WHEN BORROWING STOPS
And what if it does? Although consumers may not have kicked the borrowing habit for good, they give every indication that they're ready for a hiatus. And when consumers turn frugal, the entire economy shudders. A 1-percentage-point rise in the personal-savings rate works out to $100 billion in foregone spending, consulting firm McKinsey & Co. has calculated. That's bad news to makers of brand-name household goods, such as Procter & Gamble, which have lost sales to cheaper store brands. Carmakers also get dinged, because consumers stick with their old wheels longer, according to automotive researcher R.L. Polk & Co.
All too often, lower living standards follow close behind. That isn't the case for households whose incomes are rising, because they can pay down their debt while maintaining their accustomed level of consumption. But the millions of families who borrowed to supplement stagnant or shrinking incomes must choose between spending and reducing their debt. If they keep paying down debt, they'll postpone visits to the doctor, take fewer vacations, and wear the same clothes for another year. "In an idealized economic model," Wesleyan University economist Bill Craighead said, "interest rates, prices, and wages can adjust downward in such a way that demand remains steady enough to sustain economic activity." But in the real world, those adjustments don't happen immediately. Incomes fall faster than prices, and consumers, businesses, and government all tighten up on spending. "Without demand, there's no growth," he said, "and if there's no growth, living standards have to slip."
On the eve of the Great Recession, Americans were spending nearly all of their income. But saving has jumped sharply since.
Personal savings rate, Jan. 1959-July 2011
Source: Bureau of Economic Analysis
There's an upside to consumers leaving their credit cards in their wallets, however. Because so many consumer goods are imported, the U.S. trade deficit falls, as Americans take a pass on Korean widescreen TVs and Malaysian jeans: In July, it dropped by 13 percent to $45 billion, the federal government reported.
What remains to be seen is whether consumers' frugality will last beyond the current downturn. "Consumption is part of our DNA," said Jenny Darroch, a marketing professor at Claremont Graduate University in California. But consumers lose the urge to whip out the plastic, Darroch suggested, when they learn that Bank of America plans to lay off 30,000 and the U.S. Postal Service may dismiss 120,000 workers.
Among corporations, deleveraging is happening before our eyes. Moody's reported recently that the corporations it tracks were sitting on $1.2 trillion in cash at the end of 2010 — money that could be used to develop new technologies, invest in promising start-ups, upgrade equipment, and hire workers. Instead, they're parking their money in safe short-term securities while they wait for business to pick up. In contrast, loans to small businesses fell by $2.5 billion this spring, according to federal estimates, although a new $30 billion federal lending program has loosened up the market a bit.