How Can the Economy Grow If Consumers Become Savers?The consumer savings rate jumped to 6.4% in June, the highest it has been in a year, and far above prerecession levels. But this surge of responsible behavior on the part of Americans isn't exactly good news. Sure, it's a natural response to being unable to borrow money and to watching 401(k) accounts fall in value after a decade of trying to do what the experts say you should -- save for retirement.

With companies cutting back on salaries, people are realizing that there's only one piggy bank they can rely on: their own (dwindling) income. But with 70% of GDP growth coming from consumer spending, this high savings rate is bad news. It looks like it's time to change the structure of the U.S. economy, and one possible source of the change is corporate cash.

The current high savings rate could mean that consumers are feeling uncertain about the future. But that explanation holds no water -- after all, the only things that are ever certain in life -- regardless of who the president is -- are death and taxes.

Ominous Signs

The new dimension now is that many government spending incentives -- such as cash for appliances, cash for clunkers and homebuyer tax credits -- have expired. In addition, the U.S. Census has largely finished its data collection, which means the hundreds of thousands of temporary jobs that it provided are gone as well.

Economic growth is certainly showing signs of slowing down, as the modest 2.4% second-quarter GDP growth suggests. And without government incentives to keep consumers spending, the savings rate is likely to stay high: Consumers are probably going to be cutting back even more as those who are still employed are forced to take pay cuts.

For example, The New York Times reports that a Mott's apple juice and sauce plant near Rochester, N.Y., is asking 300 unionized workers -- now on strike -- to accept a pay cut of $1.50 a hour along with a drop in Mott's 401(k) contributions and "higher employee contributions to health insurance." At a paper mill in Madawaska, Maine, 460 union workers agreed to an 8.5% pay cut in May "to help keep their paper mill in business," according to the Times.

The New Engine of Growth: Corporate Fear


Will corporate spending pick up the slack and help the economy grow when skittish consumers become heavier savers? Apparently, no. According to the The Washington Post, orders for manufactured goods dropped 1.2% to $406.4 billion in June after declining 1.8% in May.

Corporations have also gone on a spending strike, and they're piling up cash: $1.84 trillion worth so far, to be specific. Convincing them to get that money working could mean a real boost to GDP growth -- but what could get companies to start spending it? In a word: fear. But not just any fear -- what I mean is fear of falling behind their competitors.

Companies will start to feel that fear when their earnings growth slows down after they have reaped as much benefit as they can from cost-cutting. At that point, companies will need to find their profit growth in higher sales, and the fastest way for big companies to increase sales is to acquire other, faster-growing companies that have big revenues.

Creating a Feeding Frenzy


If your leading competitor makes an acquisition, you're going to feel that fear of falling behind. One way to alleviate that fear will be to make an acquisition of your own. That will leave all the other players in your industry suffering from that same fear, creating an acquisition feeding frenzy.

Sure, I'd like to see another decade of technology-led growth, as I've written in previous articles on DailyFinance. But as long as consumers and businesses are on a spending strike, we're not going to see our economy grow much. Our best hope of ending that is companies flush with cash start feeling the fear of falling behind their competitors.

This could be what Keynes meant when he was talking about "animal spirits" moving the economy.

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isill

A prosperous economy is fundamentally all about job creation, productivity and consumer confidence, and generally, our innovative tech sector has lead us out of previous recessions.

While the state of our economy is suffering from one of the most devastating downturns since the Great Depression, some countries are actually enjoying good economic times. Where is that economic fuel coming from, and why aren't we exploiting it?

Recognized as a key economic engine, technology innovation and entrepreneurship contributes significantly to job creation, productivity and GNP. It is the driving force behind sustained economic growth and rising incomes. Why is this occurring outside the US and not within it? China, Russia, Israel, Sweden, even New Zealand are experiencing technology gains, and with it, achieving economic boom.

Intel's new microprocessor research and manufacturing is now being produced in Bangalore, India and in Israel, no longer in Santa Clara, California or Hillsboro, Oregon. Google, Microsoft, Oracle, Cisco, EMC, Symantec, and Applied Materials have also set up major operations outside Silicon Valley. Once the life blood of Silicon Valley, venture capital investment in innovative growth industries like mobile, cloud computing, open source, security software, information technology, medical devices, biotech, alternative green energies and clean tech are all finding their way to bolster other country's economies. These countries are displacing Silicon Valley's inflow of capital, employment opportunities, technology edge and its stature as a worldwide leader. As an example, Israel now has 1,800 active high tech start-ups, all hiring and expanding with a diversified pipeline well poised for continued growth as a venture-backed economy. Both IBM and Microsoft recently invested in Israel startup tech companies in excess of $300 million.

Why? Well, because we are no longer as attractive to investors. The risks in the US are now greater and the returns lower. We are quickly dismantling our country's growth engine with massive deficits, regulatory job-destroying burdens, increased governmental programs and costs, major tax increase initiatives, bailouts, export driven outsourcing, locked up credit, carried interest and capital gains tax uncertainties. All of these elements signal investor caution and cause our continued unemployment.

The impact of high unemployment translates directly into the projected wave of housing foreclosures that will hit the economy in the second half of 2010. Over 900,000 homes were foreclosed in 2009, 7.3 million home loans are now in some stage of delinquency, and the foreclosure rate for 2010 is projected to exceed 1 million homes, according to RealtyTrac, Inc. At this present rate our economy won't improve quickly enough to reverse or even slow foreclosure rates.

Much like the Great Depression of the 1930s, and the Recession of the early 1980s, history does in fact repeat itself. All indicators point to an economy which is now sluggishly at the bottom of its economic cycle, such was the case in 1933 when the Roosevelt Administration deployed its "stimulus plan" with FDIC bank deposit guarantees, SEC oversight regulations, and moved away from the gold standard so as to inject monetary stimulus via currency. Those moves translated into consumer confidence, increased employment opportunities, sparked innovation (IBM, GE, GM, P&G) and brought consumer confidence back into the banking and financial markets. Ironically enough GM's stock dropped to $1 per share during the Great Depression?it hit $1 per share again in 2009, its lowest point since 1933.

As to the 1981 economic recovery tax act, better known as "Reaganomics", the administrative policy provided a 25% cut in personal tax rates. By reducing marginal tax rates and improving economic incentives, the act increased the flow of resources into production, creating employment thereby boosting economic growth. The Reagan tax cuts proved that reducing excessive tax rates stimulates economic growth, reduces tax avoidance, and can actually increase the amount of tax payments generated by the rich. Excessively high tax rates are actually counterproductive and result in de-incentivizing capital investments (key to employment growth), which in turn suppresses governmental tax revenues. Simply put, tax cuts are key to job creation. Job creation and low unemployment are key to consumer confidence. All of which are key to economic recovery.

A prosperous economy is fundamentally all about job creation, productivity and consumer confidence. The Obama administration's focus should be on initiating tax cuts, boosting mortgage interest deductions, cutting governmental spending and deploying additional stimulus spending so as to create jobs and get us on a path to a sustainable 4+% economic growth rate. Enacting those policies and governmental mandates quickly is the key to insuring our economy's rebound and long-term success.

August 07 2010 at 4:20 PM Report abuse rate up rate down Reply
scottee

we need to be savers! and we need smaller government and fewer taxes! more spending and debt is NOT the solution to a spending a debt problem. how stupid can we all be? we need to save our money and not give it to Washington! how do we do that???

August 05 2010 at 8:06 AM Report abuse rate up rate down Reply
bluegrassguitar

Let's see if I understand...Company A acquires Company B through a stock offering to the shareholders of Company B (usually how it's done) thus "buying" its assets and debt, including customers and products. The shareholders of Company B come out ahead because they were given a premium in stock for approving the trade. So, unless I happened to own stock in Company B, what does the merger do for me? Does it somehow make me want to go out and spend money? No, not really.

August 04 2010 at 4:43 PM Report abuse rate up rate down Reply
hello

Animal spirits!? Come,come Mr. Cohan,we can do better than that. But I guess that's part of the elites thinking when the rest of humanity is seen as animals that must be prodded and pushed. What is this thing with wanting the fruit but never putting in the labour. From the ashes of the old comes the new and that requires time and building up(savings).We had a terribly planned harvest(housing boom) and now hopfully common sense is prevailing,and may people like Mr. Cohan have the patience to sit on their hands in their ivory towers and let the people on the front lines get on with the work of rebuilding.

August 04 2010 at 3:59 PM Report abuse rate up rate down Reply
xkalbr

Let's see how corporate acquisitions create jobs: consolidation = efficiency by eliminating duplication, i.e. jobs made redundant by the merger. This makes money for the people at the top of the corporate food chain who already make more than they can spend at the expense of those further down who are eliminated and have less income to spend on unemployment, and ultimately none at all once the unemployment runs out. Fewer people with money to spend accelerates the contractive force in the economy. The moral of the story: inverted pyramids are always tippy, and none more so than the wealth/income pyramid. Want to grow the economy? Try the opposite of Cohan's prescription and enforce corporate divestiture throughout the economy so that all the positions eliminated by consolidation are restored. Want a do-over on the catastrophe of the 1930s? Continue and accelerate corporate consolidation like this guy wants. How did we get where we are? By people who think like Cohan teaching MBA students. By the way, Peter, are you short the market? If so, at least somebody will make money from your idea.

August 04 2010 at 3:18 PM Report abuse rate up rate down Reply
pozboys

It should be obvious that we are in a global economy by now, and the numbers, population wise, are telling in that the US is outnumbered as far as being able to spend our selfs out of the present situation! On a per capital basis, the growing markets are all in China and India, and we will fast be taken over, in all leading consumer areas. With this in mind, our larger companies, are now in a race to see who can make the most impact in these areas of growth, and the manufacturing of goods, always a stimulus to job growth, should follow!The biggest problem to this is, most of the manufacturing is now done out of the US, meaning that the American worker is now out of the picture! Until, either by a change in tax policy,or a political "will" to penalize off shore manufacturing in some way, the situation we now find our selfs in, will not be rectified soon. The shrinking of Americas middle class bodes ill for the future of the country, and the elitist mindset of the rich and powerful, fails to take into account this vital fact, of the countries need foe this vital

August 04 2010 at 10:36 AM Report abuse rate up rate down Reply
erink91321

All Data suggests that You Save Your Money. You Will Need it in the Future. There are Many Factors Waiting in the wings, not just Economic factors, that are about to Blow the Entire System apart. Many of these Factors are Environmental as Temperatures rise Across the Globe and Crops start to Fail. Natural Resources are also Dwindling quite Rapidly and Governments are keeping that a secret for now to avoid panic. Just do the Math

August 04 2010 at 10:11 AM Report abuse +1 rate up rate down Reply
1 reply to erink91321's comment
velociwrangler

ERINK...Here's something for you to ponder in relation to the supposed Global Warming from GreenHoax gases. If there are crop failures as the atmosphere changes due to drought, should there not be a corresponding increase in rainfall elsewhere that would create new croplands, or is your world simply negative 100% of the time. I only ask because it is statistically impossible for any given enviromental change to negatively impact 100% of the people, 100% of the time in 100% of the globe.

August 04 2010 at 10:41 AM Report abuse -1 rate up rate down Reply
dlwoodford

What our country really needs are jobs. Not just high tech jobs either, our country cannot survive on high tech only. Believe it or not, not everyone wants a high tech job. We are a country of working people. We also need to close our borders and stop all the illegals from coming in here. And I really hate to say this but we need to change the policy of anyone that is born here is automatically a citizen. No other country allows any of these things, when are we going to smarten up?

August 04 2010 at 10:09 AM Report abuse rate up rate down Reply
Artie

I think this problem of over-saving is overblown. Frankly, its a good thing that people save more and hopefully becoming more responsible for their own financial well being. This country, unfortunately, has been built on credit and living beyond one's means and this is largely why we are in the morass we are in. It didn't help that our dopey Government and the Wall Street "wise guys" were largely responsible for fueling this fiasco. People need to become financially responsible, learn to live within their means and save more for their own retiremnt. People are also going to have to put their savings to work somewhere. The banks and US Treasury are paying next to nothing, especially when you factor in things like taxes and a return to traditional inflation rates at some point. So, I'm thinking the stock market is looking better and better. Also, once more people are put back to work the housing and real estate market will rebound. It is still a buying opportunity for those who have the money and the means to purchase a home. It's job creation that is the real sticking point and the most problematic issue facing this counry at the moment. Unfortunately, that is a problem that is not easily or quickly resolved in this global market, where outsourcing and the shrinking of our manufacturing base has become a chronic issue.

August 04 2010 at 10:07 AM Report abuse +1 rate up rate down Reply