US Consumers: Negative Savings, Trillions In Debt, Negative Equity, Disaster Ahead

Negative Savings
In the early years of the Great Depression, the United States recorded one of its lowest personal savings figures up to that time. The 1932 figure was a dismal negative 3.1 billion dollars. That remained the worst year on record for the next 73 years.

At the start of the 21st century, that same personal savings figure dropped from a positive 174.3 billion dollars in 2004, down to a negative 34.8 billion dollars in 2005. The following year in 2006, that figure went down even further when it reached negative 102.8 billion dollars.

General economic principles state that consumers will save some of their disposable income and spend the rest. A negative savings rate means that U.S. consumers are spending more than 100% of their monthly after-tax disposable income . Other variables aside, the overall decline of personal savings (as has been consistently calculated over the past 80 years) indicates that the percentage of household savings has gone down to zero and is now in negative territory.

Ongoing Trends
In a recent Federal Reserve report, top economists state that the recent negative savings rate was partially caused by consumer extraction and spending of home equity during the past few years . A negative savings level is somewhat unusual and is generally not expected to continue for long, however, even adjusting for the equity extractions, that same report states that the actual saving rate trended down nonetheless.

Along with a decrease in savings, there has also been an increase in consumption. Known as personal consumption expenditures, this is a measure of the goods and services purchased by consumers . The ratio of nominal U.S. personal consumption expenditures to nominal Gross Domestic Product (GDP) has been trending up since the early 1980s and is now hovering near an all-time high of 70% . That is the highest percentage of spending as compared to GDP in the entire world .

These factors in combination with low interest rates and easy credit have caused an overall increase in household debt .

When consumers spend more than they earn, they are counting on future income not yet earned to pay off their current debt. If, and when, that unearned income does not materialize, consumers are no longer able to continue purchasing on credit. When the majority of consumers begin experiencing problems paying their debts, a serious economic collapse can be precipitated.

Debt & Debtors
A debt is a financial obligation to repay an amount owed . Three general categories of those who have debt in an economy can be classified as follows: consumers, businesses, and governments.

Consumers have a broad range of debts that come in all shapes and sizes. Some are in the form of credit cards, store cards, home loans, school loans, car loans, personal loans, back taxes, utility bills, rental payments, medical bills, and many other forms too numerous to list. Suffice it to say that there are myriad ways consumers can get themselves into serious and sizeable debt. At last check, U.S. Consumer debt was at an all time high of 2.4 trillion dollars (yes, that’s trillion with a T).

Businesses also have their share of repayment obligations. Small businesses often finance day-to-day business activities on credit cards and generally repay them when the bills come in. Businesses also owe money in the form credit from their suppliers, both foreign and domestic, and also have many of the same types of debt as consumers.

Governments have a slightly different set of debts, but they’re debts nonetheless. Governments fund social projects, wars, purchase goods and services, and finance a lot of it by issuing bonds, notes, and treasury bills that all need to be repaid with interest at a future date.

Corporate, government and consumer debt all have an effect on a nation’s economy, however consumer debt can be considered the one factor that can most adversely and subversively impact the underpinnings of what fuels a nation’s growth.

Consumer Debt
While corporate and government debt does not necessarily affect all consumers, consumer debt can affect all corporate and government institutions. This is because consumer spending directly contributes to corporate profits and government revenue. If spending were to stop all of a sudden, as a result of excessive debt, so too would our economy.

In essence, the foundation of a market economy can be summed up in one word: consumption. Personal Consumption Expenditures (PCE) is what fuels the engine of growth in a market economy and constitutes over 70% of GDP in the United States. PCE can be defined as the amount of disposable income that is not saved. As noted earlier, we currently have a negative savings rate in the U.S. This means all disposable income plus additional borrowed money is being consumed. This is where debt comes in.

Excessive Consumption
Excessive consumption ends up going on credit, either via credit cards, home equity loans, or other types of loans. Home equity loans theoretically are based on built up equity in a home, however, over the past few years, home prices rose at an extremely fast pace which ranged from 7.4 percent in 2002 to 13.2 percent in 2005 (about 3 to 4 times the rate of inflation). This gave the feeling of increased wealth and prompted many consumers to borrow on this equity. As home prices began to fall in 2006 and 2007 , this perceived equity has disappeared and consumers are left with large equity loans they still have to repay and no easy way to sell their home without going deeper in debt.

Another factor that is believed to have contributed to an increase in personal debt is that many Americans have felt wealthier, and therefore have spent more, due to the mostly uninterrupted rise in the stock market throughout the 90s and the last few years .

Within the past five years, a series of interest rate cuts as well as federal tax cuts may have also played a role in stimulating American consumers to spend beyond their means.

Credit
Via our nation’s system of credit, consumers are rated by three private nation-wide credit monitoring agencies who produce credit histories as reported to them by lenders. If there is excessive debt on a consumer’s credit report, then lenders will no longer extend credit to those consumers. When consumption can no longer continue, there is an inevitable slow-down in the overall growth of an economy. If the reduction in consumption is significant the results can be far reaching.

Suppose an average consumer has gone into substantial debt via credit cards, loans, medical bills, etc. All his credit cards are maxed out and his salary is barely enough to buy some food and pay the mortgage. Once his credit limit is reached, he can no longer consume. He will no longer be able to pay his bills and can subsequently lose his home and be forced to sell things off to repay some of his debts.

His non-spending on consumer goods and services in turn affects those businesses he would otherwise be supporting. As a result those businesses see a decrease in sales and are forced to lay-off some employees. Those employees in turn are then faced with insurmountable debts that they themselves have and were counting on their future income to pay back. Those people will now be facing a similar situation as our initial consumer.

Down Cycle
These conditions can prompt a down-cycle in the overall economy and can be devastating for not just a few, but the nation as a whole. When added to an already slowing economy, the effects can be multiplied and magnified. As more and more jobs are lost, more and more consumers cease to consume. Each incident of another consumer who can no longer pay his debts and can no longer continue his consumption affects not just him and his family, but his community and his state, and eventually the nation as a whole.

Through the understanding of the multiplier effect on an economy, we know that for every amount spent there is an equal amount of saving or investment that takes place elsewhere. For instance, a purchase of a home will earn the seller a profit, the listing agent a percentage commission, the selling agent a percentage commission, and a long list of other service providers who will benefit simply from the transaction of the sale.

After the house has been purchased there will more than likely be repairs and/or renovations that will equally create a long list of contractors, landscapers, plumbers, etc. that will benefit a nation’s overall GDP by multiples of the original amount spent.

The same multiplier effect will work in reverse if other conditions in the economy provoke a recession-like cycle. This could conceivably cause a prolonged recession or potentially a depression state in the economy.

Avoiding Disaster
A manageable, controllable, non-excessive amount of debt is generally understood, expected, and good for an economy. Debt that remains within the bounds of disposable income is debt that is more than likely going to be paid back. This has a positive effect in raising overall GDP as it stimulates capital spending which lays the groundwork for future growth.

In order to avoid a negative debt impact on an economy, a nation should avoid excessive debt when inflation is high or when there are unsubstantiated bubbles in the economy (as in our recent housing bubble). Debt should not be used to finance the purchase of stocks in companies as it can drive up their prices, making consumers and corporations feel more wealthy and likely to spend more on non-capital goods and cause an inflationary state .

On a more individual level, consumers need to go back to the basic principles that were in place after the Great Depression and before easy credit. The ideas of living within your means, not buying what you can’t afford, and saving your money for a rainy day, are all necessary in a society to avoid a potentially dangerous financial situations in an economy.