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The Paradox of Thrift

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March 05, 2009 – Comments (8)

 

There's an old economic theory that has a really cool name which I believe explains what is happening with the economy right now and likely will continue to happen for some time.  It's called the Paradox of Thrift.  Essentially this means that it is a great thing for an individual to be conservative and save a nice chunk of their income...BUT...if everyone stops spending and ramps up their savings at the same time it is devastating for the economy.

Things had gotten way too out of hand in terms of consumer spending over the past decade.  Americans need to be more conservative and save more money, but this huge wave of savings all coming at the same time is going to hammer the economy, causing people to become scared and save even more, and so on, and so on...you get the idea.  As you can see in the Bespoke chart that I pasted above, the consumer saving rate has increased dramatically since this whole mess began and it has a long way to go before it reaches an appropriate level. 

Even when the economy eventually stabilizes and finds a bottom we aren't going to see the sort of economic growth that we all have become accustomed to in the U.S. and in turn companies and their stock prices over the past decade.  That's why I'm not interested in chasing possible capital gains that may never materialize in this potential era of slow growth.  A bird in hand is worth two in the bush.  I'll take my interest payments on corporate bonds now while others wait for a promise of future cap gains that may never materialize...at least not for a really long time.

Deej

8 Comments – Post Your Own

#1) On March 05, 2009 at 6:35 PM, briyan (30.77) wrote:

I agree with you here Deej ... this is one of many metrics that gives me pause when I think about the true performance of stocks and earnings growth in particular in the past.  If we look at that chart of savings rates, we can see a clear trend down toward zero starting in the early 1980s.

With that in mind, it's hard to know how much of our economic growth and corporate profits have been sustained only by this reduction in savings (combined with increasing utilization of credit lines). While one could assume there may have been some true economic growth going on during this time, we could also find that we are much more closer to a stagnant economic environment than we think.

Wipe out all the gains that were basically earned by cannibalizing our personal assets (as a society), and we're back to the 1980s, aside from inflation.  Media and very recent popular history has taught us that our American economy is robust, but few seem to have considered the fact that we are no longer "on the rise" relative to the world and thus a high growth rate doesn't really make sense. 

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#2) On March 05, 2009 at 6:50 PM, vriguy (74.43) wrote:

I am intrigued by the chart seeming to show personal savings climbed to 5% of income in 2008.  That would be surprising when the vast majority of the population claims to be just getting by.  Is the 5% savings a reflection of the wealthiest decile cutting back on discretionary spending? 

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#3) On March 05, 2009 at 6:54 PM, devoish (98.38) wrote:

I cannot help myself but to look at that chart and mark the beginning of Reaganomics/Trickledown and the decline of unions.

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#4) On March 05, 2009 at 7:02 PM, BradAllenton (31.41) wrote:

 devoish ding, ding, ding Give that guy a prize!!!  I looked at the same thing.

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#5) On March 05, 2009 at 8:06 PM, columbia1 wrote:

The paradox of thrift combined with Keynesianism. This is an excellent article, I keep it in my favorites list and read it every couple weeks, it just goes to show how backward thinking our government really is, please enjoy

http://alhambrainvestments.com/blog/2009/01/18/the-paradox-of-keynesianism/

We basically are screwed.

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#6) On March 06, 2009 at 9:41 AM, 4everlost (29.39) wrote:

Great info!

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#7) On March 06, 2009 at 9:52 AM, TMFEldrehad (99.99) wrote:

I'm not so sure I'm completely convinced - and here's why.

Under normal circumstances the savers put their money, say, in a bank.  The bank then turns around and loans that money out to someone else.  If more and more people become savers simple supply and demand would dictate that interest rates drop (as there's a greater supply of money to be loaned, but demand has remained unchanged).

This does a couple of things.  First, lower interest rates will make some people less inclined to save - acting as a counterbalance if you will.  Additionally, businesses will have acess to less expensive capital with which to expand - which will help the economy grow.

Now, if banks simply aren't lending, that's a problem so one could argue that we're not operating under 'normal' circumstances today.  Nevertheless, it would be the banks' reluctance to lend rather than people's increased willingness to save that creates the problem.

I could be wrong, but that's how I'm looking at this.

Regards,

Russell (a.k.a. TMFEldrehad)

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#8) On March 06, 2009 at 11:22 AM, TMFDeej (99.41) wrote:

Hi Russell.  Thanks for reading.  I think the key phrase that you wrote in your response is "Under normal circumstances."  We are very far from anything that would be considered to be normal right now, at least compared to the "normal" of the past decade.  Right now any of the money that people are putting into banks is getting sucked into a huge black hole on their balance sheets or being used to build up reserves.

Sure, some banks are lending right now...but fewer people want to borrow today.  Consumer confidence has been completely destroyed.  Banks can't force people to borrow money if they don't want to, even at low interest rates. 

You're right in that the more the supply there is of something, the lower its price is.  In theory if there was a ton of money floating around out there that could be lent interest rates would drop...BUT interest rates are already at a historically low level.  They can't get much lower than this to entice borrowing.

Fear rules the day right now.  People don't give a darn about the rate of return they are getting on their money, they just want to keep it from disappearing.

Businesses don't have access to cheap capital because the credit markets are broken.  Even if they get better, businesses are slashing spending at a dramatic rate...not borrowing to expand.

Deej

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