A negative savings rate?

Alan Reynolds
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Posted: Feb 16, 2006 12:05 AM
You must have heard that "Americans are spending everything they're making and more, pushing the national savings rate to the lowest point since the Great Depression." That line from Associated Press writer Martin Crutsinger was echoed on TV and in most newspapers, provoking columnists and editorial writers to bemoan the "savings crisis."

The analogy with 1933 was designed to equate a low savings rate with hard times. Actually, the savings rate is usually highest in recessions, because of fear and because recessions crush our nest eggs. The savings rate rose above 10 percent during the stagflations of 1974-75 and 1980-82 to make up for the wealth that evaporated when stocks and bonds collapsed. A low savings rate can be a sign of optimism about the future.

Since the purpose of saving is to add to wealth, the best measure of saving is the addition to wealth. In the third quarter of last year, the Fed's measure of household net worth amounted to $51.1 trillion -- up by more than $5 trillion from a year earlier. Net worth measures assets minus debts, so that 10.9 percent wealth gain also debunks any "debt crisis." Homeowners' equity accounted for only 21 percent of total wealth, so it was not just a housing boom.

Wealth gains from financial assets benefit a rapidly rising share of the population. Tax-deferred IRA, Keogh and 401(k) plans alone amounted to $6.7 trillion in 2004. Something like half a trillion dollars in dividends, interest and capital gains from such tax-sheltered investments were excluded from last year's income statistics, particularly those based on income tax returns.

A New York Times story said, "In 2003, the top 1 percent of households owned 57.5 percent of corporate wealth, up from 53.4 percent the year before, according to a Congressional Budget Office analysis of the latest income tax data." Yet the most that such tax data could show is that the top 1 percent own a big share of taxable investments. That is because the rules do not allow large sums to be stashed in tax-deferred or tax-exempt (Roth) savings vehicles. The rest of us, by contrast, now keep the vast bulk of our investment income hidden in such plans. It only shows up in wealth surveys.

To put one year's $5 trillion wealth gain in perspective, personal income was just $9 trillion after taxes. Even if we'd saved half of all personal income, that could not have added as much to household net worth as was, in fact, added. We clearly need to examine the household balance sheet -- not just a one-year income statement.

The third chapter of the new "Economic Report of the President" explains why the personal savings rate tells us little about personal savings.

First of all, savings is defined as income less consumption. Because such investments as home remodeling and college tuition are miscounted as consumption, they reduce the savings rate. Making a big down payment on an existing house lowers the savings rate, as does paying cash for a new car. Yet homes and cars are assets.

Second, corporate saving is also personal savings because stockholders own the corporations. When corporate profits are retained and reinvested, that increases assets per share and results in greater capital gains for 401(k) plans. Undistributed corporate profits accounted for more than 72 percent of total net private savings in 2004, when total private savings hit a record high despite a drop in so-called "personal saving."

Third, an increase in the value of old savings accomplishes the same thing as new savings -- it increases net worth. Yet capital gains are not counted as income or savings, so they are excluded from both the numerator and denominator of the savings rate.

Wall Street Journal columnist Greg Ip quoted Alan Auerbach of UC-Berkeley as saying, "It's too sanguine to equate capital gains with cash-flow saving -- they're not the same." This seems to suggest that a thousand dollars from writing a check on a savings account is somehow better than a thousand dollars from selling mutual fund shares.

"To live off capital gains," Ip explained, "a retiree would have to sell the underlying asset." Nonsense. Consumer spending is always financed by selling assets. Cash in your wallet and money in the bank are assets, just like stocks and bonds. Human capital (such as a new M.D. degree) is an asset that can be tapped by borrowing against future income. Income is simply a means of replenishing your assets, not a distinctly different way of financing spending. If the value of your stocks and bonds increases by 7 percent a year, you can sell 7 percent of your assets every year without reducing your wealth.

Because Ip assumes most household wealth is tied up in homes, he writes, "For many (retirees), selling their home is impractical." But you don't have to sell your home to spend a fraction of the equity. Just take out a bigger mortgage, a home equity loan or a reverse mortgage. If the cash withdrawn is no larger than the annual appreciation in property value, there is no reduction in wealth. Once you're old enough, there's nothing wrong with reducing your wealth (but heirs may disagree).

Last year's below-zero savings rate was: 1) partly a statistical illusion due to counting investments as consumption and ignoring corporate savings; 2) partly a sensible way to spread out the financial pain of surging energy prices; and 3) partly a rational response to the $5 trillion gain in household wealth.

I am not opposed to more saving, or to virtue in general. But last year's low personal savings rate was no "crisis." And the sensational analogy with 1933 was sensationally ridiculous.