A Good Piece by Martin Feldstein About the Coming Rise in U.S. Household Savings

Marty writes:

Foreign Affairs - The Return of Saving - Martin Feldstein: The savings rate of American households has been declining for more than a decade and recently turned negative. This decrease has dramatically reduced total national savings despite a rise in corporate saving. In 2003 and 2004, the combined net savings of households, businesses, and government were only about one percent of gross national income -- the lowest level in at least 50 years.

This sharp decline in saving has... reduced productivity-enhancing net business investment... made the United States increasingly dependent on capital from the rest of the world to finance that investment.... The downward trend in U.S. household saving will likely soon be reversed. In the long term, a substantial rise in household saving will have a positive effect on the U.S. economy. But the initial effects will pose problems for the United States and its trading partners. If these effects are not managed well, the result could be declines in output and employment and a corresponding rise in U.S. protectionism....

Individuals in their 40s and 50s tend to save money, whereas many in their 60s and beyond are... spending the assets that they accumulated.... Net household savings in the United States fell from an already low 1.7 percent in 2004 to -1 percent in the second half of 2005. This... stands in sharp contrast to the rate until the mid-1990s: 7 percent or higher.... That household saving has declined should come as no surprise. The rising prices of stocks and homes have made many Americans much wealthier.... Between 2000 and the start of 2005, the overall net worth of the household sector increased by nearly $7 trillion. As a result, many individuals in their 40s and 50s looked at the value of their IRAs, 401(k) accounts, and homes and rightly concluded that they did not have to save as much for their retirement as they would have had to in the past....

As mortgage interest rates have come down from nearly eight percent in the mid-1990s to less than six percent, individuals have been able to increase the size of their mortgages without having to raise their monthly mortgage payments. Although some of the extra mortgage borrowing has been converted into other savings, much of it has been used to finance additional consumption. The amounts involved have been enormous. In the past five years, the value of U.S. home mortgage debt has increased by nearly $3 trillion....

[The] basic accounting identity -- that the current account deficit is the amount of capital inflows to the United States -- links the U.S. trade imbalance to U.S. dependence on foreign capital. Accordingly, the United States can reduce its dependence on foreign capital inflows only if it reduces its current account deficit. Doing so will require a slowdown in the growth of consumer spending....

The flow of funds to the United States should be a matter of concern not only because it has increased so rapidly but also because those funds now come in what may prove to be a much less sustainable form. In the late 1990s, most of the capital that flowed into the United States came in the form of equity investment by private investors.... Today, the capital inflows to the United States primarily go toward purchasing bonds and making bank deposits, including very sizable deposits by foreign governments at the Federal Reserve.... The available data do not distinguish between purchases by banks on behalf of private investors and purchases by banks on behalf of foreign governments. But extensive conversations with officials and private bankers suggest that an overwhelming share of the foreign capital inflows in recent years has come from foreign governments....

Since governments do not make investment decisions by simply balancing risk and return the way private investors do, it is particularly difficult to anticipate their future behavior. How long will foreign governments want to keep running large current account surpluses and investing those surpluses in relatively low-yield foreign bonds? And how will they respond to developments in the United States or in the global economy in the future? These unanswerable questions add to the overall uncertainty of the global economic outlook....

Share prices are not likely to double again in the next decade, nor will housing prices continue to rise at double-digit rates. Accordingly, households will be able to increase their wealth for retirement and other purposes only by reducing the growth of their spending so that it is less than the growth of their after-tax incomes -- that is, by saving more. Most important, mortgage interest rates have stopped falling, bringing an end to the dissaving that occurred when homeowners simultaneously reduced their monthly mortgage payments and extracted massive amounts of cash simply by refinancing their mortgages. This suggests that there will be a relatively rapid rise in the savings rate.

This coming rise in household saving will eventually be good for the U.S. economy.... But a higher U.S. savings rate will also pose a challenge... it will mean a reduction in the exports to and an increase in the imports from the United States.... The coming rise in the U.S. savings rate could temporarily cause a serious problem for the U.S. economy as well. As consumer spending falls, GDP and employment will also decline. This decline will last until net exports increase.... [T]here is the danger of a time lag between when the savings rate rises and when the U.S. trade deficit declines. Such a lag would cause a slowdown in the growth of output and employment, potentially leading to a recession....

Foreign governments would thus do well to anticipate the coming rise in the U.S. savings rate.... [I]t would be best to allow exchange rates to adjust before the U.S. savings rate rises. Equally important, the United States' trading partners must find ways to increase their domestic demand in order to maintain their output and employment even as exports to the United States decline...

But it would have been much better had it included, somewhere, the phrase "government budget deficit."