In the US, the most interesting economic statistic right now is not the bullish stockmarket, the bottoming of the housing market, or the gradual emergence of the ‘green shoots’ of recovery. It is the savings ratio. American consumers, who for more than a decade were the shop-till-you-drop, maxed-out, credit-hungry motors of the global economy, have suddenly decided to start doing something their baby-boomer parents had probably forgotten all about, but which their grandparents might just dimly remember. Saving money.
Along with other over-indebted consumers around the world, they are putting aside a rising chunk of their monthly pay packet for a rainy day. That may turn into the most significant financial trend of the next five to ten years – one that has the potential to re-shape the global economy. In the medium-term, it will no doubt be a good thing, but in the short-term it will cause a huge amount of disruption. There’s no disputing the raw data.
In April the US savings ratio hit 5.7% of GDP, its highest monthly rate for 14 years. Earlier this decade, when the housing boom was at its peak, the ratio fell all the way to minus 2.7% (meaning the average American spent nearly 3% more than they earned, which even Gordon Brown might struggle to describe as prudent). Many analysts now expect it to get back towards its long-term average. For most of the 1970s and 1980s, Americans saved roughly 10% of their income. In 1975, at the peak of the last financial crisis, it hit 14.6%.
Much the same can be expected in other over-indebted countries. The British are tucking their credit cards back into their wallets too. The latest quarterly figures show the UK’s savings ratio at 4.7%, compared with only 1.7% in the final quarter of 2008. Like the US, the British savings ratio turned negative last year, for the first time since Harold McMillan was prime minister in 1958.
There is no great mystery about why this is happening. A zero savings ratio was never going to be sustainable in the long run. But soaring house prices temporarily lulled many people into an unrealistic sense of financial security. When the average house was going up in value by £10,000 or £20,000 a year, struggling to save £2,000 out of an average salary of around £20,000 looked pointless. Now, with house prices stagnant, there is little option. Consumers know their personal balance sheets are a mess. The only way to get them back into shape is to save more. And with rising unemployment, the alternative of remaining over-indebted doesn’t look very attractive.
Once they start saving, however, the sums involved are vast. The GDP of the US is close to $14trn. If it gets back to a long-term average of saving 10% of that a year, that would amount to $1.4trn – roughly the GDP of Spain. Shifting that vast sum of money from consumption to investment will have three big consequences for the global economy.
First, domestic demand will be subdued for years. It doesn’t matter how many billions Obama or Brown throw at their economies. Or how many dollars or pounds the Federal Reserve or the Bank of England command their printers to roll off the presses. When roughly a tenth of the economy is being switched out of day-to-day consumption then growth will be sluggish. As the global economy starts to recover, it’ll have to find some other engine apart from Anglo-Saxon consumers. And investors should steer well clear of firms that depend on consumer spending – such as retailers or leisure – anywhere in Britain or the US.
Next, expect a wall of money to hit the stockmarket. All those savings have to go somewhere. With interest rates close to zero and likely to stay there for the foreseeable future, there isn’t much point in putting it in the bank. Much will find its way into the stockmarket, creating a wave of money that is going to sustain the rally in stock prices we have already seen over the last three months. It will also rescue the financial services industry in both the US and Britain. Steeply rising levels of deposits and the fees to be earned from steering that money into the stockmarket will make banking profitable once again. Over time, it will even bail out the banks from the crazy loans they made at the height of the bubble.
Lastly, it is going to lift the pound and the dollar – eventually. As the Anglo-Saxon economies start to re-balance away from consumption and towards investment, their huge trade deficits will narrow. They may not hit a surplus, but they will get closer to balancing than they have for twenty years. Over time, that is going to strengthen their currencies.
Ordinary consumers in the US and Britain have figured out something their political leaders are still too nervous to tell them. They have to lower their living standards and rebuild capital for the future. That is long overdue. Individuals can’t spend more than they earn for more than a very short period of time without running into big problems, and neither can countries. Over time, the new ‘savings economies’ of Britain and the US will emerge in much better shape. But it is going to be a rough ride,and will shift the global economy dramatically.