A Nation of Savers?

11/13/2008 11:00 am EST

Focus: MARKETS

Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, says the painful deleveraging process will force formerly free spenders to tighten their belts.

For decades, the household and financial sectors of the US economy incurred massive leveraging. Household debt, including mortgages, skyrocketed from 47% of personal income in 1959 to 117% in the fourth quarter of 2007—and from 25% of gross domestic product (GDP) in the first quarter of 1952 to 98%.

Now, deleveraging is the order of the day. House prices are down 18% from their peak in the second quarter of 2006, but have 23% further to fall to reach our peak-to-trough decline of 37%  as 1.8 million excess houses, the result of overbuilding in the 1995-2005 boom, depress prices.

As consumers retrench, the GDP weakness just reported for the third quarter will probably be followed by declines running at least through the end of 2009 that will cumulate to a 5% decline, clearly the most severe since the 1930s.

Consumer retrenchment means slashing discretionary spending on autos and motorcycles. But consumers are also axing small items like meals out, booze, bottled water, and $5 cups of coffee. Consumers are also beginning to regard monthly payments on credit card, auto, home equity, and student loans as discretionary.

Consumers slashed their saving rate from 12% in the early 1980s to zero recently. In the 1980s and 1990s, the long bull market in equities encouraged stockholders to save less and borrow more. They figured that equities would continue to rise.

Then, when stocks collapsed in 2000-2002, [they] never recovered to their dot.com peak and are once again collapsing. And if house prices fall to our target, 25 million homeowners will be under water, with their mortgage principals higher than their homes’ values. That’s almost half the 51 million homeowners with mortgages and a third of the total 75 million homeowners.

Individuals’ $3 trillion in 401(k) accounts are taking a beating as stocks fall. Even before the unemployment rate leaps toward the 8%-plus top we expect, 20% of those 45 or older have stopped contributing to their 401(k)s. Few have enough to fund comfortable retirements. Indeed, “hardship withdrawals” from 401(k)s are leaping even though they incur 10% tax penalties as employees increasingly worry about just meeting day-to-day expenses.

Households age 50-plus had only $89,300 on average in retirement accounts on September 30th, not enough to replace even one year of $95,000 in annual income for the typical 50- to 59-year-old household. Furthermore, only 49% of eligible workers in their 20s contributed to 401(k)s, and less then 20% save at all for retirement.

So, without any significant remaining assets to fund oversized spending, US consumers will be forced into a saving spree. Our forecast of a one-percentage-point rise in the saving rate per year for the next decade would bring it to about 10%, still short of the early 1980s level.

The pattern of the last quarter-century is for American consumers to spend as long as they can finance it by saving less and borrowing more. If we’re right, that attitude will change, not because people suddenly decide to become financially responsible but because they have no alternative.

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