The “New Normal” and U.S. Budget Deficits

As reported in previous posts, The Obama administration has forecast that the U.S. federal government will rack up another $9 trillion in debt over the next 10 years (barring the enactment of tax increases and/or new spending programs). That forecast was based upon an assumption that economic growth will rebound vigorously from the current recession. The growth forecast appears to be reasonable — topping out at a 4.3% inflation-adjusted rate in 2012 — as it is consistent with the experience of recent U.S. economic history. (You can see the assumptions here. Click on the “economic assumptions” tab.)
But what if the assumptions are wrong? What if economic growth is slower than forecast? How much higher will the budget deficit be then?
Here is bad news for anyone who thinks that the economy will rebound as strongly as in the past three recessions: A recent survey by AlixPartners, a global consulting firm, suggests that consumer spending, which has driven past economic recoveries, will be far weaker than in the past. In a survey of 5,000 households, Americans said they plan to start saving 14% of their earnings on average when the recovery takes hold. If they make good on their intentions, observes AlixPartners, $1 trillion a year of consumer spending would be sucked out of the American economy.
Admittedly, there’s a big different between what Americans say they will do and what they actually will do. The chances that the U.S. savings rate will actually reach 14%, in my estimation, are remote. Look at our history: Household savings rates wobbled mostly within the 7.0% to 12% range from the end of World War II through the early 1990s, then plunged to 2.0% or below for most of the 2000s, sinking as low as 0.3% in 2005. A 14% rate would exceed the historical highs for the past 60 years, according to St. Louis Federal Reserve Bank data.
Are the respondants to the AlixPartners poll engaging in wishful thinking? Perhaps. But consider this: Personal savings have increased to 5% of income this year, no mean feat when unemployment is heading toward 10% and underemployment is rampant. Consider also that Baby Boomers have awoken to the need to plan for retirement, which means they must build savings in a big hurry, and Generation Ys, convinced that the U.S. social safety net will be in tatters by the time they retire, aspire to savings rates of 20% of income.
Let’s ponder what would happen if U.S. personal savings simply returned to historical norms of 7% to 11%. Let’s say only $700 billion a year gets sucked out of the economy as Americans start saving more. The Gross Domestic Product is roughly $14.3 trillion. That’s equivalent to about 5% of the GDP. In other words, there will be roughly 5 percentage points less economic activity than would have been the case if savings had remained at the dismal levels of the 2000s.
How many trillion dollars will that add up to over the next 10 years? I can’t say — I’m not smart enough to do the math. But it’s a lot.
For the record, I think a higher savings rate is a good thing — for the individuals who do the savings. Americans need to sock a way a lot more money if they want to enjoy their retirement. The larger pool of savings also also will dampen future increases in interest rates.
Unfortunately, what’s good for Americans as individuals may not be good for Uncle Sam. If AlixPartners is right about the “new normal” in spending and saving patterns, the new-found American frugality will dampen spending, near-term economic activity and government receipts. Deficits will run even higher than forecast, and the looming fiscal apocalypse will be even closer than we can imagine.
Have a nice day!

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17 responses to “The “New Normal” and U.S. Budget Deficits”

  1. Anonymous Avatar

    "Americans said they plan to start saving 14% of their earnings on average when the recovery takes hold. If they make good on their intentions, observes AlixPartners, $1 trillion a year of consumer spending would be sucked out of the American economy. "

    Kind of makes you wonder where they will invest all that savings.

    Iberdrola, the Spanish wind turbine maker? China Solar?

    Maybe its time to invent the mattress money belt.


  2. Anonymous Avatar

    Let's see, if we spen enough to keep the economy running we are doomed because of conspicuous overconsumption, and if we save enoough to protect ourselves,the we are doomed from fnancial collapse anyway.

    Sounds a lot like the classic cost benefit curve to me: too much one way or the other, and Total Costs go up.


  3. what would be an interesting chart would be this.

    From… say 1920 (or whenever they started doing such stuff) on the first line would show the 10 year projection across the graph for each year.

    then the second line would be the actual that came to be.

    would especially like to see it in our prior recessions and around the time that the budget actually got balanced (in theory).

    with respect to savings rather than spending.. I'm not smart enough to figure out what happens to $100 spent at WalMart or $100 deposited in your bank but I'm pretty sure the $100 in the bank doesn't really stay there.. it goes somewhere and does something, right?

  4. Anonymous Avatar

    "$100 in the bank doesn't really stay there.. "

    The bank loans out $90 for each $100 it has on deposit. $10 stys there the other 90% is at risk.


  5. First, great post. Jim Bacon goes quant on us? Good to see. I don't think that the growth estimates are reasonable. I read the assumptions on GDP growth. I also read some history. Only 5 times since 1940 has the US experienced three consecutive years of GDP growth > 4%.

    Yet, that is exactly the assumption in this budget for the three years 2012 – 2014. I will acknowledge that the strongest growth spurts often follow recessions so the growth rate is a possibility. However, I consider the 2012 – 2014 growth rate to be a very optimistic possibility.

    Your thinking on the savings rate is both interesting and somewhat incomplete (in my opinion). It's interesting to see how you draw a line between baby boomer demographics and savings. However, I wonder about two things:

    1. The baby boomers are already old from a career perspective. The US Census Bureau defines the baby boom as those born between 1946 and 1964. If you were born in 1946 you turn 63 this year. If you are not already retired, you are very close. If you were born in 1964 you turn 45 this year. You still probably have a good 15 – 20 years of work left. So, let's say all the Boomers wake up and start saving more. The first year of baby boomers turns 65 in two years. Hard to understand how they continue saving. They will be fully retired and dis-saving (is that a word?). Each year another traunche of baby boomers falls into the dis-savings bucket. I wonder how easy it will be to get back to the historical savings rate.

    2. The Federal Reserve has been artificially holding down interest rates for years now. This is a subtle point. When interest rates are high people forego consumption because the return on investment favors savings (i.e. investment). The invested money is used to build productive capacity. But productive capacity for what? Capacity to build goods and services to be consumed. At some point, this capacity is producing more goods and services than can be consumed and the value of the productive capacity drops. So, in accordance, interest rates drop too. Now, saving is disincented and people increase their consumption. Which works off the excessive inventory and then works off the excessive capacity and then makes capacity valuable again which makes interest rates rise. This rise in interest rates makes investment in productive capacity rise again. It's a balanced system. Interest rates are signals to people as to whether to invest or consume. And interest rates fluctuate with the investment – consumption cycle. Or, at least they would fluctuate with the investment – consumption cycle if a dark and sinister outside force didn't intervene.

    What happens when the Fed artifically holds down interest rates? Two bad things. First, the signal to invest (i.e. save) is never sent so consumption continues unabated. Where are these goods made if the productive capacity is not being added? In other countries which have high enough interest rates to encourage investment and the creation of goods for sale (rather than the consumption of goods). Or, in the United States with money borrowed from other countries which have higher rates and, therefore, higher savings. Second, the cost of consumer credit drops so that borrowing is encouraged. This borrowing fuels even more consumption.

    To be continued ….

  6. In an unaltered system the interest rates would rise as consumption pressures output. This would put the brakes on consumption since savings becomes more valuable. In a system where a greedy and self-centered monopoly artifically keeps interest rates low in order to encourage economic activity the natural cycle is broken. And that's just what the Fed did.

    The economic meltdown was only partially caused by Obama or Bush. It was primarily caused by the Fed. And the Fed just keeps up the quantitative easing. You can't raise interest rates now!! It will deepen the recression. And you can't raise interest rates after the recession, it will kill the recovery!!! You can't raise interest rates between 2012 – 2014, it will stifle tax receipts needed to pay off the deficit.

    We have gotten to the point where the mis-guided and arrogant members of the Federal Reserve can almost never find a time when raising interest rates makes sense. And, of course, these self-proclaimed "masters of the universe" could never just let interest rates float. Oh no… That would imply that the invisible hand of the market is smarter than the masters of the universe.

    Tomorrow's rant – Who owns the Fed? The answer is a very surprising revelation for most people.

  7. Anonymous Avatar

    "The invested money is used to build productive capacity. But productive capacity for what? Capacity to build goods and services to be consumed. "

    I tried to say that, but Groveton did it better.


  8. Anonymous Avatar

    "Interest rates are signals to people as to whether to invest or consume. And interest rates fluctuate with the investment – consumption cycle. "

    and the money supply, right?


  9. James A. Bacon Avatar
    James A. Bacon

    "You can't raise interest rates now!! It will deepen the recession. And you can't raise interest rates after the recession, it will kill the recovery!!!"

    Well said, Groveton. That pithily sums up the reigning philosophy of the Federal Reserve Board. That's what got us into the stagflation mess of the 1970s, it's what created the current crisis, and it's undoubtedly what will create the next crisis.

    (Just substitute the words "taxes" for "interest rates" and you get the Republican argument for not increasing taxes. Oops, I just slit my own throat, didn't I?)

  10. James A. Bacon Avatar
    James A. Bacon

    Groveton, you raise a good point regarding savings and Baby Boomers. If I may paraphrase: If AlixPartners' anticipated savings boom relies upon Baby Boomers bolstering their savings to reach that 14% figure, they must be smoking something. Boomers will start drawing down their savings (dis-saving) as they retire — which some of them are doing already.

    I totally agree with you. Indeed, it is my argument that as Baby Boomers and their peer generations around the world start retiring, they will draw down the global supply of savings.

    The AlixPartners study did a generational breakdown and found that different generations will save at different rates. The older generations say they will save at the rate of 8%, Boomers at 12%, Gen X at 14% and Gen Y at 20%.

    In theory, the older, retired generations should be dis-saving. But they may be scared enough about the future that they're tightening their belts. The same logic applies to Boomers as they retire.

    A related point is that large percentages of Boomers say they will work longer before retiring than they had anticipated. It would not be surprising to see the average retirement age rise by 2 or 3 years.

    (Your intention to retire early is not reflective of most peoples' thinking, or financial situations. Besides, after a couple of years of deep sea fishing and loafing around, you'll get bored and start working again — maybe not what you're doing now, but starting a new business or something. Count on it!)

    Another factor to bear in mind is that the question refers only vaguely to saving "after the recession ends" and should not be taken as an indicator of long-term intent. Americans may decide after they meet their savings goals for two or three years, they can ease the throttle.

  11. re: 90% at risk – only if not insured by the FDIC.

    who owns the Fed?

    are we arguing against the existence of the Fed or we accept it's legitimacy but disagree with how it does business?

    so be clear…

    do we need a Fed function or not?

    re: "spending" one's savings

    and the concept that investment capital "builds productive capacity".

    I always have this problem.

    Why would someone invest their money to build a widget factory if there were already a bunch of widget factories.. in fact so many.. that there was actually excess capacity?

    is there a presumption that there is ALWAYS some product or serve that is in short supply and the reason is that their is not enough investment money to fill the gap?

    Then ya'll confuse this with spending..

    first off.. who says that your savings would be used to invest in business in THIS Country?

    so .. the idea that people convert their savings to spending.. being a bad thing because it reduces investment capital is questionable in my mind…

    and second. worrying about people spending their money on stuff made overseas .. won't be fixed by trying to keep it in savings over here….

  12. Darrell -- Chesapeake Avatar
    Darrell — Chesapeake

    Boomers will save 12%. Somebody is smoking something alright.

    Boomers were at the top in transferring their equity stakes to real estate related investments because of their huge stock losses in 2001. Now they have been hit again, not only in RE but in retirement savings plans. Today's theme is "In God We Trust, not bankers, brokers or politicians." Another sure fire path to tears.

    Boomers are a large part of company downsizing efforts to reduce wage and benefit programs. Hard to save when your new job pays 30+ percent less than the old one.

    Boomers are jumping on the SS bandwagon before the money runs out. Most of the ones I know are planning to take SS at 62 and continuing to work even if it reduces their benefits in the short term. They get a recompute at full benefit age, and the money they earn is stashed away. Is it a rational plan? Who knows, but many reports say it's a wash to waiting or facing possible future benefit reductions.

  13. Anonymous Avatar

    re: 90% at risk – only if not insured by the FDIC.

    No Larry, the money is still at risk. The depositor is insured against that risk. The insurance is paid for with fees from the banks – who get it from their depositors.

    Just because you are insured, doe not mean you don't have a risk. Yu rroof blows off you get paid for a new roof: meanwhile you still have a problem.


  14. Anonymous Avatar

    "Hard to save when your new job pays 30+ percent less than the old one."

    Well, you just save 12% of thirty percent less, right?

    Anyway you slice it,it comes out of consumerism and that hurts the economy, leading to more layoffs.

    The Japanese ahd high savings rates, but what has their economy done for the last decade?


  15. Anonymous Avatar

    Why would someone invest their money to build a widget factory if there were already a bunch of widget factories..

    Build a better widget.

    No one buys watches anymore, because they give the away with cellphones.

  16. FDIC insurance vs no insurance

    without FDIC insurance, Ray… where would folks "Save" their money? in a mattress?

    the average person has two non-FDIC options

    1. – use their own knowledge and experience to figure out what to invest in – a dumb strategy IMHO

    2. – rely on professional investment folks – these are the folks that "helped" people lose 20-50% of their savings

    So.. if you are an ordinary smuck (vice a richer one) you probably don't have more than 250K to put in a safe place.

    But you're totally wrong Ray.

    If your money is in a FDIC bank – you get it back – no matter i that bank goes broke or not.

    as far as the depositor is concerned, there is no impact.

  17. "investing in widget factories"

    the conventional wisdom is that money is always looking for something to invest in…

    and that factories don't get built unless there is money available to get them built.

    well.. you could build all the car factories you want but if there is no one to buy the cars.. it's a bad investment.

    and that's the problem with a down economy…

    building new manufacturing capacity in a down economy where there is much reduce demand for manufactured products won't fix the economy.


    unless someone is thinking that – that is a good way to reduce the numbers of unemployed..

    give them a job, pay them.. even if there is no demand for what they are producing?

    People with real money are not going to do that.

    they're going to find some other way to invest their money…probably overseas somewhere where there is a demand for widgets.

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