Americans are known for a lot of things, but saving isn't one of them. In the credit-fueled spending spree that personified the last decade, the national savings rate dropped to all-time lows – even turning negative in 2005.
We all know that saving is important, and when the economy hits upon tough times, having money in the bank can be a godsend. With inflation fears running rampant, though, is saving really worthwhile? Here's why saving money is still sage advice in an economy that's struggling to recover. (Learn more about saving in Save Without Sacrifice and It's Never Too Early To Start Saving.)
The past two months have shown us that recovery isn't something investors can take for granted. Since the beginning of 2010, we've seen key economic metrics miss analyst expectations and stocks have slinked lower as a result. There's a connection between our languishing savings rate and the economic straits we find ourselves in right now. It all begins with credit …
The widespread acceptance of credit in the past two decades has helped fuel significant growth in the U.S., but it has also come at a significant cost. With credit freely available, particularly in the last few years, consumers took to using their credit lines (and home equity, for that matter) like a savings account. As a result, they stopped saving. In January 1959 Americans saved 8.3% of their income, but by early 2008 that number had shrunk to 0.8%.
As the credit market seized, and consumer credit lines began to shrivel, people started to realize that the credit limits on their accounts weren't the same as cash in the bank. (Learn more in 9 Reasons To Say "No" To Credit.)
Savings Bring Recovery
The idea that savings help out in a tough economy isn't an earth-shattering revelation. But you might be surprised to find out just how much a high savings rate can speed up economic recovery.
One of the biggest challenges to our economy in the last 18 months has been the chain reaction of defaults that is endemic to our credit system. As a collapsing real estate market shoved overextended consumers underwater on their mortgage payments, those same consumers found themselves slashing spending at the last minute and going into default, which, in turn, cut economic output and increased job losses putting even more people in tough spots.
A small number of consumers and lenders were very quickly able to affect a larger portion of the economy because of the financial system's interconnectedness.
How Savings Help
To be sure, higher savings reserves mean that consumers have cushions that can help absorb overwhelming expenses without digging the hole deeper. But just as importantly, having a higher portion of income allocated to savings means that living expenses are lower – and consumers can adjust their budgets to spend a larger chunk of income on increased mortgage payments or better compensate if they lose their jobs.
That ability to cope with financial hardship ultimately means that the economy recovers much faster. After all, when the bills are being paid, the banks, utilities and grocery stores can keep their doors open – and their workers employed.
Savings, Government and Risk
That's not to say that savings are without risk; anyone who held stocks in their retirement accounts in October 2008 can attest to that. Even government intervention can work against savers - stimulus spending and increased inflation both work against your cash. (Learn more about government intervention in Economic Meltdowns: Let Them Burn Or Stamp Them Out?)
When a government provides stimulus to its citizens, it typically finances those expenses through additional sovereign debt, which needs to be paid off by future generations. In a sense, the savers are forced to bail out non-savers when the government gets involved. Simply printing extra money is another way that governments pay for stimulus. When that happens, there's a serious risk of inflation, the number-one killer of savings.
With inflation, each dollar in your savings account has less real purchasing power. It's the reason why a loaf of bread cost five cents in 1910 and averages more than $2 today.
And while those risks are very real, widespread savings essentially eliminates the need for government stimulus in the first place by shoring up the nation's finances at the consumer level. As with most economic crises, the national savings rate shot up following 2008's real estate collapse, as those who could afford to save stashed their cash anticipating tougher times ahead. But already, we've seen savings rates take a hit as the economy and the stock market rebounded last year.
On both a personal and national level maintaining a solid savings rate is one of the best cures for economic woes. Although that means that Americans will have to live within their means, it also means that we'll be less susceptible to economic downturns in the future. What remains to be seen is whether consumers will remember the lessons of the last few years and maintain a more cautious savings level when credit flows freely once again.
After all, if we can't learn from our mistakes, we'll be doomed to repeat them.