By Stephen S. Roach Saturday, October 1, 2011
Filed under: Economic Policy
One of the clearest lessons of Japan’s lost decade of the 1990s is that balance sheet recessions do not end until damaged balance sheets are repaired. Unfortunately, that lesson seems all but lost on the United States today as policy makers and politicians throw all but the right medicine at America’s lingering balance sheet recession.
Unlike Japan, where zombie-like companies and banks struggled for years in the wake of a wrenching post-bubble carnage, in the United States it is consumers who remain in the grips of an unprecedented squeeze. A record pre-crisis consumption binge was built on the quicksand of two bubbles—property and credit—both of which have now burst. Overly indebted, savings-short American consumers were left to pick up the pieces.
The good news is that there has been some progress on the road to balance sheet repair. The bad news is that it hasn’t been nearly enough. Total household sector debt has come down from a peak of 130 percent of after-tax, or disposable, personal income in 2007 to around 115 percent as of mid-2011. Yet that reading still remains well above the nearly 75 percent average that prevailed in the final 30 years of the 20th century. Similarly, the personal saving rate has risen from the rock-bottom low of 1 percent hit in 2005 to 5 percent at present—again, an improvement, but well below the nearly 8 percent norm of 1970 to 2000.
With balance sheet repair incomplete, American consumers have all but abdicated their traditional role in spurring economic recovery. Consumer expenditures have expanded at only a 0.2 percent average annual rate since the first quarter of 2008. Never before in the post-World War II era has American consumer spending been this weak for this long. An unprecedented 2.2 percent annualized contraction from the first quarter of 2008 to the second quarter of 2009 has been barely offset by a decidedly subpar rebound of only 2.1 percent over the subsequent eight quarters.
Desperate for consumers to return to their old risky habits and start spending again, Washington has upped the ante on monetary and fiscal stimulus—two rounds of quantitative easing by the Fed, with another “twist” to this strategy now in the works, and unprecedented deficit spending. Not surprisingly, these policies have failed to jump-start U.S. consumption. The classic tools of fiscal and monetary stimulus are blunt instruments that do not ease the specifics of lingering balance-sheet distress that ails American consumers. A less circuitous approach is needed.
One such option would be policies that address the economic insecurity that persists due to inadequate household saving. Yet, encumbered by historical baggage, Washington has been unwilling or unable to address this direct approach to balance sheet repair. In large part, that’s because it remains spooked by the 1930s Keynesian imagery of the “paradox of thrift,” when fear-driven saving was thought to have hobbled aggregate demand and deepened the Great Depression. Ironically, American families have been urged by many economists, policy makers, and politicians to ignore the virtues of prudent financial management. Yet, consumers know full well that they reduced their savings because they mistakenly believed that open-ended appreciation in the value of their homes was an easier way to set aside money for the future. The bursting of the housing bubble has re-ordered financial priorities for many Americans. By pushing the personal saving rate back up from 1 percent to 5 percent, U.S. consumers have chosen to dismiss the bad advice they have been getting—preferring instead to push ahead with efforts at balance sheet repair by rebuilding severely depleted saving balances.
But with personal saving remaining below historic norms, this journey has only just begun. That leaves recovery in the U.S. economy still facing stiff headwinds. Creative saving policies must be given much greater emphasis if the American consumer—and the U.S. economy—is to escape the clutches of a lingering balance sheet recession. Sure, there is a timing problem—families should not be urged into an immediate diversion of income into saving that might exacerbate an already weakened recovery. Lagged implementation of savings incentives is a more prudent course of action in today’s shaky economic climate. Timing issues aside, American consumers must turn their attentions to the longer-term benefits of increased saving. Five specific proposals come to mind:
• First, an expansion of existing IRA and 401(k) programs. There is no need to re-invent the wheel. These are well-established defined-contribution saving vehicles that collectively held $7.8 trillion in assets at the end of 2010, or approximately 45 percent of total retirement assets in the United States, according to the Investment Company Institute. Currently, for those under the age of 50, annual contribution limits for IRA plans (totaling $4.7 trillion) are set at $5,000 per person whereas limits for 401(k) plans ($3.1 trillion) are $16,500. In both cases, increasing contribution limits is the least the government can do in a world where saving returns are severely distorted by unconventional monetary easing.
• Second, targeted saving incentives for low-and middle-income workers. Currently, around 50 percent of all American workers (approximately 78 million people) have no retirement plan whatsoever. Making the existing Saver’s Credit, enacted in 2001, refundable for some 45 million low- and middle-income tax filers who do not have any federal tax liability would be an important step in repairing this hole in America’s social safety net.
• Third, automating the saving process. Administrative complexities often frustrate individuals and impede saving flows. This can be addressed by offering direct deposit options for splitting paychecks into checking and saving accounts such as IRAs. This is consistent with a proposal recently offered by the Obama administration. Further automation could be implemented by allowing a portion of tax refunds to be directly deposited into IRA or 401(k) plans. With more than 109 million Americans (or 77 percent of all taxpayers) receiving tax refunds totaling over $325 billion in 2010, this automation option has especially strong potential.
• Fourth, tax reform—specifically, moving away from an income-based personal tax structure toward a consumption-based tax, such as a value-added tax (VAT) or a national sales tax. This would change the relative price of saving versus consumption—providing families with much greater incentives to forgo current consumption in favor of saving and future consumption. Exemptions for low-income individuals would have to be built into any such proposal.
• Fifth, a normalization of monetary policy. Like the case in Japan, the Fed’s zero-interest-rate policy penalizes savers and represses personal income. Moreover, easy money tempts individuals to stretch for return by moving back into riskier assets such as equity and residential property. Yet this is precisely the same madness that distorted household balances sheets in the years before the Great Recession. The sooner the U.S. central bank restores some semblance of normalcy to monetary policy, the greater the chance that saving incentives will be grounded in expectations of more normalized returns on more secure financial assets.
Saving is not a “four-letter word”—even for a U.S. economy in the throes of a very serious post-crisis shakeout. Saving is the sustenance of investment and future growth—something that has been sorely missing in the U.S. economy over the past 15 years. Saving imperatives loom all the more critical for the 77 million baby boomers now beginning to retire. Moreover, rebuilding domestic saving is equally vital to wean America from continued reliance on foreign saving—and the massive current-account and trade deficits such external dependence spawns.
The traditional tools of fiscal and monetary stimulus are not the medicine for the balance-sheet strains that continue to afflict U.S. consumers. A more direct approach is needed. Increased saving is one of the most important palliatives for the balance sheet adjustments that will make post-crisis America whole again. The United States is in desperate need of a long-term growth strategy. That can’t happen without a new saving agenda.
Stephen S. Roach, a member of the faculty at Yale University, is non-executive chairman of Morgan Stanley Asia and the author of The Next Asia.
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