Americans embrace saving as nest eggs shatter

Americans who were banking on soaring home and stock prices to finance their retirement will have to go back to saving the old-fashioned way, ushering in a new era of frugality that may last for years. For much of this decade, easy credit that helped inflate the housing bubble and boost financial markets meant households did not need to set aside as much for a rainy day. Spending accelerated while the savings rate declined to near zero.

The trend is reversing now that the financial upheaval has blown a $7 trillion hole in Americans' wealth. Households are curbing spending at the sharpest rate on record, and economists see only a tepid rebound beginning late next year.

It seems the golden age of spending for the American consumer has ended, and a new age of thrift likely has begun.

As recently as the early 1980s, U.S. households were socking away about 10 cents out of every dollar to cover emergencies or save for retirement. By 2005 the saving rate was below 1 percent, thanks largely to higher returns on investment in the stock market and real estate, and financial innovation that made borrowing easier. The savings rate in 2008 stood at 0.2 percent and is expected to climb to 4 percent by the end of 2009. That would represent the sharpest eight-quarter rise in 50 years.

Flush with investment wealth, consumers stepped up spending over this decade, even though wage growth remained tepid. Imports soared, particularly from China, driving up both U.S. deficits and Chinese surpluses. From the start of the housing market boom in 2002 through 2007, imports from China rose by 157 percent to $321.4 billion.

Economists have long warned that these trends were unsustainable, and Americans would eventually need to curb consumption while China boosted its own domestic demand. The credit crisis is doing precisely that, but at such breakneck speed that it is worsening an already grim economic outlook. The global economy simply cannot adjust fast enough to the sudden drop in U.S. demand.

Households typically change spending behaviour gradually when they sense big shifts in their wealth. This time the effect may be much quicker because consumers have been bombarded with alarming news stories comparing the current slump to the Great Depression of the 1930s. At the same time, banks have grown wary of extending credit and global investors who eagerly bought securities tied to consumer debt have backed away, driving up borrowing costs.

For the economy, the rate of savings itself doesn't matter as much as what is happening to consumption, which accounts for two-thirds of U.S. economic activity. During the 1980 recession, which was the last time that the savings rate rose sharply, consumers cut back so dramatically that the percentage of income spent on personal goods and services dropped to just under 74 percent at the end of 1981 from nearly 77 percent in the first quarter of 1980.

If history is any guide, next year's spending decline may be severe. An increase in the savings rate must be accomplished. Not just in the US, but all over the world. Gear up buddies, start saving before its too late.

Information Source : The world wide web