The End of Affluence

Increasingly, even economists and bankers are coming to understand that we are in the midst of a global economic shift. The core of this change is the inevitable decline in American consumption, which for a generation has been fueled by borrowing and debt. The bill now has to be paid, so the trend of steadily growing U.S. affluence can not continue. Because consumer spending constitutes almost three-quarters of the U.S. economy, a decline in consumption will cause a general and long-term economic decline in this country. A slowdown in the world’s biggest economy will, of course, affect the whole globe.

The centrality and toxic nature of U.S. consumerism is highlighted in an op-ed piece in this week’s New York Times by Stanley Roach entitled “Dying of Consumption.” “It’s game over for the American consumer,” writes Roach, who is the chairman of Morgan Stanley Asia. His argument and many of the statistics he uses are similar to those I marshal in my chapter on “The End of Affluence” in The End of the American Century. Roach points out that for over a decade, “vigorous growth in American consumption has consistently outstripped subpar gains in household incomes.” The consequence has been a long-term decline in household savings and a huge increase in household debt. From 1950 to 1985, American consumers saved roughly 9% of their disposable income. Beginning in the 1990s, that rate steadily declined, dipping below zero in 2005—for the first time since the Depression. At the same time, consumer and mortgage debts rose from 77% of disposable income in 1990 to a record 127% in 2008.

According to Roach, this

“decade of excess consumption pushed consumer spending in the United States up to 72 percent of gross domestic product in 2007, a record for any large economy in the modern history of the world. With such a huge portion of the economy now shrinking, a deep and protracted recession can hardly be ruled out.”

The problem is that the whole American economy is built on consumption. The U.S. doesn’t actually produce much any more. Manufacturing has steadily declined as the linchpin of the American economy, and now constitutes less than a fifth of GDP. The imminent bankruptcy of the U.S. auto companies is simply another (albeit big) element of this downward trend. Meanwhile financial services—primarily banks and mortgage companies—have steadily grown, mostly by providing loans to consumers to finance purchases their incomes will not allow. So when both consumption and financial services decline, on top of the previous decline in manufacturing production, there is not much left. It will take a long time to rebuild the U.S. economy. There will be much belt-tightening for the middle class, growing unemployment, and more suffering by the poor.

Roach is opposed to “tax cuts aimed at increasing already excessive consumption.” I make a similar argument in my previous post on “Tax Cuts Will Make Things Worse.” Such cuts will decrease federal revenues, which are desperately needed to allay the new and mushrooming costs of unemployment insurance and mortgage foreclosures, not to mention the preexisting problems of health care, education, the environment, Social Security, and Medicare, all of which have been under funded for a generation.

Meanwhile, both the Bush administration and the incoming Obama team seem to feel that the best way to alleviate the economic crisis is to promote even more deficit spending, by both government and consumers. The federal deficit, already at record high levels, will balloon even higher with a trillion dollars or more of bailout money. Much of this money is being thrown at banks, mortgage companies and financial institutions to enable them to lend even more money to consumers who are already deeply in debt. This may (possibly) help stimulate the economy in the short run. But in the long run, we all have to stop spending and buying so much, and learn to save and invest. As Roach sums it up:

"Crises are the ultimate in painful learning experiences. The United States cannot afford to squander this opportunity. Runaway consumption must now give way to a renewal of savings and investment. That’s the best hope for economic recovery and for America’s longer-term economic prosperity.”

This shift, from consumption to savings, will be wrenching and painful for America, and for much of the rest of the world. As Britain’s Economist magazine notes (in "The End of the Affair"), America’s “return to thrift” presages a recession that will be both “long and deep.” It marks a fundamental shift in global economics, and in America’s role in the world.