By Robert J. Samuelson
Monday, August 30, 2010; A13
The logic of the economic recovery isn't working -- or, at any rate, not well. By that logic, over-borrowed Americans would repay loans and replenish depleted savings, creating a temporary drop in consumer spending and economic activity. But once savings increased and debt declined, consumer buying would strengthen. It would replace the Obama stimulus program. Hiring would improve; the recovery would become self-sustaining.
We're still waiting. Just last week, economic growth for the second quarter was revised down to a meager 1.6 percent annual rate.
Why is the recovery faltering? There are many explanations: a depressed housing market; weaker-than-expected exports; cautious corporations. But consumers, representing 70 percent of the economy's $14.5 trillion of spending, are the crux of the matter.
It isn't that Americans aren't behaving as anticipated. They may actually be outperforming. "Consumers are deleveraging (reducing debt) . . . and rebuilding saving faster than expected," writes economist Richard Berner of Morgan Stanley. In 2007, the personal savings rate (the share of after-tax income devoted to saving) was 2 percent. Now it's about 6 percent. Temporarily, this hurts buying. Declines in consumer spending in 2008 and 2009 were the first back-to-back annual drops since the 1930s. Since World War II, annual consumption spending had fallen only twice (1974 and 1980).
This severe retrenchment might now signal a rebound in consumer spending, says Berner. Suppose -- to take a simple example -- a family has after-tax income of $100,000 and wants to raise its savings rate from 2 percent to 6 percent. Saving would go from $2,000 to $6,000. Spending would drop from $98,000 to $94,000. But after savings reached 6 percent, any additional income would boost spending. A $1,000 increase would result in $60 in saving and $940 in spending.
Debt reduction works the same way: first pain, then gain. (There's a connection. Borrowing reduces a household's saving and repayment increases it.) Household debt has already dropped $800 billion from its peak of $11.7 trillion, estimates economist Mark Zandi of Moody's Analytics. The Federal Reserve reports that debt service -- the share of income going to interest and principal payment -- has decreased from almost 14 percent in early 2008 to about 12.5 percent, the lowest since 2000.
If Berner's right, the worst is over. He expects consumption to grow 2 to 2.5 percent annually, propelling a steady -- if unspectacular -- recovery. Indeed, consumption spending grew at a 2 percent annual rate in the second quarter. Berner forecasts unemployment to decline slowly to about 9 percent by year-end 2011.
The trouble with this analysis, as Berner admits, is that it presumes that most of the adjustment has already occurred. But what if worried Americans are only midway? In the past decade, they counted rising stock and home wealth as "saving," which rationalized high borrowing and spending. Now, the process may work in reverse. Since late 2007, lower home and stock values have shaved about $10 trillion from household wealth. If Americans tried to replace most of this through more annual saving, consumer spending would remain weak for years.
History suggests this is conceivable. In the early 1980s, the savings rate averaged 10 percent. People saved against the unknown, and anxieties were widespread. In the University of Michigan's survey of consumer confidence, only a fifth of respondents expect unemployment to drop over the next year. A mere one quarter of households think their incomes will be higher in a year; in late 2006, the comparable figure was almost two-thirds. Consumers aren't "itching to resume old spending habits," notes economist Richard Curtin, the survey director. Adopting a "defensive outlook," they're prone to "pare their debt" or increase "reserve" savings.
The well-to-do aren't spared. The richest fifth of Americans -- whose household incomes started at $100,000 in 2008 -- account for about 60 percent of consumer spending. "A lot of people who are in the lower-income affluent -- from $100,000 to $250,000 -- have dropped out of the luxury market," says Pam Danziger, whose firm Unity Marketing regularly surveys the top fifth. "They're back to the middle class." In her 2010 survey, 33 percent of respondents said they're eating out less often and 25 percent have expanded or started using retail store coupons.
The present pessimism could be a passing fad. Doubts about recoveries are standard in the early years, notes Susan Sterne of Economic Analysis Associates. Still, there are calls for government to do more. But with interest rates already low and budget deficits high, additional actions might boomerang, especially if they seem desperate and aggravate anxiety.
The recovery is a creature of confidence, or its absence. "In normal times, psychology doesn't matter much. It reflects economic conditions," says Zandi. "But in abnormal times, it's the reverse. Psychology determines economic conditions." What the boom and bust left is a massive case of collective doubt.