Thursday, May 28, 2009

Is Saving Bad for the Economy?

I recently heard a radio ad that was telling everyone to just go out and spend money. There was no advertisement for any particular product. Just - "Go Buy Something. Stimulate the Economy."

I read a post on The Simple Dollar that touched on this issue and thought I would make some additional comments on the subject.

Personally, I find it infuriating when people claim it is our fiduciary duty to spend money to "stimulate the economy." Either that or I hear people make excuses about taking on large amounts of debt or making extravagant purchases by saying, "Well, at least I'm stimulating the economy."

It's an interesting topic. I don't claim to be any financial expert but I think I should at least present a few facts of WHY economists claim spending stimulates the economy.

What do economists mean by "Economy"?

Generally when people refer to the "economy," they are most likely referring to GDP (Gross Domestic Product). GDP is basically just the sum of all economic activity, and this is how economists measure it :

Consumer Spending + Gross Investment + Government Spending + Trade Surplus (Deficit).

Consumer Spending generally makes up around 70% of our GDP. So if GDP is considered to be the measure of our “economy” - then yes, Consumer Spending is one of the biggest factors.

Saving does not contribute directly to GDP but can have an indirect effect. Saving and investment helps provide capital for other businesses and individuals. This capital can then be used to build factories or houses or do something that increases GDP.

Is Saving Hurting the Economy?

A recession is by definition, is negative GDP growth for two consecutive quarters.

The current recession is a result of two very significant changes in GDP.

, consumer spending changed dramatically. When consumers as a whole went from a savings rate of NEGATIVE 2% to POSITIVE 5%, that net change in such a short amount of time is what caused such a sharp decrease in GDP. So yes, saving instead of spending has caused a sharp drop in GDP, but I don't think that means it has been "bad for the economy."

Second, two of the largest inventories in United States (Houses and Cars) have fallen in demand/price - and no amount of credit or loans is going to fix it. These relate to the "gross investment" portion of GDP. We have been seeing a lowering of inventories and gross investment because of the fallen demand.

These are the two fundamental reasons for negative GDP growth. And GDP is what economists are referring to when they claim that spending stimulates the economy.

So, Spend or Save?

The good news is that now the savings rate is at a healthy level, we will most likely only see increases in future consumer spending. As soon as the housing market corrects itself and we can get rid of the excess waste in the auto industry, we should only see increases in the gross investment portion of GDP.

I personally believe that saving is incredibly important, and the lack of saving in the last decade is one of the reasons why this recession was necessary. Honestly I think that the debate of spending vs. saving is pointless. This is a personal decision that should be decided by individual needs, not by macroeconomics. My only advice is to spend less than you earn and don't think that "stimulating the economy" should give you carte blanche to spend whatever you want.

Wednesday, May 6, 2009

Save and THEN Spend!

Below I've included a widget from one of my new favorite ideas out there to make your life feel "financially planned." It's called SmartyPig and it is an online savings account (with the highest interest rate I've found anywhere right now - don't worry, it's totally legit and FDIC insured) that allows a more interactive and more rewarding way to save.

With your account you can set up any number of "savings goals" - and with each goal you determine the total amount you want to save and by what date you want to meet your goal. Then you set up an automatic withdrawal - and watch the piggy bank fill up.

Imagine if this is what we did with every purchase? Instead of paying $300/month for a car... imagine SAVING $300/month for a car (and earning 3% interest instead of paying 6%!) and then buying it once you save enough. One thing is for sure... when you borrow money you feel like you can afford a lot more than you actually can, and you end up buying more than you normally would.

I would recommend, that even if you are paying $300/month for your car right now, the MOMENT you make that final payment - vow to NEVER stop making a car payment! You're going to need a car again eventually. If you put continue to make your car payment and save $300/month, you'll be able to purchase your next car with cash - and trust me, earning interest instead of paying interest with your car payment makes a HUGE difference.

This is why I plan on never borrowing again except to purchase a home. Even then I hope that I don't buy more than I can afford. Below I linked the widget just to show you how SmartyPig is turning saving into something social and fun. If my savings goal right now were something other than a goal to give gifts to others, I would ask that all gifts to me be contributions to my savings goal! Maybe I should start saving for something fun instead of practical.