Secret of long-term economic success

Wow! That’s a bold title. Right?

Let’s distill it all down to principles shall we?

The model for long-term economic success is:

• income > spending = savings (or investments)
• savings/investments are directed to places where benefits > costs

And that is all it takes. The wonderful thing about this is that it is scalable. Meaning that it applies equally well to individuals as to businesses. This also provides a very nice criteria for evaluating the health of a nation’s economy.

So how has the U.S. done? Not well. For almost a decade folks and businesses in the U.S. have spent more than they have earned. And what is more, they have made some very poor investment decisions as well. Ouch!

I said above that the model is scalable, yes? That implies that there are smaller and larger participants in the economy. The smaller and more numerous participants are you and me, the Consumers. And how have we done? Many of us have done abysmally. A large number of us are leveraged up to our eyeballs (as the old commercial goes). What’s worse, the savings/ investments culture that was created during the Great Depression is largely gone. This means that it is no longer part of our cultural DNA to save money.

When I made my proposal for change several months ago I had said that the U.S. consumer needed to learn how to save money again. I also said that in the context of “the people need to change” for there to be a recovery. The job for consumers was to begin saving again and to pay attention to their investments. So how is the U.S. doing in this deep recession? Pretty well.

Forced by the recession to really pay attention to their finances, many U.S. consumers have gotten savings religion. Many economists feel that even once the economy recovers that this trend will continue. They are forecasting growth in spending at around an inflation-adjusted 2%, rather than the previous decade’s 3.5%. This is a huge reduction of ~43%!

[As an aside: which businesses do you think will be hurt by a reduction in U.S. consumer spending? That’s right retailers and restaurants. So would you want to invest there?]

While this number sounds troubling to a particular type of business, according to the model I outlined above, this is a GOOD thing. Why?

Because it should restore balance to the worldwide economy that has been way too dependent on the U.S. consumer’s penchant for credit card, home-equity loan, and other debt-fueled spending that has been financed by emerging markets, such as China whose citizens are savers. How can the U.S. be healthy in the long run if we are debtors? Obviously, we cannot be healthy.

The question is whether or not this change in behavior is temporary or permanent? It’s really hard to say as behavior ultimately drives spending and as we all know behavior can be very hard to change. However, because of the huge population bubble of the Baby Boomers having lost a lot of their retirement savings in the last two years, it is very likely that they continue to save at the levels that are being established in the recession. Whatever the case may be, this is one of the most important things for us to continue to pay attention to. The model that I shared with you provides the basis for understanding its importance.

Jason