Paradox of thrift

By Xavier Brenner

My housekeeper has a nicer car than me.

Now, granted, 75% of America probably has a nicer car than me. I'm driving a car that, while only four years' old, looks like it's going on 20 because my kids have utterly destroyed it.

On the flip side, the car is paid for so I refuse to pay a single nickel to get it fixed up until my kids are older.

So I wouldn't necessarily find it odd that my housekeeper has a nicer car than me… except for the fact that she drives a black Mercedes Benz.

 

Benz Math

Now, I'll never fault a person for having good taste in cars.

But I've done the back-of-the-envelope math, and I also know that the monthly payment on that car consumes a huge chunk of her income.

It's phenomenally bad for her personal finances to own a Benz… but it's great for the dealership that sold it.

And that brings me to one of the more interesting concepts in economics:

 

Dilemma

The paradox of thrift.

In a nutshell, it's good for an individual family to be frugal. You have more savings to tide you over when times get tough, and you build wealth for the future.

But if everyone gets frugal at the same time, the economy grinds to a halt and there's less wealth for everyone.

For the wonks out there, this is an extension of the fallacy of composition, the error of assuming that what is good for the individual must also be good for the group.

 

Savings Strategy

I save a little over a third of my after-tax income. That's fantastic for me and my family. We're a lot less likely to get booted out of our house or be denied credit if or when we need it, and I'm able to sleep a lot better at night.

But if everyone did what I did, our economy would probably be back to the Stone Age.

Every cable company would be out of business (I cut the cord years ago). And there wouldn't be a lot of people shopping at the Mercedes dealership either.

 

Thrifty Masses

The problem is, there are a lot more people like me these days, either by choice or necessity, which is a big reason why the economy has been stalled out in a slow-growth funk for the past decade.

Roughly 10,000 baby boomers enter retirement age with every passing day, and most of them aren't even remotely close to prepared for it.

According to the Federal Reserve's latest Survey of Consumer Finances, the median American household, with the head of the household aged 65-74, has a net worth of only $232,000, which would include home equity.

Interestingly, the same survey reported that only 53% of American households save any money at all; the rest apparently live paycheck to paycheck.

That $232,000 isn't going to get you very far in retirement.

Assuming the standard 4% annual withdrawal, you'd be looking at an annual income of $9,280.

 

Millennials

But their children, the millennials, aren't exactly big spenders, either. Entering their careers with mountains of student debt, they're marrying and buying cars and homes much later in life than the generations that came before them.

Again, all of these people are doing the right things on an individual level. But collectively, this tightfistedness throws a massive wet blanket over the economy.

That's why, in my opinion, we've had years of aggressive monetary policy by the Fed, and political movements to raise the minimum wage and to forgive student loan debt.

However, in my opinion, raising the minimum wage by a couple of bucks or forgiving some portion of student debt isn't going to compensate for the retirement of 10,000 people per day.