Yesterday’s report on consumer incomes, spending, and saving showed a sharp rise in the personal savings rate; it also showed a decline in nominal personal incomes, the third in a row, reflecting the weakening economy.
I don’t know who else has made this point, but it’s quite clear that we’re in serious paradox of thrift territory here. Or perhaps more accurately, we’re in a paradox of debt. Consumers are pulling back because they’ve realized that they’re too far in debt. The economy is shrinking in large part because consumers are pulling back. And the result, almost surely, is to leave household balance sheets worse than ever. I can’t do this accurately until the Federal Reserve’s flow of funds data have been updated, but almost without question the ratio of household debt to personal income has been rising, not falling, as consumers try to save more.
He calls this process, following Edgeworth, "damnification", but, as he says in an earlier post, there's another, even more problematic form of damnification (or as Jagdish Bhagwati would have called it “immiserizing growth"), that can confront an economy which is deleveraging and contracting at one and the same time - as the US and Spain are currently doing, and that is price deflation.
But there’s at least one more form of damnification that has me really worried: the paradox of deflation. An individual company or worker can preserve a business or a job by accepting a lower price; but when everyone does it, we get debt deflation — a rising real burden of debt, which weighs on the economy — and also start to have deflationary expectations built into lending and investment decisions, which further depresses the economy. And once you’re in a deflationary trap, it’s very hard to get out.
Now, according to the Bank of Spain in its latest quarterly report on the Spanish economy..... "job destruction and the tightening of financing conditions also contributed to the scaling back by consumers of their spending decisions, dampening the expansionary effects on disposable income stemming from the rise in wages, lower infl ation and the fiscal impulse linked to the personal income tax deduction applied in June. All these factors, along with the reduction in the real value of household wealth, are prompting a rapid recovery in the household saving ratio, which rose in Q3 to 11.9% of disposable income in cumulative four quarter terms, compared with 10.2% on average in 2007".
Now I haven't done any calculations here either, but I would say, along with Krugman, that almost without question the ratio of household debt to personal income has been rising, not falling, as consumers try to save more here in Spain too, and not only that, as I was arguing yesterday, the second form of damnification is about to arrive. Better never to have reached this point, but, unfortunately, there is no turning back the clock now.