The Pulse of Capitalism

Issue Number 99-4, February 2000

The Personal Sector

As reported in the Pulse, previously-published data indicated that the personal saving rate had fallen to zero by the end of 1998, a development that attracted comment in the popular media. Newsweek (2/22/99) headed an article "Hell No, We Won't Save! Americans seem to have rejected thrift yet are wealthier than ever. Can this be? Can it last?" U.S. News and World Report (3/22/99) headed its article "A Penny Earned is a Penny Spent Nowadays: As spending rises, the savings rate vanishes." Newsweek comments, "We seem to have created a perpetual motion machine, but behind this remarkable performance is a puzzling phenomenon: the virtual disappearance of personal saving."

On October 28, the Bureau of Economic Analysis released revised estimates for 1959-99 from the 11th comprehensive revision of the national income and product accounts. According to the revised estimates, real GDP is growing faster than previously estimated, and the rate of personal saving is higher, though still with a pronounced downtrend.

These revisions remind us again that economic data is imprecise. GDP data involves millions of transactions susceptible to different interpretations and treatment; changes to keep up with a changing economy are inevitable. Even with these changes, long run trends usually do not change. This article reviews the long term trend of personal saving.

As the table shows, the decade of the 1970s marked a turning point in the disposition of disposable personal income. Prior to that decade, both d.p.i. and personal saving rose at a faster rate than personal outlays. After that decade, personal outlays increased faster than both d.p.i. and personal saving. The trend accelerated in the 1990s when personal saving in current dollars actually fell to below the 1980 level. Personal saving as a percentage of d.p.i. was 10.2 percent whereas by the third quarter of 1999 it had fallen to 1.4 percent. Offsetting changes, of course, occurred in personal outlays. [Personal outlays include personal consumption expenditures, interest paid by persons, and personal transfer payments to rest of the world (net).]

Personal outlays equal about two-thirds of gross domestic product, and the consumer is regarded as the most important determinant of economic activity. When outlays rise (and savings fall) as a percentage of d.p.i., the economy receives a temporary stimulus. When the savings rate fell from 4.5 percent of d.p.i. in 1997 to 3.7 percent in 1998, this stimulant equaled .8 percent of d.p.i. or $50 billion. Since the rate has been falling since 1992, equivalent amounts have been experienced each year.

Another development shown in the chart is the marked slowdown in the growth of d.p.i. during the nineties - the lowest of the postwar period. Much of this decline no doubt relates to the fall in overall inflation. But could it also reflect a decline in real income growth? Perhaps the falling savings rate is an attempt to offset falling incomes.

It is especially ironic that the savings rate (and the absolute value of saving) should fall at a time when Americans presumably have higher incomes than ever, and at a time when the government offers extensive subsidies (in the form of tax deductions for IRA contributions, etc.) designed to encourage saving. It would indeed appear that the advertisers and the banks have convinced consumers that "a penny earned is a penny spent". They have created a cultural reversal that leads people to gratify their desires before they earn the money to do so rather than after they earn the money to do so.

Assets and Liabilities

A negative savings rate would imply that total borrowing by the personal sector exceeds the saving that does occur. Debt, then, is another factor that must be considered in assessing the financial position of the personal sector.

As in the preceding table, the greatest percentage gains for assets and liabilities were registered in the 1970s, reflecting general inflation. In the 1980s, liabilities grew faster than assets, but in the 1990s this order was reversed. From 1990 to 1998, household holdings of corporate equities plus mutual fund shares rose from $2,191 billion to $8,798 billion, an increase of 302 percent. By contrast, total household assets rose only 118 percent. This differential is responsible for the large increase in the ratio of assets to liabilities in the 1990s. But even if rising stock prices exceeded the growth of liabilities in the 1990s, from 1950 to the present liabilities still rose more on a percentage basis than assets.

Some economic commentators contend that the decline in saving is a natural consequence of increasing wealth; that with their stock market holdings rising so rapidly Americans do not feel any need to save. U.S. News and World Report puts the argument as follows:

"Even so, many Americans are using rising stock prices as a substitute for thrift, a potentially disturbing trend. During the past six years, household debt has increased faster than income. That's not a huge problem for the 84 million Americans who directly or indirectly own stocks so long as the bull market continues to swell their assets to match their expanding liabilities. But the higher markets go, the riskier they become. It isn't just the enormous amount of debt says Wall Street guru Henry Kaufman, 'but also the enormous risk the consumer is taking by being in the equity market.'"

In assessing the assets argument, it should be remembered that liabilities (chiefly mortgages and consumer credit) represent fixed dollar amounts that must be serviced on a specific schedule. Most financial assets (stocks and bonds), on the other hand, have market-based values that can change from day to day. In a period of financial turmoil, any attempt to meet payments on liabilities by selling assets further contributes to the turmoil. In other words, the debtor may find himself selling into a collapsing market. This is why incurring debt on the basis of rising stock prices is so risky.

There is another consideration. The data shown above represent aggregate data for all households. Equally important is the distribution of assets from rich to poor. This distribution is described by Current Issues (FRB New York 4/99) as follows:

"We find that stock ownership still lags far behind housing as a share of most household's portfolios. Most corporate equity is held by the wealthiest 10 percent of the population, while more than half of all households hold no corporate equity through any channel. In contrast, a large majority of households own real estate, which represents roughly two-thirds of their overall assets.

...

"Drawing on the results of the most recent survey (Survey of Consumer Finances), we find that the typical household in 1995 had 66 percent of its total assets in real estate and no portions of its assets in corporate equity.

"...Although differences in the assets of the three (wealth) groups are quite apparent, housing completely dominates corporate equity in the portfolios of all but the wealthiest households. In fact the chart confirms that the aggregate equity and real estate data shares reported in the Flow of Funds Accounts are more characteristic of a household at the 95th percentile than households at the midpoint of the wealth distribution."

These findings pretty well demolish the wealth argument. If most households own no corporate equities, they would have no incentive either to reduce saving or increase their spending simply because of rising stock prices. The wealthy minority that hold most of the equities are more likely to have acquired even more equities than to have increased their consumption. In addition, the relative decline in saving began in the 1980s and has intensified in the 1990s.

It is now clear that the servicing of debt payments on liabilities is more dependent on disposable personal income than on asset valuations. It is not very practical to meet mortgage payments or credit card payments by selling your home, even though a way has been found to do this in the form of home equity loans. Therefore it is instructive to compare the growth of debt with d.p.i. and savings.

The table shows that household debt has grown faster than income ever since 1950. Savings grew faster than income until 1980; since then it has plummeted. Both increases in debt and lower saving add to the spending stream in the year that they occur. But the longer they go on, the weaker the personal financial position becomes. Can they continue long into the future? The direction of the economy may rest on the answer to this question. Readers are invited to form their own conclusion.

The GDP data for the first three quarters of 1999 show a decline for Germany, while the other four show advances or no change. Industrial production accelerated in Canada and the U.S. but was little changed in Germany, Japan, and the UK. Retail sales were stronger in all countries except Japan where they were still negative.

Consumer prices still rose 3 percent in the U.S. despite all the public reassurance that "inflation remains well contained." Prices fell in Japan but rose in the other three countries. Unemployment rates declined except, again, in Japan, where it is now higher than in the U.S.

Short term interest rates fell to an amazing .07 percent in Japan in June 1999 and were only .23 percent for the nine months; in the other countries they also fell. Stock indices, on the other hand, all rose to new highs.

The U.S. negative current account balance continued to mount, pointing to a new record for 1999. Britain, too, incurred a large imbalance while the Japanese surplus is somewhat lower. The Japanese currency strengthened during 1999, with little change in the other major countries. The German currency is no longer traded due to the introduction of the Euro.

[The August 1999 issue of Survey of Current Business details the definitional and classificational changes made in the 11th comprehensive revision of the national income and product accounts. For example, the revision recognizes business and government expenditures for software as fixed investments, and government employee retirement plans are reclassified so that the savings associated with those plans is shifted from the government to the personal sector. These and other changes result in numerous revisions to previously published data. For a complete description refer to the August-November issues of the Survey.]

Real gross domestic product grew 5.5 percent in the third quarter of 1999 after increasing 1.9 percent in the second quarter. The industrial production index advanced another four points, about the same pace as in 1998; capacity utilization continued to fall. Manufacturers' new orders rose strongly, led by durables. After rising in the early part of 1999, new construction tended to level off; by November the contracts index was 162.

A continuing rise in nonresidential fixed investment led to another record in real private domestic investment; equipment and software led the advance. Business sales have grown faster than inventories in recent years so that the inventory-sales ratio in September was 1.33, the lowest in at least a decade. Retail sales and inventories have grown apace, with little change in the inventory-sales ratio.

Real per capita consumption expenditures rose even faster in 1999 than in 1998, as suggested by the surge in retail sales. Continuing growth in services employment was one of the stimulants to this rise in consumption.

National income rose about $100 billion (a.r.) in the third quarter with $86 bn in the "compensation of employees" category. Per capita income increased 2.4 percent through three quarters compared with 3.1 percent in 1998. Average real weekly earnings rose less than in 1998.

Gross saving continues to grow strongly despite another decline in the personal sector as business and government saving continue to grow. The commodity price index had come back to the 1998 level by November 1999 with all categories in the 83-88 range. This is not saying much since it represents prices more than 10 percent lower than those in 1990. Producer prices have been stable since 1996 but have been in a slow uptrend since April due mainly to consumer non durable items. Corporate profits advanced 34.2 bn (a.r.) in the first three quarters of 1999 versus an advance of $8.2 bn in 1998.

The ten year Treasury interest rate rose steadily through 1999 along with high grade corporate bonds. This rise no doubt is related to the slower growth of the M-3 money supply and a slowdown in purchases of U.S. Government securities by commercial banks. The pace of bank lending for other purposes also slowed in 1999. Consumer credit grew more rapidly than in either 1998 or 1997 even though commercial banks reduced their holdings of this type of debt.

Total credit market debt grew at a 6.9 percent pace in the first three quarters of 1999, about the same as in 1998. Non federal debt grew 9.3 percent while federal debt was -2.4 percent. Almost $200 billion of federal debt has been paid off since early 1998.

The negative trade imbalance on goods and services through three quarters of 1999 far exceeded the record imbalance of 1998. Just four years ago the imbalance was less than $-100 billion; in 1999 it will be well over $-200 billion. The imbalance results from a strong upturn in imports of goods along with an actual decline in exports of services. In any other nation such a development would be viewed as a serious problem, but as long as the dollar remains the world's reserve currency, it is ignored in the U.S.

With such a large outflow of dollars, which come back to the U.S. in the form of foreign investment, it is not surprising that the net investment position also worsened to a new low. As a consequence the "balance on income" in the current account was $-13.9 billion through the third quarter; until 1998 this item had been positive.

The changes in foreign ownership of U.S. securities are also significant. For two years foreign purchases of Treasuries have declined, whereas foreign purchases of other securities have accelerated.

Treasury yields climbed during 1999 even though the Treasury did not need to raise new money because of the budget surplus. The decline in foreign purchases did much to offset this fall in new offerings. At the same time the acceleration in purchases of other U.S. securities reinforced the historic boom in stock prices.