The Paradox Of Savings

February 25, 2009

piggy bankBy John Newcomer:

The economy is in the toilet, unemployment is going through the roof, housing prices are plummeting, and we are in one of the worst recessions in our nation’s history. So what do the economic gurus say we are supposed to do to get us out of this mess — SPEND.

But wasn’t it the spending that got us into this mess? Yes, our savings rate went from 9% in the 1960’s to a negative .6% savings rate in 2006. In 2006, we as a nation actually spent more than we made. In simple terms, we, as a nation, were spending way beyond our means.

Now, we are scared, so people are saving again. In November 2008, we saved $229 billion dollars for a 2.9% savings rate. In December 2008, we saved $378 billion dollars for a 3.6% savings rate. January 2009 figures are due out March 2nd and are expected to show even greater savings.

This is the “Paradox of Savings.” We save when we should spend and spend when we should save. Japan went through this in the 1990’s. They saved when their economy went into a recession. Unfortunately, once their economy rebounded they continued to save. The result is their economy is still in a recession and is now getting worse.

In 1957, our economy was in recession. President Eisenhower went on television and pleaded with the American people to go out and buy a car. Yes, just like today, the automobile industry was in trouble in 1957. President Eisenhower resisted tax cuts and government spending, but pleaded for more consumer spending. Although this was the correct message, it did not work. President Kennedy, on the other hand, lowered taxes, and stepped up military and space exploration spending, and the economy recovered.  In other words, the government started spending more.

This seems counter intuitive but to pull our economy out of this tail spin, we need to look back at history and follow the advice of President Eisenhower and President Kennedy. Both the government and we, as a nation, need to spend more right now and save a little less. It seems crazy, but to avoid the “Paradox of Savings” we need to act counter intuitively.