Economics question

[lukeh]

My understanding is that many places are in economic trouble because people don't save and spend more than they make. In the USA I believe that for quite some time we actually had a negative savings rate. We all have heard how the average person has large credit card balances, little saved for retirement and our very own government is trillions in debt.

So what would happen to the economy if people started being more responsible. What if most started saving 10% of their salary, paid of their credit cards and quit buying the latest and greatest. And let's say the government cut way back on spending and had a balanced budget. If we turned into savers instead of spenders would unemployment rocket to incredible levels and the county be at risk of collapse?

I guess what I'm asking is are we screwed either way? My brain tells me we would be better off if we all put the max we can afford into our 401k and didn't carry a balance on our credit cards. How about if we saved and paid cash for purchases which maybe means putting 150k on all our cars and keeping our TV sets a while longer. Would these principals destroy us as we wouldn't require near the production we currently require? What would happen to all the people doing the jobs that produced all this stuff that we no longer need so much of?

[oldE]

What would happen to all the people doing the jobs that produced all this stuff that we no longer need so much of?

I guess all those poor Asian factory workers would be SOL.

Les

[MRM]

In the short term you get the largest, longest and deepest recession since the Great Depression - decreased spending equals decreased demand equals less stuff being made which results in overall contraction of the economy. In large part, that's what has been going on for the last few years. And, actually, the savings rate has been up markedly over that time.

In the long run, you have a return to normal consumption, but on a much healthier basis where people have all of their income available to spend - plus interest income, without having interest on debt dragging them down. If the entire country did this you would have extremely low interest rates, but less general consumption. If savings get too out of control, you get Japan with a stagnant economy (although their economy stagnated for many other reasons) and extremely low interet rates because the supply of money is great and the demand is small.

Some level of debt is needed for the economy, if for no other reason than it provides an investment for people who need to buy bonds.

Also, don't be too fooled by the US negative savings headline. That figure does not include any home equity, and for the most part, investments in stocks. I don't remember whether the savings rate includes or excludes 401(k) accounts, but I think it excludes them.

So while Americans are comparatively spendthrifts, it isn't quite as bad as it looks at first blush.

[Jim Richards]

What about a tax policy shift away from taxing earnings and investment, and towards taxing consumption?

[Christien]

This is a very interesting question I've considered many times over. On the one hand, we had a near-depression because of way too much credit and not enough responsibility (to grossly over-simplify the matter), yet on the other hand we had government urging us to spend more, because it was good for the economy.

I don't have an answer that I believe is 100% correct. I think if literally everyone (or 95%) of people starting living well within their means and saving money, we would indeed have a huge issue with jobs, because of the lack of demand for consumer products, whether they be TVs, cars, travel, etc. Granted, many of those affected would be jobs overseas but you still have to pay someone here to unload the truck and sell the goods.

I think we've built an economy based to a large degree on credit, and that's too entrenched to change. You mention putting money into your 401k - well, that's credit as well, just the other way around. The bank (or whoever) is borrowing money from you and paying you interest, so they can use that money for other things.

I think in order to truly have an economy that functioned within its means, we'd have to go back to using gold as currency.

[MRM]

Just so you know, if we went back on the gold standard we would freeze the size of the US economy at about 1955 levels. There just isn't enough gold in the world to support a modern economy. If anyone starts telling you the wonders of the gold standard, he is either not fully informed or thinks that a 1950s era economy is the ideal to which we should return. In anticiation of the inevitable Ron Paul reference, Paul unabashadly promotes a 1950s-era US economy - with rollbacks of civil rights legislation and all. We could support that kind of economy again if we went back to men as the sole breadwinners, etc. But it is unrealistic today.

There is good debt and bad debt. Good debt provides a return that is greater than the cost of borrowing and is within your means to repay comfortably - student loans, business expansion loans, home mortgages. Bad debt provides no lasting benefit and puts you at risk of defaulting - multiple gas guzzling SUVs for soccer moms to drive to Starbucks in, HELOC to buy big screen TVs and a media room that's already outdated. You get the point.

[Christien]

Originally Posted by MRM

We could support that kind of economy again if we went back to men as the sole breadwinners, etc. But it is unrealistic today.

Never mind that, how about the fact that there population has nearly quadrupled since then? That's one thing I think people tend to forget about when we discuss things like "why can't it be like it was back in xxxx?"

[Superman]

The sky would fall and the Earth's orbit would decay, hurling us into the Sun and a fiery death.

Worse than that, consumption would decline. This is the one thing American's do better than everyone else.

[Zeke]

lukeh, what you're seeing is the backlash of exactly what your questions infer. The credit debt has gone down and retail business is affected. It's not evenly dispersed over the whole retail sector. For instance, how many pairs of shoes have you bought in the last 2 years vs. the prior 2 years?

People can always walk a few more miles in their old shoes.

[jcommin]

70% of our economy comes from consumption. We are spenders. The income tax system was rewards consumption and penalizes savings. We deduct mortgage interest and years ago could deduct credit card interest, car loans before the laws were changed. However, it didn't change our spending habits as the population took out 2nd and 3rd mortgages to buy the same items. This interest could be deducted. At this time the credit card companies lowered the interest rates to keep the consumer spending.

All of this has changed. With less discretionary money, the consumer will spend less. Job growth will be slow as many of these jobs won't come back. It's a new day. You/we/I will need to save more, this won't be a choice. Lack of pensions, higher health care costs, big government deficits (at all levels), loss of wealth from homes and pension plans will drive the need to save. What the economy looks like in the future will be the consequence.

[Christien]

Originally Posted by jcommin

70% of our economy comes from consumption.

I read this recently, and was absolutely dumbstruck by that figure. The implications of that are really, really worrying. Not chicken little sky is falling worrying, but still quite concerning.

[Zeke]

Originally Posted by jcommin

70% of our economy comes from consumption. We are spenders. The income tax system was rewards consumption and penalizes savings. We deduct mortgage interest and years ago could deduct credit card interest, car loans before the laws were changed. However, it didn't change our spending habits as the population took out 2nd and 3rd mortgages to buy the same items. This interest could be deducted. At this time the credit card companies lowered the interest rates to keep the consumer spending.

All of this has changed. With less discretionary money, the consumer will spend less. Job growth will be slow as many of these jobs won't come back. It's a new day. You/we/I will need to save more, this won't be a choice. Lack of pensions, higher health care costs, big government deficits (at all levels), loss of wealth from homes and pension plans will drive the need to save. What the economy looks like in the future will be the consequence.

Nailed it there.

[RWebb]

Originally Posted by Jim Richards

What about a tax policy shift away from taxing earnings and investment, and towards taxing consumption?

problem is do you trust "them" to make that transition cleanly?

or to futz things up with lots-o-lard for lobbyists?

[jyl]

On the "70%" figure - note that since at least the 1960s, it's been over 60%.

[GH85Carrera]

Wow, I guess I am bad for the economy. My daily driver is a 1986 El Camino that I bought in 1991. My toy is a 1986 911 that I bought in 1995. My wife decided she needed a new car so she got the first new car she has ever owned recently. The TV in our living room is 12 years old. The TV in my garage is from 1984!

I guess I need to get to consuming, I may have another beer!

[wdfifteen]

Originally Posted by Jim Richards

What about a tax policy shift away from taxing earnings and investment, and towards taxing consumption?

In an economy that is based on consumption that would be economic suicide.