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From 1950 through the early 1990’s, the US savings rate was in the area of 8% to 10% of personal income. A
steep descent started in 1993 ending with the saving rate being below zero in 2005 and 2006. In May 2007 two
economists took differing views of the long-term effect of this decline in savings on the US economy.

Now recessionary fears there have prompted repeated calls from Wall Street for the Federal Reserve Board to
lower interest rates to stimulate more borrowing. Questions have been raised about the effectiveness of doing

The Argument

The cover story of the May 28, 2007 issue of Barron’s was an article titled “The Great American Savings
Myth.” The author, economics editor Gene Epstein, contended that the US saving rate was not as dismal as it
appeared from the government data. The basis for his argument was:

  • National saving data is not properly computed. Capital gain income is not included in the savings
    total, but tax on these gains was subtracted, resulting in an understatement of national savings.
  • Investment in intangibles is likewise not captured in national savings statistics. This investment causes
    growth in the value of businesses that households may own. However, these investments are expensed
    by businesses, also understating savings.
  • According to data from the Federal Reserve, from 1996 through 2006 household net worth, rose by
    31.7%, a good figure in comparison to other ten year periods.

The thrust of Epstein’s article was that US economy (as evidenced by the growth in household net worth) seems
to be doing fine, regardless of negative savings trend.

The implication was that you don’t have to save out of current income as long as your assets are appreciating.

The Issues

  • Is it possible for the US economy to grow while having a negative savings rate?
  • Will monetary stimulus be effective after periods when households have borrowed heavily to maintain
  • Is borrowing for consumption purposes something that households should be doing?

The Rebuttal

The counter to Epstein’s article was written by Paul Kasriel, Director of Economic Research at the Northern
Trust (“Gene Epstein’s Great American Savings (sic) Myth,”, May 30, 2007). Those who can
deal with Econospeak should read the article in its entirety. For those who are not so inclined, here are the key

  • “Savings involves spending present income on things that hold the prospect of producing future
    income.” (For households this generally represents the acquisition of financial assets.)
  • “One factor that determines the wealth of an economy is how fast its real capital stock is growing.”
  • “Not only has the growth in the U.S. real capital stock been slower in recent years, but the composition
    of that growth has shifted radically toward household-related capital stock vs. business-related.”
  • Through the mid 1990’s Net Financial Investment (growth in financial assets less growth in liabilities)
    was always positive and averaged 64.5% of the savings rate. (Households were allocating a healthy
    portion of their savings for purchases of financial assets.)
  • “ . . . .starting in 1999, households’ net increase in liabilities has exceeded their net acquisition of
    financial assets.” (During this period Net Financial Investment averaged NEGATIVE 3.56% of personal
    income. Debt increased more than financial assets.)
  • In 1998 household leverage (liabilities/market value of total assets) was 13.75%. In 2006 the figure
    was 19.5%.

Kasriel paints a picture of an economy that levered up and bought something other than financial assets that will
generate a rate of return that will meet debt service requirements. His position is that the negative savings rate
and non-investment uses of debt financing will have a negative effect on growth in the US economy.
Our Perspective – Analysis at the household level

Economists deal with aggregated data, most of it compiled by the Federal Reserve. Our perspective is at the
microeconomic level. Are households making good financial decisions? Are they positioning themselves to
make progress towards retirement goals?

Households go through a well-defined life cycle. They start the process of preparing for retirement by
accumulating capital, the goal being to replace wage income with investment income. Retirement is possible
when enough capital has been accumulated to meet expected future needs from income and principal without

The process of capital accumulation involves the interaction between:

  • a) Wage income
  • b) Income on accumulated household capital
  • c) Income and wage taxes
  • d) Personal consumption

Ignoring any distinction between capital appreciation and income recognized for tax purposes,

  • Increase in household net worth = a + b – c – d

Having financial assets allows households to lower taxes on total income. This occurs by:

  • Investing in vehicles that produce tax deductions (IRAs, pensions, etc.)
  • Producing investment returns that are not currently taxable (growth stocks or income generated in pension accounts)

Having adequate financial assets also allows households to assume higher levels of risk, which in turn should
generate a higher rate of return. These households can tolerate illiquid and more volatile investments, and can
face bear markets without having to sell assets to raise cash.

Consumption is also a factor in capital accumulation. A low level of personal consumption relative to income
allows households to fund up tax deductions and build capital more quickly. When financial assets reach critical
mass, the effect of compounding takes over. A high savings rate aided by low consumption allows assets to be
rebuilt quickly after bear markets. Low consumption also has financial advantages during retirement. It allows
households to delay taxable withdrawals from retirement accounts and delay taxable sales of appreciated assets.

How does this image of a high performing household stack up against the trends that Paul Kasriel has noted?
Let’s go back to Kasriel’s data and compare pre 1992 performance of households with recent performance.

In the 4 decades from 1952 through 1992, households had a high savings rate and consistently allocated a high
percentage of their savings (65.3%) to increasing financial assets. In 2002 through 2006 borrowing actually
exceeded investment in financial assets, resulting in a negative figure for Net Financial Investment.

  • When Net Financial Investment is negative, it means that cash for debt service increasingly comes
    from wage income. This is exactly the reverse of what households should be trying to accomplish.
  • The low US savings rate reflects a high rate of personal consumption relative to current income. This
    will slow the growth in household net worth and result in assets being consumed more quickly during
    retirement. Think wage substitution. Saving out of current income is an integral part of this process.
  • The composition of household investment has become skewed towards nonfinancial assets (real estate).
    This will reduce investment returns and will also slow the growth in household net worth.

As an example of the last item, let’s look at a household that invests in personal use residential real estate.
Assume that both real estate taxes and operating expenses are 1.25% of fair market value (2.5% in total). This
means that the property would have to appreciate by more than 2.5% per year to generate any financial rate of

An argument can be made that personal use is an economic benefit, but the income that is foregone (opportunity
cost) exactly offsets this. The net result is that the household has money tied up in an asset that generates no
financial return. Operating expenses offset appreciation. From a purchasing power perspective the return is
negative. (The investment breaks even on a cash flow basis, but inflation erodes purchasing power.)

The prototypical household that is set up for making real financial progress does the following:

  • Maintains a high savings rate so its capital stock grows
  • Invests in assets that generate the highest rate of return
  • Keeps household costs under control (This is key part of having a high savings rate.)

Is this what’s going on in the US economy? Well, there is more than ample evidence of suboptimal behavior by
households. Households are borrowing and investing in… residential real estate. In addition to saving less,
households are investing in an asset class that won’t produce a return.

The issue– Can we borrow our way to prosperity?

Is it possible for households to make progress financially without saving from current income? Well, if
households don’t save out of current income, this means that increases in household net worth can only come
from two sources:

  • From holding gains on assets previously purchased
  • From holding gains on assets purchased with debt financing

It is unrealistic to expect that households can engage in margin buying of assets and generate a positive rate
of return. More likely, income and carrying costs will simply net out. The negative US saving rate implies
that Americans are consuming part of the holding gains from their capital stock (residential investment and
investment in financial assets), slowing the process of wage substitution.

What, then about Gene Epstein’s argument that since household net worth was growing, the problem of a
declining savings rate is overstated? This seems to be based exclusively on the growth in household net worth.
The behavior is bad, but the outcome isn’t so terrible. This is a statistic in search of a theory.
Then why was growth in household net worth from 1996-2006 so robust? Easy credit. There has recently
been an overvaluation of assets, most notably residential real estate, based on mispricing of credit. It is likely
that some of the gains of household net worth will be given back as the appropriate risk premiums return in the
financial markets.

The inflation in real estate prices over the past several years has led to investment in residential housing stock
that will not grow future household income. If inflation runs at 2% to 3% and real estate appreciation parallels
the inflation rate, any holding gains from owning personal use property are offset by operating costs.
Investment in residential real estate is essentially a form of consumption. If households want to increase their
future investment income by building their capital, there is no substitute for saving out of current income.
Americans would be better off investing in financial assets, since these assets should generate a much higher
rate of return.

It appears that the mispricing of credit masked the ugly reality of what was happening to household finances.

  • Households were not saving enough, boosting current consumption at the expense of building
    household capital.
  • The investment that did occur was in the wrong assets.

It took defaults in the weakest link in the chain (subprime borrowers) to expose the fallacy of overuse of credit
as a substitute for savings. The appearance of Gene Epstein’s article in Barron’s is similar to the famous
Business Week article of August 13, 1979 that announced the death of equities, just of the eve of a 20 year bull
market. The need for savings always existed, but was papered over by the availability of cheap credit. Now it
can’t be ignored. Substituting credit for saving was always a dead end.

The tax angle

There is a powerful positive effect on the economy from home equity borrowing. Households have cash to
spend, but don’t pay income taxes on the loan proceeds. And if a primary residence is sold, the first $500,000
of gain is exempt from tax. This is the tax free perpetual motion money machine… as long as home values
are increasing. There is a powerful feedback effect. Tax free borrowing stimulates the economy, increasing
household income and confidence, leading to… more borrowing which in turn drives up real estate prices. It’s
an economy on steroids.

The use of cash out refinancing and tax free sales of real estate has been a financial planning boon to retirees.
Appreciating real estate has been a source of tax free cash, and has allowed retirees to limit taxable retirement
plan withdrawals.

However, there are practical limits to which households can practice the cash out refinancing – buy consumer
goods game. Eventually leverage must be unwound. The two most visible events that prompt this are
retirement and job loss. As corporate layoffs have become more pervasive, the timing of this unwinding of
leveraged is accelerated. It is never convienient to the debtor. (What would you like to do, borrow on your
home at 6% or pay tax on an IRA distribution at 28%?)


We are now 7+ months down the road since the Barron’s cover story. A lot has happened. The DJIA index has
retreated about 1,500 points from its 2007 peak. The market is in the process of pricing a recession into stock
prices. Credit is contracting.

The recent expansion in household debt has profound implications for the direction of this economy. If
households wake up to the reality that having a leveraged balance sheet is not a workable long-term strategy,
then what will come of the stimulus efforts of the government? There will likely be fewer people willing to
“take the bait” and go out to borrow and spend.

In our December 2003 article “The Problem With Sequels,” it was noted that the Bush administration was
throwing both monetary and tax cut stimulus at the economy in advance of the 2004 election. However, the
implications of the eventual withdrawal of this stimulus would likely not be pleasant.

The same could be said about the attitude of American households in boosting consumption with tax free cash
from refinancing. It’s fun while the party’s on, but hell when the loans have to get repaid. One of the grim
realities of life is that borrowed money must be paid back with after tax dollars. Every loan dollar that gets paid
back requires about $1.40 of pretax income. This turns into an economic drag where debt liquidation occurs on
a mass scale.

This is the consideration that makes the impact of additional monetary stimulus a dubious proposition.


Now more than ever, start acting like a high performance household.

  • Reduce household expenses to generate savings and add to your capital.
  • Minimize taxes by making the maximum contributions to pension plans and IRAs.
  • Invest where you get the greatest return. Focus on investing in financial assets. Reposition nonearning

If you’ve got too much debt, develop a plan for paying it off in an orderly manner, either from savings or asset


The Great American Savings Myth, Gene Epstein, Barron’s, May 28, 2007

Gene Epstein’s Great American Savings (sic) Myth, Paul Kasriel,, May 30, 2007