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.