Why You’re Going to Save More, Like It Or Not

Congratulations, America: You’re learning how to be thrifty after all.

Now, for the sake of the economy, would you please cut it out?

By now, we’re all getting familiar with the “paradox of thrift,” as famed economist John Maynard Keynes put it: Saving money is a good thing in general. It helps stave off unneeded debt and makes money available for investment. But the modern economy is driven by consumer spending, so people need to buy stuff if the economy’s going to grow. It’s especially destabilizing if everybody switches their habits all at once, and we flip from a nation of spenders to a nation of savers.

Yet that’s what is happening. The personal saving rate—the amount of disposable income left after consumers are done spending—has surged over the last few months, hitting 5.7 percent in April. A year ago, it was almost 0. Since the early 1980s, when it peaked at about 12 percent, the saving rate has drifted down steadily, barely interrupted by recessions or other events. It even dipped below 0 in 2005, meaning that Americans, collectively, were spending more than they earned.

[See how to find gold in a recession economy.]

Too much spending and debt is one of the reasons we’re in an economic pickle now, but Americans weren’t quite as profligate as the low saving numbers suggest. And the mismatch between saving and spending earlier this decade helps explain why spending will be crimped in the future, no matter how determined we are to splurge.

It doesn’t show up in the savings data, but many Americans thought they were saving over the last few years—mainly because they were spending money on their homes. Under the prevailing wisdom at the time, home values always rose, so any money you socked into your home was an “investment” likely to produce a positive return. Just like savings. As home equity skyrocketed, the “wealth effect” led people to believe they were sitting on found money they could use for retirement, their kids’ college tuition, and everything else we typically save for. As a fringe benefit, they bought countertops and appliances and stone for that new pool in the backyard, juicing spending and economic growth.

[See the upside of economic carnage.]

People had similar attitudes toward the stock market, which rose handsomely from 2002 to 2007—at the same time interest rates on CDs and savings accounts were falling. It was logical to put less money in the bank, earning 2 percent, and more into investments likely to offer a much higher return. “What drove the savings rate down was stock price appreciation and housing appreciation,” Bruce Kasman, chief U.S. economist for J.P.Morgan Chase, said at a recent conference. “People spent on those because they thought it was like saving.” It helped that jobs were plentiful for most of that time, with the unemployment rate well below 5 percent. So if you lost your job you’d probably be able to find another one quickly, which made it less important to build a supersafe rainy-day fund.

Obviously the prevailing wisdom was wrong. Spending money on real estate and stocks wasn’t the same as saving. The housing bust and stock-market rout slashed Americans’ household net worth by $11 trillion in 2008—almost $100,000 per U.S. household. We feel less wealthy, and in fact we are less wealthy.

[See how you can prosper, even now.]

We’re also redefining what it means to save whatever money is left after paying the bills. Putting it into your house is out. The stock market has bounced back a bit in 2009, but it’s still down 40 percent from its 2007 peak—and far too risky for people with savings they actually want to keep. So we’re rediscovering old, boring ways to save, like putting money into CDs and insured bank accounts. And that includes new stimulus money the government is hoping will pump up the economy. Instead of spending the extra cash showing up from tax rebates and higher incomes (for those lucky enough to get a raise), Americans are saving most of it.

For the next several years there are likely to be few alternatives. House prices are likely to be stagnant at best, and volatility will define the stock markets. With jobs scarce and likely to stay that way, building that rainy-day fund suddenly seems a lot more important. Interest rates are creeping up, meanwhile, making plain old bank accounts look like a reasonable place to stash your cash. A bit better than the mattress, anyway.

[See why things may never return to normal.]

Better savings habits will make consumers more secure. But they could also keep the economy in the dumps. Economist Gary Shilling predicts that the savings rate will increase one percentage point per year for about 10 years. Consumer spending, as a result, seems likely to fall from 70 percent of economic activity to 65 percent or less, which means slower economic growth, fewer jobs and even more conservative spending and saving habits. We used to envy our neighbors’ new acquisitions. Now we wish they’d make a few more.