is a little too political for me

I like that, its a good source for international political news.

Quote:

After things get really bad its too late. There is at least a 6 month lag before the lower interests rates even start to work. He's too conservative.

Yeah but what if we get stuck in a few years of stagnation like Japan, if we don't have a few % points of give then we're ****ed badly.

DuncanK · March 18, 2003, 15:09

Quote:

Originally posted by Boshko
Yeah but what if we get stuck in a few years of stagnation like Japan, if we don't have a few % points of give then we're ****ed badly.

We can't let it get as bad as Japan. Just because we drop our interest rates down right now doesn't mean that things are as bad as they are in Japan. If the economy improves because of the measure then we could avoid a recession. However, if we wait until we are in a recession the drop in interest rates will have a smaller effect. Larger stimulus will be needed, but we won't be able to use the interest rate as a tool. I say since interest rates are so close to zero right now we are in serious danger and we can't risk a recession. Everything should be done immediately to avoid one.

Case · March 18, 2003, 19:29

I really don't think that the US's current situation can be compared to Japan's. Japan's woes are the fault of the country's failure to reform it's outdated financial system and to reduce government intervention in the economy. AFAIK, the US's economic structure is OK, and this recession is largely the hangover from the stockmarket bubble of the 90s combined with lower consumer and business confidence.

As such, the correct responce by the US authorities would be to kick start the economy through increased government spending while trying to stabalise the international situation to encourage business investment and consumer spending.
Note; when I say government spending, I'm not talking about tax cuts: from what I understand, the US Federal and State Governments tax bases are already too small to balance the government deficit over the economic cycle.

Quote:

Originally posted by Boshko
Good article, if I wasn't an impoverished student I'd buy an Economist subsciption despite the right-wing slant.

Ditto. The Economist is also great magazine for long flights - on my way home from Europe I bought a copy in Paris and finished it over India.