Consumer Spending Turns to Saving as Recession Aftershocks Shake Confidence
Of all the bubbles that have burst recently—the wealth bubble, the housing bubble, the credit bubble—the one whose bursting hurts the most is the bubble of confidence. The confidence of Americans is shaken not only in their own economic futures but in their business and financial leaders who once seemed to be bringing a new level of prosperity. These "masters of the universe" were thought of as financial savants, then idiot savants, and now just idiots. The root of the word credit comes from the Latin credere, which means "to believe," but now the American public does not believe in the world of finance, and without that faith and trust, finance cannot work.
Everybody—consumers, bankers, small investors, pensioners, industrialists—is dazed and confused by talk of losses in the trillions of dollars, an avalanche that nobody foresaw or imagined. Today it seems almost self-evident that everyone borrowed too much, creating a level of debt that is crushing our economy. The government's stimulus program and the bold actions of the Federal Reserve were timely and on a large scale, but banking debt still threatens to choke up any incipient recovery. Consumers and businesses are dependent on banks, but the banks lack the strong balance sheets and profit-making incentives to make the kind of loans that keep an economy humming.
Spending is tumbling not just in America but worldwide. We face a synchronized downturn in almost all countries. In the fourth quarter of 2008, the U.S. economy and Europe's each contracted at an annual rate of 6 percent; Japan's, by 13 percent. The drops came at lightning speed.
Everybody feels something new has happened—something mysterious and dangerous unlike any other downturns since the 1930s. Most Americans, in several surveys, say they feel we won't come out of this downturn for five to seven years and may never enjoy again the economic growth that improved the lives of so many families. We are, after all, fundamentally a consumer society, and most consumers now believe that the pain will be lasting and the effect permanent. A recent survey by AlixPartners of 5,000 Americans across all key demographics suggests that spending will return only to 86 percent of prerecession levels. Americans plan to save an unprecedented 14 percent of their total earnings (the average savings was only 1.4 percent for the prior decade).
On average, the people in the Alix survey have lost something like 25 percent of their retirement savings and now plan to retire later, extending their retirement age by 3.6 years to age 65.2 versus age 61.6. The purpose is to make up for the decline in their 401(k)'s and the drop in the equity value of their homes. Almost 30 percent had to raid their retirement or college savings to pay bills. About 70 percent are concerned about the very survival of their employers.
The new "normal" levels of spending and saving from all these pressures and anxieties could last for a decade across the whole fabric of life. A staggering 88 percent say they'll reduce dining out; about 80 percent will cut back on clothing, leisure activities, or entertainment; and 65 percent on travel. Fifty-eight percent say that even after the recession, they plan to buy less expensive things, and 77 percent plan to wait for sales. They are delaying home improvement programs and forgoing big-ticket purchases—and when they do buy, it will be after a lot of price shopping. Overall, they are pessimistic, believing it will be almost six years before their net worth can recover to prerecession levels.
Cast aside now are the assumptions that their home values were buoyant and their financial assets would grow over the long term. The level of pessimism is uncharacteristic of America: Sixty-one percent feel that the economy has yet to hit bottom; two thirds say it won't recover until 2011 or later; and only 43 percent see us getting back to prerecession levels.
If consumers do what they say and devote 14.3 percent of total income to savings, the impact will be great. When $10 trillion of our gross domestic product is devoted to consumption and when personal spending goes down commensurably when the savings rate goes up, we are looking at a cut in consumption of more than $1 trillion below prerecession levels. The people surveyed say they plan to keep savings at these levels for an average of eight-plus years, and nearly half of them said they'd do that over 13 years. On top of all this, a new fear is that the national debt we are incurring through deficit financing could transform the United States into a banana republic. We will have to service this debt and our soaring Social Security and Medicare entitlements when record numbers of baby boomers retire over the next two decades. All these costs will depress future incomes and income growth.
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Your Future -This Way or That
The People Next Door
It seems easy to understand why the people next door drive a car that must be 14 years old, dress quite plainly and don’t much if anything on landscaping. He is a sell-employed carpenter and she is an assistant in a doctor’s office. Neither has a college education. But, each of their three children went to an Ivy League undergraduate college and then on to an Ivy League business, medical and law school. One of the children mentioned to you how grateful they were to have left school without a cent of debt. When you’ve spoken with either of the parents over the years, they’ve never complained about their children’s educational expenses or indeed about anything to do with money. How can this be? Their combined incomes can’t be over $100,000, yet it seems they may have paid over a half million dollars in educational expense for their children. Your annual household income is $250,000 but you live paycheck to paycheck.
The main difference between you and your neighbors is that they are sitting on a stock portfolio worth $4 million, throwing off more than $120,000 per year in dividend income. You couldn’t raise $10,000 if you had a month to do it. How in God’s name did this come to be? Neither of the neighbors inherited anything.
Here’s what happened. In the early 1970’s, when your neighbors and you were in the early 20’s, they realized they would probably not make great incomes so they decided to live beneath their means, utterly to ignore advertising, to buy used cars, stay out of bar rooms, restaurants and malls, and to invest what little they could spare in the stocks of companies that sold things to other people, such as you.
They bought shares in what was then Philip Morris, and of Johnson & Johnson, Colgate Palmolive, Procter & Gamble, GE, Wal-Mart, Coca Cola, William Wrigley, and Abbott Laboratories. They got into Microsoft in the late 1980’s at 10 cents per share. They had the broker deliver the shares to them so that they could reinvest the dividends and buy more shares without paying brokerage commissions. Over a period of some 35 years, your neighbors invested maybe $200,000 of their own savings plus all the dividend income. While you were going through your considerable income buying new cars, running up big credit card balances shopping at Burberry’s, Barney’s and Brooks Brothers, Neiman Marcus, and Bloomindales, eating out 5 times a week, ordering drinks made with premium priced liquor and leaving money on the tables of Indian-run casinos, your neighbors were reserving against their future obligations and for a time when they might not want or indeed be able to work. While you were unable to separate your wants from your needs, your less well educated neighbors had no trouble doing that for themselves. The result is that capitalism turned your income into your neighbors’ principal. One not so small consequence was that their children could apply to Stanford, Princeton and the University of Chicago without requesting a cent of financial aid. If you don’t think that sways the minds of top college admission committee members, think again.
Now, your neighbors love their jobs, in large part because they know they don’t need them and could cease working on any given day. You and your spouse hate your jobs because you know you have to keep them and maybe to work until you are 70 or older. You might want to continue to be most cordial to your neighbors’ children. When you end up looking for a job, one of them might give you a reference.
Oh, wait…you suddenly awaken from the horror of this wretched scenario and discover it was but a dream and a nightmare at that. You are still only 28 and what has been written above is but one possible outcome. Fortune has favored you and given you a second chance. If you are comfortable with the future outlined above, keep doing what you’re doing and you’ll get it. Keep spending all your income on consumer junk and trying to live as if you were a person with money and be sure to plan to work for a high school kid when you are 70, maybe parking cars.
If, on the other hand, you want to be able to live more or less without financial worry, curb your spending now and begin investing. Sure, driving a flashy car, having $50 lunches and $100 dinners, drinking martinis made with Grey Goose vodka and buying $500 Jimmy Chu shoes seems stunningly enjoyable now, but, I assure you, it won’t come up to having $4 million when you are 60.
We are in for a lost decade like Japan
There are signs all around that the "good 'ol days" are gone for good. Friends are pulling their kids home from private schools and out of state and private colleges. The average college student graduats with $45,000 of (unbankruptable) student loan debt.
One-third of my daughters 40-friend fellow-graduate circle from engineering school is couch-surfing (unemployed, living temporarily with friends or family); another third is really worried about job layoffs, wage and hour cutbacks and job security; and the third that is well-employed are saving like crazy, living simply, and knowing they cannot ever depend on Social Security, Medicare or traditional defined benefit pension plans. This recession is affecting elderly, parents, the youth and children...and all are going through a generation-changing "great recession".
When the Gross National Product of the US depends 71% on consumer spending and the spending significantly declines generationally...this means a change in the entire American economy. It may NEVER be the same again.
predictions
How can anyone make such long term forecasts? People in this country have short memories and little discipline. The savings rate will be back to negative and another asset bubble will be created. Gas was $4.50/gallon only last summer. People are again buying large vehicles thinking that these lower oil prices will hold forever.
Everything changes very quickly today. Mort writes these articles as if he has a crystal ball.
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