December 13, 2011


Title: The savings dilemma

Sub-title: Politicians preach about the importance of stimulating consumption to get the economy moving again. Are they right?


Kevin Hughes, an economist at the Canada Mortgage Housing Corporation was in Europe recently visiting some older relatives. During his stay he noticed a bag of rags clogging up one of the closets, which he offered to take out with the trash. “Not on you life,” he was told. “You never know when they could come in handy.”


Hughes told the story at a meeting of the Association of Quebec Economists earlier this month to illustrate the change in attitudes that has taken place during recent decades regarding the virtues of thrift. At one time saving was considered a worthwhile endeavour and a habit worth teaching children. The “Protestant,” work ethic, which took hold in the United States, also included a respect for frugality, which spread to non-Protestants both there and in Canada.


However starting with the advent of the baby-boomers, - the “Buy-now, Pay-later Generation,” - both savings, and the very idea of saving went out the door. The result, as everyone knows, was the massive US housing bubble, and ensuing recession and financial crisis. Yet here in Canada, nobody seems to have learnt anything. According to Statistics Canada, household debt hit a record high during the third quarter, and the only savings most of us do is related to retirement or kids’ educations.


The virtues of thrift

That said, the increasingly hectic pace of modern life means that the benefits of building up a nest egg, to tide you over during tough times, are rising too.  The first manifestation is the disappearance of long term careers. Unless you work in the public sector, your chances of keeping the same job for the rest of your life are near-zero. Recessions, outsourcing, and creative destruction (eg. bank tellers and gas station attendants whose positions were replaced by ATMs) force people to move between jobs several times during their careers. Having money set aside provides major assistance during those transitions. 


Jobs aren’t the only thing that isn’t permanent – chances are your “significant other” isn’t either and that ahs financial consequences too. Close to half of all legal marriages will end in divorce. For common law partnerships the statistics are worse.


That’s important because homeowner couples are often indebted to the point that meeting monthly payments requires two salaries. That means making a quick home sale to ensure a speedy breakup can create significant losses, especially when market timing is poor. As a result many couples are forced to remain in toxic relationships for financial reasons. Having a nest egg set aside won’t solve all of those problems. But it will provide confidence that the couple can make it through tough times in an orderly fashion.


Having a next egg also makes it easier to navigate “black swan,” events.  Popularized by writer Nassim Taleb, these are events that people never imagine will occur. Yet like real black swans (which nobody thought existed, until they were discovered in Australia) black swan events, such as weddings, funerals, unforeseen medical expenses, do occur. If you live long enough, they are certain to occur, many times.


Disincentives to saving

Yet despite the obvious benefits of saving, there are precious few clear incentives, beyond prudence, to do so. Continued relatively easy credit availability here in Canada means that people generally figure that if hard times hit, they can always borrow money on their credit cards or take up a home equity loan.


In addition, the interest rates paid by financial institutions are currently below the inflation rate. That means at yearend, your purchasing power has decreased. Worse, unless you put your money in a Tax Free Savings Account, you will actually pay taxes for the privilege of keeping money aside.


Furthermore almost all public and private sector incentives push people to spend. Part of this related to what economists call the “paradox of thrift,” which is that while saving is good for individual households, if everyone does it, economic production falls, and everybody is worse off. As a result, almost all public policies these days are designed to encourage spending, as opposed to saving.


Social trends, particularly the increasing importance of short-term appearance also favour spending and borrowing over saving. Our increasingly fast-paced society means we go to increasing numbers of job interviews, parties, school events, singles bars and business functions, where we need to assess others quickly. If we borrow money, we can finance almost any look that we care to assume. And those we are influencing are unlikely to ever find out about. However those who save money, and live modestly, will often be judged severely, as being more homely and less successful than the spendthrifts.


What goes around…

That said, although savings rates are unlikely to bounce back to historic levels anytime soon, there may be some room for optimism at least on the debt front. “The National Balance Sheet Accounts, indicate that the federal government’s move to tighten mortgage interest rates earlier this year made some headway in curbing the growth of household liabilities,” notes David Onyett-Jeffries, an economist at RBC Economics, in a recent note to the bank’s clients. “We expect credit growth to continue to moderate on the forecast horizon.”


There is however cause for caution, notes Hughes. “Many economists today weren’t around during the recession of the early 1990s, so they do not realize just how bad things can get,” says Hughes. “However older folk who have been through really tough times, will tell you about the virtues of preparing to navigate through those periods.”


Maybe we could learn a little bit from them




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