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Lack of Personal Savings: The Weakest Link

In my opinion, the single most important reason for the melt down of the economic system over the last 18 months has been the lack of personal savings held by American families. As demonstrated by the graph below, compiled by the Bureau of Economic Analysis of the US Department of Commerce, Americans have "thrown in the towel" on savings over the last 10 - 12 years. What may have been one of the most telling signs of the then pending financial market collapse was the negative savings rate we scored in 2005! For the first time since data has been gathered, as a country we actually took our savings to a negative level in 2005 to support our insatiable spending habits.

Since 1993 we have dropped below our 50 year average savings rate every year until the last month of 2009. At that point, presumably we reacted to the disaster in the financial markets by establishing more prudent savings habits which have taken us back toward the 50 year averages. However, several months do not constitute a trend, and I will watch these savings rates very closely in the months ahead to help determine if we have actually turned the corner on this recession. Looking at the situation logically, with unemployment at historic highs one would expect savings to decline. However, my point is that savings declined well before the unemployment rate began to rise, and actually savings have increased since the unemployment rates have peaked!

This behavior in our savings rate tells me that we have much more capacity for saving as a nation than we have exhibited. If we can increase overall savings in the depths of a recession with record unemployment levels, it stands to reason that we should have been able to do much better while most of us had jobs and the economy was sailing along at a record pace.

The chart below (chart 2) shows personal savings data on 5 of the 7 largest economies; I don’t believe it is a coincidence that 3 of the 5 strongest economies in the world had rapidly declining savings rates leading up to financial collapse which was triggered in 2007.

By contrast, if we look at three of the emerging economies in the Asia Pacific Region, China, India, and Korea, (charts 3 & 4) we see that of the three countries, only Korea has suffered similar declines in personal savings. Correspondingly, and in my opinion not coincidentally, of all three countries, Korea has suffered the greatest impact of the recession.

In the macro economic (big picture) sense, the ability to save leads to the ability to weather occasional adversity, which in turn softens the blow of recession to the entire economic system. Just consider the brutal collapse in real estate values and the resultant explosion in foreclosures. In general terms, a much higher personal savings rate would have extended the ability of families to continue to service mortgage debt, and consequently stifled many of the foreclosures. The bursting of the real estate bubble was tied to the subsequent demise of the credit markets and the disastrous effect on the retail goods markets, both of which are inextricably tied to the housing market.

In conclusion, America needs to mend its habits regarding personal savings in order to effectively deal with the current and future prospects of economic downturns. I have written in this space before that the most effective means of building a personal savings account is to systematically contribute to that effort at every pay period. Whether it is $10, $50, or $500 it won’t make a real difference unless it is done consistently; like clockwork. At first it is not easy because we are going to have to forego some of the things we have come to enjoy. However, when the roof springs a leak or the college tuition invoice is in the mail, it is very gratifying to be able to transfer funds from savings to checking as opposed to seeking a loan, or worse, having to tack on additional expenses to our already overburdened credit cards.

©Patrick J. Catania 2010 The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances. We welcome your feedback and ideas regarding this service. To submit a comment or idea for a future article, please email us at member.feedback@bcu.org