Friday, June 26, 2009

Saving Rate Surge and Recovering from a Recession

As I have said many time in the past, America had become a country of spenders, reckless spenders. From the government to Wall Street to Main Street. America believes to deeply that consumptions is everything to the point where it no longer see the different between healthy consumption and unhealthy consumption; thus, it have leads the world economies into the dire economic recession that we are all in now.

For the first time since 1993, the US saving rate finally surge to 6.9 percent (saving rate were hovering around zero prior) as total income increase by 1.4%. However, commentators and economies alike view this as a negative in a time of recession. Poor consumer spending could slow down the economy as a whole, putting businesses out of businesses. I, on the other hand, view this increase in financial responsibility as a key step in economic recovery, because, unlike the reckless shorter solutions that are being implemented at the cost of trillion of USD, increase saving start to solve a fundamental problem that caused the recession. A natural step by the market and by people to correct an error within the system. Read on to know what I mean.

One of the biggest problem behind the current recession was the fall of the housing bubble. The housing bubble started due to two main factors: liquidity pumped into the system to deal with the .com bubble crash, and the Communities Reinvestment Act. The increase liquidity provided the money needed to start the housing bubble as investors moved their money from the market to real-estates. The Communities Reinvestment Act forces lenders to take on risky account in large quantity. Smart institutions realize they don't really want to hold on to these risky loans; hence, they repackage these loans and used it as collateral to funds their own investment. This proved to be a very successful moves which increased the demand for bad loans. Using bad loans as collateral, institutions started to repackage them and these bad collateral in turn become a major piece in many institutions balance sheet with each risky loan being held by server institutions as collateral. Lenders that didn't copy the same behavior would be left out of the market. Furthermore, with risky individual being able to buy homes, banks now offer them a home equity line of credit (HELOC) to further increase their lending businesses and improve their balance sheet to investors. This fuels an American culture that was already full of reckless consumers.

Credit demands have to be fill by saving, but with a saving of less than .5%, how are American spending like they never have before? One was foreign investment, but that can only go so far as America need to keep its capital account positive to offset the trade imbalance in the current account. To meet the credits demand in America, financial institutions how have a tremendous tool at their disposal due to the housing bubble, the Communities Reinvestment Act, and HELOC. With increase housing price lead to demand for houses from speculator, the CRA make for easy access to these houses for those that would otherwise not qualify, these new house then help creates wealth for new individual that increase their demand on more speculation, this again increase demand for houses, and all this start a vicious cycle that is the bubble economy. Then there is the added HELOC that help finance anything else. With a situation like that, how is it that we not see what the end result would be?

After all that ranting, the question remain: why is an increase in saving a positive thing when we need consumers to help businesses get healthy again? Simple, in this environment, healthy consumption is much more important than reckless consumption. Businesses at this point does not merely need consumer to sustain them alone, but they need financial institutions to start lending again so as to help them meet payroll and give them stability. With a 6.9% saving rate, that is neither extremely high or low. It is also a legitimate first step toward solving our current crisis by providing banks with a solid base to start lending again. Growth is fuel by both investment (a function of saving) and technological progress. We had lose that formula for growth for a long time, and this is a step for getting back to where we were.

Secondly, the decrease in spending could be a huge positive in this environment where there is too much money being added to the system. This decrease in aggregate demand could be what is needed to fight off inflation while still having the abilities to fund all the "recovery program" in the short term. Without this increase in saving, sadly, I would see huge inflation right now which would defeat any hope of recovery that we might have. I would like to end this entry by saying that we should all be happy that we, as American, are naturally fixing this recession by behaving rationally, and to think positive as sign are pointing toward a recovery.

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