Saving, Not Spending, Key to Improving Consumer Confidence

At the height of the crisis four years ago, American consumer confidence was high and the average household’s debt-to-personal income was 114.76%. This means that for every dollar the household earned, it held $1.1476 of debt.

Clearly, this was not sustainable and dragged down consumer confidence. Since the crisis four years ago, the average debt-to-personal income has come down from 114.76% to the most recent reading at the end of 2011 of 101.1% (source: New York Federal Reserve).

This shows that the average American, with less consumer confidence, is at least paying down his/her debt somewhat. But with the average household still holding slightly more debt than money coming in, the average American still has some work to do in order to restore consumer confidence.

Unlike most economists, I don’t subscribe to the notion that 90% (one dollar earned for $0.90 of debt) is where the average debt-to-personal income level should be.

The real headwinds working against consumer confidence is a decrease in real wages, which I’ve been highlighting recently. If the average wage cannot keep up with inflation, then the average American must dip into savings to make up the difference in order to maintain his/her standard of living. Consumer confidence cannot improve under these circumstances.

Speaking of savings, if interest rates are close to zero, then the average American earns little in interest income, which he/she needs to help pay down debt. Consumer confidence can’t grow if debt is not paid down.

When we take all the above together, it means that GDP growth will be nonexistent in 2012. Since 70% of GDP is made-up of consumer spending, GDP growth cannot pick up any momentum when consumer confidence is faced with the above scenario.

This is not because I want to see the U.S. in a recession or that I’m against consumer spending and growth. It is actually just the opposite.

If the consumer earned higher wages to offset inflation and had some money left over to pay off some debt, combined with earning higher interest on savings so that the interest income can be used to pay down debt, then consumer confidence would strengthen.

If the average household’s debt-to-personal income was, say, 50% ($0.50 of debt for every dollar earned), then the average American consumer would not have a high debt burden to stress him/her out, which would increase consumer confidence. Under these circumstances, consumer spending and growth can resume!

The White House is fighting a natural process. Households must be encouraged to save so they can pay down debt and reach a point where the debt is manageable, so that consumer confidence can grow and consumer spending can resume. The government should not only be helping people save, but also encouraging it—how’s that for a change?