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The Paradox of Thrift: How a Better Savings Rate is Fueling the Recession
by David Fessler, Advisory Panelist
Saturday, September 12, 2009: Issue #1091
We’ve all heard this from our parents: “Spend what’s left after saving, instead of saving what’s left after spending.”
Or perhaps this was drummed into your head: “Always save for a rainy day.”
The idea of saving didn’t just start with our parents’ generation, however. Ben Franklin was giving advice on saving way back in 1732 in Poor Richard’s Almanac: “If you would be wealthy, think of saving as well as getting. Creditors have better memories than debtors.”
As the recession of 2008 hit, Americans suddenly stopped spending, paid down their debts and started saving – some for the first time in their lives…
As a result, America’s savings rate – as a percent of disposable income – has leapt from a little over 1% to over 5% in just the last 18 months, according to the Bureau of Economic Analysis (BEA).
At first glance, things would seem to be improving. But there’s a sinister force at work here. It’s called the “paradox of thrift” – and it’s sending America to the poorhouse.
The Paradox of Thrift
So what is the “paradox of thrift” exactly?
It’s a concept that was popularized by John Maynard Keynes, a famous British economist whose ideas have had a major influence on modern economics.
It goes something like this: When consumers stop spending and start saving, the overall demand for products and services drops and unemployment rises. In turn, this causes the overall nationwide savings rate to drop because of the decrease in consumption and the slower economic growth that ensues.
One can therefore draw the conclusion that an increase in savings is harmful to the overall economy. Think of it this way: If a person stops spending, he or she is affecting someone else’s income, and their ability to spend, and so on.
You could also conclude that this situation could feed on itself and things could get even worse: More savings… even less consumption… more unemployment, etc. And if nothing drastic is done, it will.
So what are the options?
America is Looking for a Global “Assist”
For a start, how about other countries picking up where we left off?
With different countries in different stages of development, it stands to reason that some are in the consumption stage and could pick up the slack where the United States left off back in 2007.
There’s just one problem: The U.S. economy is a $14 trillion-per-year juggernaut, and all the developing countries in the world put together don’t come anywhere close.
Bottom-line: The ability of developing nations to step up their spending wouldn’t adequately balance out the increased savings going on here in the United States.
So if international consumers can’t (or won’t) spend money fast enough to reverse the trend, then who will?
If you guessed Uncle Sam… bingo! Thing is, governments in other countries are in the same boat we are…
The Paradox of Thrift Demands Spending Money
The “paradox of thrift” demands that money be spent in order to reverse the current downward trend brought on by the drop-off in consumer spending and the drastic increase in individual savings.
Will it work? According to CNBC economist Steve Leesman, any time the government introduces money into the system and increases the deficit, resident and non-resident spending increases to keep pace.
This will increase the demand for products and services, so manufacturers will have to hire people in order to meet the increased demand, and that will beget even more spending, more hiring, etc.
However, this approach is highly controversial and political. And in some people’s minds, it’s just laying the groundwork for the next financial meltdown.
Stop the Ride, Please… I Feel Sick
So are we destined to keep repeating this spending cycle in order to grow as a nation?
The answer is “no.” But here’s the real problem: Foreign investors are financing the U.S. government’s massive economic stimulus spending plan.
And while foreigners are content to continue buying U.S. dollars for now, they’re tiring of Uncle Sam and his lavish spending habits – and they’re beginning to look elsewhere for places to park their cash.
The bottom line is this: The current process of deficit spending is unsustainable. The U.S. government – like the rest of us – has to begin to pay down its debt.
Sure, it’s a painful process for governments, just as it is for individuals. But in the long run, the paradox of thrift won’t be a paradox at all. Higher savings will indeed lead to greater investment and prosperity.
As another old saying goes, “Frugality is its own reward.”
Good investing,
David Fessler
P.S. Speaking of saving money, check out the Investment U Course, devised by my colleague, Dr. Scott Brown. In it, he’ll show you how to build a seven-figure fortune – from scratch. And don’t worry… it’s not some elaborate, complex program where you need an MA in Mathematics and fancy software to figure it out. In fact, you don’t even need a calculator. Scott shows exactly how to start from humble beginnings and work your way up in an amazingly simple way through powerful, step-by-step instructions. Check it out here.
- Debunking The Paradox of Thrift: Why Consumer Spending Won’t Save Our Economy
- Compounding Your Interest: How To Increase Your Saving’s Return
- Economic Data: What Can You Believe?
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3 Responses to “The Paradox of Thrift: How a Better Savings Rate is Fueling the Recession”
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David Fessler is an Advisory Panelist for Investment U and The Oxford Club, one of the world’s most exclusive and prestigious networks of private investors.
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September 12th, 2009 at 12:56 am
Hi David Kessler,
You made a good point with Keynesian Economics which I also studied. What you are overlooking and neglecting is the cause of this savings. Our dear Republican Government and the Gas Prices. In the 70’s we could compare our economy to a punch bowl full of marbles, the more you restrict it the more that falls out and is unusable. We now have a layered economy, each dependent on the other. When the fuel companies (oil) decided it was time to rape our economy every one started with holding money for another fuel price hike. Now bring that up and put it on the table for everyone to see. The hard to digest truth. The upper level or higher income levels are the least effected and the last to see what is really going on. The oil companies scared everyone in to a, quit spending mode, or faux savings posture. Let’s call an ace an ace. Uncontrolled pricing on barrels of OIL! So why did America change parties? It couldn’t be that the existing controlling parties let the public know in “NO UNCERTAIN TERMS” that it really did not care for the people, their rights, their humanity, the very fiber of their economy. Neglecting the very things they were entrusted with, the financial welfare of Americans. The very “ACHILLES HEEL OF AMERICA” (OIL),the whispered rumors of the party stuffing itself with cash via oil. It reminds me of third world politics, only worse.VLT
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September 13th, 2009 at 3:51 pm
David,
I don’t think the spending problem will be fixed until the income inequality problem is fixed. When the vast majority of employees are getting 2-4% annual raises, as their cost of living goes up 8-12% yearly, the pool of discretionary income just gets smaller. Overpaid execs need to start sharing the wealth with the labor force in order to get spending money out there on main street.
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September 14th, 2009 at 11:12 am
On the other hand, saving produces capital which can be used to expand the economy…
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