U.S. personal spending increased in December by the most in five months, evidence of increasing demand that may invigorate the economy this quarter.
The 0.9 percent rise was more than forecast and followed a 0.5 percent November gain that was larger than previously reported, the Commerce Department data showed. A price gauge tied to spending and excluding food and fuel, the Federal Reserve's preferred measure for tracking inflation, rose 1.9 percent in 2005, slower than the previous year.
Even with the higher incomes, Americans spent $42 billion more than they earned in 2005, cutting the personal saving rate to minus 0.5 percent, the lowest since 1933. That suggested to some economists that consumer spending may slow later this year.
Savings is money people put aside for a rainy day. It's money they can access quickly, easily and with no penalties. It's the proverbial "money under the mattress". Standard financial planning dictates to put away at least 6 months of expenses in a bank account "just in case."
First, an economist defines savings as the amount of money leftover after a consumer buys all his stuff. According to the just released personal income figures from the Bureau of Labor Statistics, national savings totaled -67 billion in December 2005. For the last three quarters of 2005, the numbers were (in billions) -21, -158 and -33 respectively. In other words, the US consumer has routinely spent more than he made for the better part of the last year.
There are many people who have automatic deductions from their paycheck for various investment vehicles such as 401(k)s and IRAs. However, the figures for these various investments are also low. According to the latest Flow of Funds Report (page 112) from the Federal Reserve, defined benefit plans net acquisition of financial assets has been negative for the last 10 years. Defined contribution plans (such as 401(k)s) saw net acquisition of financial assets (in billions) of 16, 17, 24 and 18 billion for the years 2001-2004. These figures come in around 1% of total GDP at best. IRAs saw the largest infusion of contributions over the 2001-2004 period, with contributions in billions of 182, 194, 211 and 244 respectively. These figures are between 1-2.5% of US GDP. In addition, these funds are not easily accessed; there are high-withdrawal penalties for using these funds before retirement. This makes them less attractive for day-to-day savings.
There is also an argument that homes are actually a form of savings. However, what the proponents of this idea fail to remember is home loans must be paid back; they are not free of charge. If an individual is laid-off and obtains a home equity loan, he still has to pay the loan back. This is not savings in the classical sense of "money put aside for a rainy day". It is in fact a loan.
The bottom line is people are literally spending everything they make - and then some.
From a macro-economic perspective, savings is vitally important. Individuals deposit their savings in a variety of institutions - typically banks - which pool these individual deposits into larger chunks of money and lend them to borrowers - typically businesses who are investing for future growth. This whole process is called financial intermediation. When individuals don't provide individual deposits, financial intermediaries must obtain lending capital from other sources.
This is why foreign capital is so vital to the US right now. We have no national savings base to lend ourselves. Instead, we rely on other countries and individuals to provide US financial intermediaries with funds to then loan out to American business.
Here is the real kicker: if the US starts to save actively, US GDP will drop. Consumer spending is responsible for about 70% of US GDP growth. If US consumers slow down their consumer spending, the economy as a whole would suffer. In other words, US economy is set-up to require massive consumption at the expense of savings.
Here is the final point: savings is equity - or ownership. Instead of relying on ownership, individuals now rely on debt to finance their lifestyle. Instead of looking forward to what they will buy, they look to the future to what they have to pay-off. Consumer spending is centered on one massive revolving credit loan.
And with little money left over in case of an economic shock, people are just begging for a big problem if the economy slows.
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