We need humility

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Today, as I write this blog entry, the U.S. Economy is in crisis. We have a massive consumer and mortgage debt problem. Gasoline and food prices are going through the roof. The U.S. dollar is plunging. People are losing their jobs and their homes. All of this is pretty nasty stuff. How do we get our economy back on its feet again? How do we sustain the rebound? What do we do? And what should we do?

The answer is simple; but, finding the political will is difficult. The answer is: we must save and invest in the future.

That one simple statement reflects the full measure of what we must do not only now in a time of crisis, but what we must always do in order to be economically secure and prosperous as individuals or a nation. Let me expand on this idea below.

SAVINGS
Let’s look at the first half of my simple statement: to save. As we discuss national savings, it may help to think about the U.S. economy as if it represented a family. So, when we talk about the collective saving of the United States, one could liken that to the savings of an individual and her family. Dictionary.com describes savings as “a reduction or lessening of expenditure or outlay.” This means that savings is the opposite of consumption. The best way to look at savings is as a transfer of purchasing power today to tomorrow because when we save we forgo purchases today so that we can purchase tomorrow.

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So, if a worker received a paycheck of $1,000, that worker would have to buy less than $1,000 worth of goods in order to save. The rest would go into a bank account or a Certificate of Deposit (CD) or a Money Market fund or what have you. The percentage of that paycheck one saves is their personal savings rate. Now, a lot of people think they are saving money when they pay down their mortgage or when they invest in the stock market. This is not savings. From an economy-wide perspective, this is actually labeled consumption in the National Income and Product Accounts (NIPA). An individual might look at this as investment, but it is certainly not savings. Why not?

Savings means safely putting money away today in order to use it tomorrow. The money must be safe; it needs to be there when one is ready to spend it. When one invests in the stock market, the bond market or the housing market, one can lose money as well as gain money. This means the money is not safe. Therefore this does not qualify as saving.

We can also dis-save! Dis-saving means spending more than one earns. We accomplish this by spending everything we earn. We can then spend even more in one of three ways: selling off assets, withdrawing past savings or incurring debt in order to pay for consumption.

Now, if we take this concept to a national level, savings is represented in the NIPAs as “Personal saving.” One often hears that the U.S. has a low savings rate. What that statement means is that we, collectively as workers, have a low personal savings rate. What’s low and what’s high? Well, as recently as 1984, Americans saved more than 10% of their income (see table). Today that rate is under 1%. The Japanese, on the other hand, saved as much as 20% of their income in the 1970’s.

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A low or negative personal savings rate is generally a sign that a family (or collectively, a nation) is either spending too much or earning so little that it cannot afford to save. One could get into a huge sociological discussion as to why one family saves and another does not — or why one culture saves and another does not. But, the fact is people save less in two instances: when boom times are so good that they over-consume or when bad times are so hard that they can’t make ends meet.

So, after World War II, the United States saved more than 7% of its income per year for nearly 40 years until 1984. Since then, there has been a steady decline to where we save less than 1% today.

INVESTMENT
That brings us to the other side of economic prosperity: investing. Dictionary.com defines investment as “the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value.” A good way to think about investing is using past accumulated savings in order to build future economic prosperity.

So, if a worker deposited $100 of saved wealth today in a bank or money market account or in a CD, the bank would invest the money in a company or project. A good investment might return $105 or $107 tomorrow. The bank would pay the worker interest and keep the rest for its profit.

Now, if we take this concept to a national level, investment is represented in the NIPAs as “Private Investment.” These investments in Physical Capital include things like homes, office buildings, factories, roads, bridges, computer equipment, software and so forth. Since World War II, the U.S. has invested 10-15% of its income per year.

For me, there is also an investment in Human Capital. That means, we can invest in our know-how, skills and knowledge through our schools and job training.

THE GAP
If you noticed, there seems to be a gap between savings and investment here. The question then is: how can the U.S. invest so much if it saves so little? The answer is it borrows the savings from abroad. Since America consumes more in foreign goods and services than it makes, it pays more to foreigners than it receives. This excess money is then invested back into the US. So, in a very real sense, trade imbalance is helping us to finance our investments.

This imbalance between savings and investment and between what we sell abroad and what we purchase from abroad cannot last. In so doing, we have dis-saved and sold off our assets to foreigners, reduced our home equity, raided our bank accounts and built up piles of debt. Our staggering debt load on an individual family level is matched by our national debt as a nation, which is now in the hands of the Chinese, the Japanese, the Saudis, Russians, and Brazilians.

The crisis we are now in is a direct result of our having saved too little and consumed too much as individual consumers and as a collective whole, as a nation.

So, again, the answer is clear. We need to save and invest in the future. To do that, we must first reduce our debt and then start saving. But, therein lies the biggest challenge we face: How do we face up to the fact that in order to move forward individually and as a nation we must tighten our belts, cut back on consumption and take the time to work our way back into prosperity? This will take humility and lots of it. And humility is something the American government and its citizens are sorely lacking today.

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