A Threat From Savings?

The idea Americans might start to save too much might strike you as halfway between ridiculous and absurd. After all, we have been scolded from birth about how profligate we are and, verily, how this will lead us to ruin.

But the threat is real. John Maynard Keynes influenced two generations of economists for better or worse by advocating an increase in government expenditures when individuals and businesses shift their preferences from spending to saving.

I last wrote about the issue in February 2003 and concluded:

If you want people to save more -- and in an economy wrestling with deflationary pressures, that in itself is something of a debatable proposition -- you have to provide them with a return. Lower rates are counterproductive. Raising the real return on capital, however, may be effective. For this reason, the Bush administration's proposals to eliminate the double tax on dividends, to effectively cut capital gains rates by adding retained earnings to the cost basis of stocks and to expand retirement account contribution limits, deserve a full and complete hearing.

If the concern then was price deflation, the concern today is asset deflation. And if the tax cuts worked then as a form of fiscal stimulus, is such a prescription warranted today? Let's update the analysis with a few modifications.

Savings From Thin Air

Milton Friedman once joked he could create a three-line Form 1040: 1) How much did you make last year? 2) How much do you have left? 3) Send it. This is more or less the approach the Commerce Department takes toward counting savings. Consumption is deducted from income, and savings are the residual. If it sounds good enough for government work, it is government work.

We can modify the number somewhat by using disposable income, which nets out tax expenses. As an aside, my state and local taxes here in Cook County, Illinois, seem to be rising in price as if they were food and energy. If we divide savings by disposable income, we get a higher savings ratio in the charts below.

If we map these savings rate with a one-month lead against the logarithm of the constant-dollar S&P 500 plotted inversely, we find people really do, in John Kenneth Galbraith's words (name-dropping economists today, aren't we, Howard?), believe they have created wealth out of thin air. With the very prominent exception of the late 1990s bubble, savings rates have tracked the fortunes of the stock market closely.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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