Are People with Big Savings Accounts Hurting the Economy?

In the last two decades Japan’s economy has faced a lot of turmoil after having decades of consistent growth. Although there have been many contributing factors to Japan’s slowing economy, one of the factors had to do with the savings rate of the typical consumer. Japanese consumers simply saved a lot more of their money than their counterparts in other part of the world. Since the money that they have is a zero-sum game, there’s also a lot less consumer spending going on, meaning that businesses make less money and end up hiring fewer employees.

It’s a classic cause for a recession. Consumers are afraid that the economy is facing a down turn, so they spend less money on consumer products; companies in turn make less money and have to lay off employees, leading to even lower consumer spending, repeating the cycle all over again. Some financial types have argued that the fact that many consumers are taking a hard look at their budget and spending less money on luxury good, holding on to vehicles longer, taking fewer vacations and avoiding larger purchases is one of the major contributing factors to the current recession the United States is facing.

Does this mean that we should go out and spend as money as possible with whatever we have? That’s what we’ve been doing as a nation for the last 20 years and it didn’t work out so well. Consumers got very used to buying things with borrowed money. People forgot how to use the word “no” and instead searched for creative means to finance the things that they could not afford. Consumer debt levels, especially on credit cards, went through the roof.

Ultimately the idea that we should spend all we can to bolster up the economy is unsustainable. When an economy is based on consumers buying everything they can, and more often than not on credit, eventually the bottom will fall out. Consumers will become too heavily leveraged and unable to make all of the payments they signed up for on a monthly basis. That’s essentially what happened last year.

Some consumers signed up for exotic mortgages with initial low interest rates because it made the payment smaller at first. They often did this because they could not afford to swing the payment on a traditional 15 or 30 year fixed loan. When their teaser-rate wore off and their interest rate adjusted upward, their monthly mortgage payments skyrocketed making it so they could not pay their bills. This means the banks had to foreclose on them, the banks lost money, and consumers saw real estate prices starting to fall for the first time in 7-8 years, so the market froze up and we are where we are today.

Consumers are going through a process of “de-leveraging,” or reducing the amount of debt that they carry. Although decreased spending might cause the economy to suffer short term, over the long term having consumers pay for goods and services with assets that they actually own is better, because it’s sustainable. When people pay for goods and services with borrowed wealth, eventually they will become over leveraged. When people pay for goods and services with cash, that just doesn’t happen.