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Despite what bearish commentators may be telling you about the health of the US economy, the notion that US consumers are spending more than they are earning after-tax is an "old wives tale" – say some economists.
The best measure of household savings in the US is the Federal Reserve’s Quarterly Flow of Funds Accounts, says Claymore’s Chief Economist, Brian Wesbury. According to this data US households had $62.5 trillion in assets at the end of September, $11.4 trillion in liabilities and a net worth of $51.1 trillion.
"This is a record level and $5 trillion more than a year earlier", Wesbury exclaimed in a note to clients on January 2, 2006.
Of the increase, financial assets improved by $3.3 trillion suggesting that US households may be one of the best, not worse, savers in the world.
Market bears have long touted a negative savings rate statistic as a reason to be skeptical of the future health of the US economy. What are they missing, if anything?
It appears that the methodology for calculating the savings rate by some agencies like the Bureau of Economic Analysis may be flawed. For example, when a car, home or computer is purchased, the entire amount is subtracted from income, even if it is paid for over time – skewing consumption upwards.
Spending on education is also considered to be part of consumption, however education is an investment and according to Wesbury would be treated differently on a set of corporate books. Moreover, capital gains on 401K’s, IRA’s and other savings accounts including the gain on a home are excluded from income. However, taxes paid on these gains subtract from income creating what is known as a downward bias on income.
Furthermore, as the number of retirees grows, consumption funded by personal savings will continue to grow. Since savings is not part of the income calculation, this will exacerbate the perception of a negative savings rate in the US and in other places like Canada.
Wesbury also explains the difficulty government has separating business spending from personal spending because so many small and large businesses buy office supplies and construction materials at retail outlets like Office Depot, Staples, Home Depot and Lowes.
"To the extent that government counts business spending as consumption, savings will be undercounted", he said.
Finally, personal income, wages and salaries are often initially understated and then later revised upwards. Given the likelihood of a positive revision in 2005, the negative savings rate could easily be revised away.
BMO’s Deputy Chief Economist Douglas Porter says, "The savings rate has been a lousy leading indicator for consumer spending in both Canada and the U.S. in recent years. That is, just because the savings rate is low (or even negative) tells us nothing about whether spending will lose momentum or pick up speed in the year ahead. In addition, the savings rate doesn’t even help tell us if household finances are improving or deteriorating. Household net wealth is now at its highest level on record at more than 5 times disposable income in Canada, and that is in spite of a reported negative savings rate."
The bottom line is that the savings rate can be a highly misleading measure by itself, and should be treated with a great deal of caution by investors.
The next time you read or hear about a negative savings rate being used to support a pessimistic outlook for the economy – don’t be naďve. Things may not be as bad as some would have us believe.
Neil Murray is an investment advisor and financial planner with BMO Nesbitt Burns Inc. in London. Reach him at (519) 646-2313 or e-mail neil.murray@nbpcd.com.