Politics & Policy

The Savings-Rate Scare

Like the "twin deficits," you shouldn't lose sleep over it.

By Victor A. Canto and Andy Wiese

’U.S. Savings Rate Near a Low Point” was the headline of a recent Wall Street Journal article. In fact, according to the story,

It was the lowest rate recorded since the U.S. government’s monthly savings data began in 1959, with the exception of October 2001, when statistical quirks related to the prior month’s terrorist attacks produced a small negative savings rate.

If the low savings rate is a warning sign of a problem, it’s not a new one. The personal savings rate has been in a secular decline since the early 1980s.

The declining savings rate is commonly blamed for many real and imagined ills of the economy. For example, the low personal savings rate and the budget deficit are used by policy makers to explain the deterioration in the trade deficit. That was the gist of Alan Greenspan’s recent talk in Europe. He argued that the budget deficit reflects a low savings rate, which in turn produces a trade deficit, which in the long run could be unsustainable and thus produce some major financial crises.

This “twin deficit” hypothesis is at worst an incomplete economic analysis and at best a near tautology. Anybody who has taken a macroeconomics class remembers that national income accounting tells us that in an economy closed to international trade, savings will always equal investment. Similarly, once the economy is open to international trade the relationship is modified to where a country’s net savings (the excess of investment over domestic savings) equals the net sales of goods and services (the trade balance). This is what brings us either to a tautology or an incomplete analysis.

Since net savings is the mirror image of the trade account, the only way the budget deficit will match the trade deficit is if private savings and investment net to zero. In this light, asserting that a budget deficit leads to a trade deficit (i.e., the twin-deficit theory) is a faulty economic analysis.

People who worry about the low savings rate and the magnitude of the trade balance implicitly assume that a zero trade balance is the only true equilibrium. That’s why they say it will take some time for the dollar or interest rates to change the trade deficit and/or low savings. However, these people ignore the fact that a zero trade balance is only an equilibrium condition for economies with no international trade.

Absent intergalactic trade, the only closed economic system we know of is Earth. Global equilibrium requires that all countries collectively have a zero trade balance. Equilibrium, however, does not require that each country satisfy the zero trade balance, only that the net be zero. A country can have a deficit as long as it is covered by the rest of the world.

If history is any guide, the U.S. had persistent trade deficits during the 18th and 19th centuries and we emerged as the preeminent economic and military power of the 20th century. Since 1982 the U.S. trade balance has been in deficit for most of the period, save for a couple of quarters during 1991. In the last 25 years we have, on balance and by most accounts, been quite prosperous.

During the last 25 years we have also seen two major cycles of dollar appreciation and depreciation, as well as large cyclical fluctuation in U.S. interest rates. And yet private savings and the trade balance trended down irrespective of the behavior of the dollar and interest-rate behavior.

So, the U.S. savings rate is near a low point. What’s causing this? Isn’t net-worth rising? Yes it is. Doesn’t that mean savings should also be rising? Not at all. Ask yourself this question: If someone wins the Super Lotto, how much is he going to save out of his next paycheck? The answer is not very much.

This leads to an important question: What constitutes true net savings? Is it the actual savings (an income statement) or the change in net worth (a balance-sheet item)? When one thinks about it, both will result in a higher net worth. If you take the sum of private savings and the change in net worth as a percent of GDP as the approximation of the true savings rate, by my account, that rate is on the order of 10 to 15 percent today — within the historical range. That’s quite a different story than the one the deficit mongers are telling.

The savings rate and the trade balance are flows, and as such, they are part of the economy’s income statement. On the other hand, net worth is part of the economy’s balance sheet. It is a mistake to judge a company solely on their income statement without paying attention to their balance sheet. The same logic applies to countries.

We have the strongest balance sheet in the world today. With President Bush pushing his second-term initiatives for tax reform and the “ownership society,” we should continue improving our balance sheet both in absolute and relative terms.

– Victor Canto, Ph.D., is the founder of La Jolla Economics, an economics research and consulting firm in La Jolla, California.


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