Americans spend every cent - and more

Critics say America's negative savings rate can't be sustained and see a recession coming. Are they right?

By Chris Isidore, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- Don't call us the Grinch for bringing this up with Christmas right around the corner, but Americans are spending more than they're earning, and some critics say the economy is at risk because of this.

Friday morning the government will report on personal income and spending for November. For the last 19 months, the report has shown a negative savings rate. That means American consumers are spending more than they're taking home after taxes. The savings rate was a negative 0.6 percent in October. In other words, the typical American spent $100.60 for every $100 of take home pay.

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The savings rate compares after-tax income to the money spent on a wide range of items. It turns negative when people take on additional debt such as home equity loans or other credit, or sell assets, so they can spend more than their take-home pay.

Before the current streak of negative rates started in April 2005, only one month on record back to the late 1940s had a negative savings rate. As recently as the second quarter of 1985, Americans were saving more than 10 percent of their paychecks.

Dean Baker, co-director of the Center for Economic and Policy Research, said the negative savings rate cannot be sustained over the long run. It will end when consumers cut back on spending, which in turn will spark a recession, he said - something he sees happening as soon as next year.

"This is when we should have a very high savings rate," he said. "Most of the baby boomers are still in the work force in their prime earning years. Instead we have this incredibly low one."

Largely to blame for the negative rate, Baker said, is the spike in home prices over the last five years that convinced many Americans they no longer needed to save. Many also pulled cash out of their homes via home equity loans and mortgage refinancing - cash they used to buy cars, flat-panel TVs, child care or other goods and services. Many upgraded their homes.

But since Baker believes the current housing slump will worsen next year, he's forecasting a drop in spending as well. "People will have to cut back their consumption because people can't spend at the same rate," he said. "That's a big hit to the economy."

Consumer spending, in fact, accounts for about 70 percent of gross domestic product, the broadest measure of the nation's economy.

But other economists say the negative rate overstates the problem of consumption versus savings. They note the savings rate doesn't measure things like money going into bank accounts, 401(k)s and other retirement plans or mutual funds. Nor does it measure equity built up in people's homes.

They also point to gains in household net worth despite the negative savings rate as a sign that the typical household is flush, and will keep on spending.

"A lot of folks who will read the numbers about the negative savings rate will say 'Thank God that's not me'," said Steven Wieting, senior economist at Citigroup. "I don't deny that the level of precautionary savings has trended lower. But the savings rate is the tail, not the dog."

Wieting said the negative savings is small enough that future revisions to income or spending calculations could result it being positive once again. "The savings rate is close to zero," he said. "I would love for us to not focus on whether it's a little negative or a little positive."

More important, he believes, is that other measures show that household wealth has continued to grow even in the face of the low savings rate.

Numbers from the Federal Reserve show that third-quarter household net worth is up $2.8 trillion, or 7 percent, from a year earlier, even excluding gains in real estate. While some of that has occurred from the stock market rally, the figures show broader gains than that.

"Spending may be high compared to income, but there are important offsets to that," said Wieting. "If we look at total outstanding wealth to spending, then spending is low."

Wieting said it will take more than the recent slump in housing prices to change consumer behavior and put the brakes on spending. "I don't' think attitudes change very rapidly," he said. "They'll look at the totality of their household balance sheet along with income and savings. I would expect there to be only a very gradual recovery in the true level of personal saving."

But Baker said that asset gains aren't permanent enough to keep spending strong going.

"Asset prices fluctuate. If you're showing the run-up in net worth, you know it's because of asset prices," he said. "To say that means we don't have a problem with savings is kind of silly."

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.