BUSINESS

THE SPENDING TRAP

Trouble looms if consumers rediscover their savings accounts

DAFNA IZENBERG October 9 2006
BUSINESS

THE SPENDING TRAP

Trouble looms if consumers rediscover their savings accounts

DAFNA IZENBERG October 9 2006

THE SPENDING TRAP

Trouble looms if consumers rediscover their savings accounts

BUSINESS

DAFNA IZENBERG

As the U.S. housing market deflates, a slowdown in the North American economy now seems unavoidable and economists have begun to ask a frightening question: what happens if, and when, we start saving our money again?

Saving was once considered an integral part of any household budget. But over the past decade, Canadians and Americans have substituted credit cards and car loans for savings accounts. Savings rates, a measure that compares monthly earnings with monthly spending, have been steadily declining for 10 years. In Canada, the savings rate is down to one per cent; in the U.S., it’s dipped into negative territory for the first time since the Great Depression. “People have changed their perspective,” says Don Drummond, chief economist at TD Bank Financial Group. “If they want a new car, where they might have 20 years ago thought, well, we’re gonna have to save for two years to buy that new car, now they borrow and buy it right away.”

All this is raising serious questions about how consumers—who account for more than two-thirds of the North American economywill cope when the economy inevitably hits a rocky patch. Over the past few years, as people watched their homes skyrocket in value (in the U.S., prices have risen over 60 per cent since 200l), they began to borrow against their home equity. “You basically say, I made $20,000 on my house last year, that’s my savings,” says Benjamin Tal, senior economist at CIBC World Markets. “You

let the house do the saving.” Or, as MerrillLynch’s chief North American economist David Rosenberg says, “We turned our house into an automatic banking machine.”

But every bubble has to burst. As real estate values fall in the U.S., many who have been counting their home as their nest egg are waking up to empty savings accounts. “Are you going to sell your house just because you lose your job or you need $25,000 for an emergency? It’s not liquid,” says Tal. Inevitably, economists believe, people are going to revert to the old-fashioned way of saving—not buying as much.

Rosenberg believes we’re in uncharted territory. “How consumers will respond to a balance-sheet shock from deflating real estate values is an open question,” he says. Drummond estimates the wealth people drew from their homes fuelled half the consumption growth in the U.S. for the last three years. But the experts are cautiously optimistic of a relatively soft landing, as both the U.S.’s Federal Reserve System and the Bank of Canada brace for a rise in savings. The Fed, which raised interest rates 17 times over the last two years, has left them alone since August, and is expected to start cutting them in the new year. Canada is likely to follow suit.

Economists predict a gradual upward shift in the savings rate to the neighbourhood of two or three per cent. Chances are, we’re never going back to the days when saving 10 per cent of your paycheque was considered normal. Rosenberg, who is Canadian, believes there will be some “subdued” spending in the U.S., but a sharp collapse is unlikely. After all, he says, even in the most desperate times, shopping is still a North American national pastime. Nl