Personal Income and Savings: The Paradox in Action

Buried in these numbers, released Monday, is a dark and worrisome problem: BEA : News Release: Personal Income and Outlays, December 2008

Take your time to view the Personal Income [Current Dollars] line. You will see that personal incomes, unadjusted for inflation, have been declining during the last three months. Down 0.1% in October; 0.4% in November; and 0.2% in December. This is a very clear sign of the shrinking workweek and rising unemployment that are now features of our current crisis.

Scroll down the page and you will see that Personal Savings jumped strongly in December reaching $378.6 billion, up from $299.1 billion in November.

Now let’s put these two numbers together.

Households are obviously saving more. The jump in December is a sure sign that the recession is making the average American family much more conservative and less willing to spend. Fears about layoffs and the general weakness of the economy have caused people to ratchet down spending very dramatically. Plus the continued downward spiral of home prices has reversed the ‘wealth effect’ that underpinned the public’s willingness to take on more debt during the last decade or so. Now it seems as if there is a ‘poverty effect’ causing an exaggerated flight from debt.

But, as we have seen before, an increase in savings does not necessarily mean that household balance sheets are stronger. Those falling personal incomes betray a source of weakening. As incomes shrink even the extra savings are not enough to stop balance sheets eroding. So in all likelihood families are even worse off after their savings efforts than before. We won’t know for sure until the Federal Reserve publishes it’s detailed look at money flows in early March [they are quarterly figures], but it is beginning to look as if we are in the midst of a classic squeeze.

Extra savings means less demand. Less demand results in less income. Less income forces extra savings. And so we spiral down. It is the ‘paradox of thrift’ working to full effect.

The only way out is to replace the lost private spending with massive public spending. Now. Every day lost means more jobs are lost and the problem worsens. This is an textbook example of the failure of free markets to self adjust within reasonable bounds.

Look at those numbers. The textbook is wrong. How lovely is it to see the falsification of a hypothesis right before your eyes.

Of course we have known all about this since Keynes pointed it out in the 1930’s. Maybe this time we will absorb the lesson. Under some circumstances government is good.