Saturday, February 03, 2007

U.S. Savings Rate was a Negative One Percent in 2006

It was reported on Thursday that the savings rate for 2006 was a negative one percent. This is the fifth time in 74 years that the savings rate has been negative for an entire year. There were two times in the 30’s 1932 and 1934 when unemployment was 20%. My question for years has been, so what. Is the savings rate a measurement of any value?

What is the savings rate? According to the government it is the net of all income minus the net of all expenses by all entities (government, companies, individuals). Let us look at an individual savings rate. Theoretically between ages 16 and retirement age, the person should be saving. They do this in the hope of achieving a balance sufficient to provide their needs in retirement. During retirement what is a person’s savings rate? Possibly in the first few years the individual may be saving, but most likely by the end of the fifth year, the individual is in spending slightly more than they save. During the course of a life time theoretically the individual has a net savings rate of zero. Everything that is saved during working years is spent during the retirement years.

With that stated, what is the theoretical savings rate of the United States or for that matter any country? We know there are about 160 million workers who for the most part create more than they spend. We also know there are about 40 million retirees. Assuming retirees take 42% of life time indexed wages from workers in the form of Social Security, another 2.9% of wages in the form of Medicare taxes and with drawl from savings to live on. There is a point at which the savings rate will go negative. In fact it must go negative in the case of the United States.

A boom begets a boom and a bust begets a bust. About every 20 years the births per year increase and then begin to decrease. Because people work for 45 years and retire for about 20 years, we have a natural wave of up and downs. With a decreasing birth rate per woman, the ups and downs are flattening out and making the last up more pronounced.

If there are four workers for every retiree, then each worker who is supporting a retiree at 70% of their pre retirement income must contribute each one fourth of the 70% just to be at a zero percent savings rate. Now this will change with over sea's investments. However, in this simple analogy I think it is clear that a negative savings rate should be expected.

Now for the bad news. Because Social Security and Medicare are both pay-as-you-go programs and are not funded, we have a problem. Had these programs taxed the current retirees sufficiently to fund their own benefits, then we would be drawing down on stored wealth. But because they were not funded using accrual accounting, we have nothing to draw down but our savings rate of current workers. This means the national savings rate will only get worse.

In my opinion there should be several savings rates. One for those who are working. This will indicate how well current workers are preparing for their future retirement. The other is the negative savings rate of retirees. This will indicate how fast accumulated wealth for retirement is being consumed.

NBC-33 Debate poll results from 2002