Sunk by Saving?

Story Highlights:

• Consumer spending makes up about 70% of gross domestic product so many believe if consumers don't spend, we're sunk—some even think more saving makes things worse.
• Such arguments forget government statistics are often flawed and the fact we can save at all is a good thing.
• Further a dollar saved isn't a dollar lost—it's a dollar reallocated. The global view shows either more consumption or saving can result in economic growth.

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It's no mystery our economy has weakened considerably in the last year, and the holiday season focused attention squarely on consumers. Would folks miraculously turn out in droves, or would shopping malls be all dressed up with nowhere to go? The answer was, predictably, somewhere in between but very much on the weaker side—and that has lots of folks worried. It's well known: Consumer spending makes up about 70% of gross domestic product. And to make matters worse, one recent argument claims, , as evidenced by a rising official savings rate, is eating away at consumption and will exacerbate the recession.

But we urge caution taking such arguments at face value. For starters, the fact people can save at all refutes the claim we're entering the irrevocable stagnation some expect. Also, as discussed here before, our official saving rate is. Those caveats aside, consumer spending and the economy are demonstrably weak. Can less consumer spending and more saving aggravate an already bad situation, as is suggested? We don't think so.

Consumers and producers aren't radically different species—they're the same animal. Consumers can only spend precisely what they produce, plus whatever credit is extended to them. So it's not possible for consumers to singlehandedly "save" the economy by just buying more. In fact, it makes little difference whether they buy anything at all, just that they keep producing!

Some believe in order to crawl out of this recession, folks have to spend, spend, spend. (Oddly, these are the same people who complained a year ago our official savings rate was too low and that was bad. Now they want to complain that saving is bad.)

But that's not right. As long as folks don't physically stash cash under the mattress, it will benefit the economy in the long run. Why? Because a dollar not spent isn't a dollar lost to the economy—it's a dollar reallocated. In modern capital markets, US savers put their money into a bank or investment account—maybe their IRA or a 401(k). From there, one dollar's savings is injected into our economy through the magic of our capital markets system. That dollar doesn't sit idle—not even in a money market fund—it fuels investment. It becomes future innovations that would otherwise lie fallow. It's those innovations that drive long-term growth and economic health.

Just because some choose to "save" as oppose to spend doesn't mean an economic recovery is doomed or will even be forestalled. Think globally. China has had huge official savings and economic growth while the US has had negative official savings and economic growth. This just means the US traded off savings and production for consumption, while China did the opposite.

As poor economic news continues to arrive, many may decide to shift gears from consumption to saving, but that won't necessarily forestall a recovery. Investment of all kinds will do as much, if not more, to help aid recovery when it begins.