We must change our national savings rate. To rebalance the U.S. trade position from deficit to balance requires that the sum of private and public savings match domestic investment. In other words, a country must not produce less than it consumes if it wishes to balance its trade position with the rest of the world.

I also think that a massive shift in consumer behavior is under way—one that will produce great benefits in the long run but slow our recovery in the short term…In the long run, higher saving promises to channel resources from consumption to investment, making capital more readily available to retool industry and fix our infrastructure. But, in the here and now, such a rediscovery of thrift means fewer sales at the mall, and fewer jobs on assembly lines and store counters.

[A]s people come to grips with the fact that their finances are more uncertain than they had ever thought they would be, they are not likely to resume spending at the pace they once did. As a result, we should not expect consumer spending to return to the 70 percent share of GDP that it posted just before the recession began.

[W]hile the announcement that the Social Security trust fund will begin its decline one year earlier is an important fiscal event, the swelling of overall entitlement debt to more than one hundred trillion dollars has far more serious implications for economic growth—implications we are poorly positioned to address given the budget deficits we face today.

Our successor generations are coming to grips with this daunting reality. Faced with the prospect of a government that they believe may be unable to deliver on its promise of long-term fiscal balance—particularly with regard to entitlement programs—these individuals might logically begin to alter their consumption patterns, spending less today to save more for tomorrow. There is nothing wrong with increasing savings. But, in an economy driven by consumption, this intertemporal hedging may dampen the pace of future economic growth.

I agree with your premise that it's important that the Chinese begin to appreciate further. 

Let me just raise a couple of issues which I guess I would call tactical issues, without addressing any specific legislative proposal.

The first is that the currency, while an important issue, is probably in itself not going to solve the trade imbalance problem. There are fundamental saving/investment imbalances, both in the United States and abroad, which need to be changed in order to make real progress on the trade balance.

And in particular we have emphasized with the Chinese the importance of structural changes in their economy, such as increased safety net and improved financial system, that would increase the share of their output going to consumers and being consumed at home. And the combination of currency appreciation and this other set of measures is really what's needed to begin to move things in the right direction.

So I would urge you to broaden your focus just a bit, beyond the currency, to talk about the savings and investment balances that need to be adjusted in both the United States and in China.

     The pension bill that was passed by Congress recently had a provision in it that allows employers to create savings plans with an opt-out provision. That is, an employee is put into the savings plan unless they explicitly request to be let off.

     There's a lot of research which suggests that that opt-out type approach, that most people will stay in the saving plan, and you get very significantly effects that way...

      One, one might consider, I suppose, using the existing Social Security system. There was a big debate here in Congress, of course, about so-called carve-out accounts, et cetera. Something that might be less controversial possibly would be an add-on account, whereby individuals had a chance through their payroll saving -- through their payroll taxes to contribute to an independent account that would be in their name.

In the Q&A session

An alternative perspective on savings and consumption is that the strong recent growth in household spending indicates optimism about future income prospects, rather than any fundamental recklessness. The labor market is reasonably tight, with the unemployment rate at 4.5 percent. Earnings are growing at about a 4 percent rate. The working age population is growing at a 0.9 percent annual rate, and payroll employment has grown significantly more rapidly, at a 1.6 percent rate for the last few years. While employment growth won't be above average forever, prospects for real income growth look pretty solid. Moreover, household net worth is up to 5¾ years of disposable personal income, and has been rising during this recovery, which suggests that savings, properly measured, might not be so low after all.

When a population can be characterized as middle aged, then the economy should tend to have a higher saving rate than when it can be characterized as elderly. Thus, as the population of a country moves from middle aged to elderly, it is reasonable to expect a country’s saving rate to decrease. Unless the country’s investment rate moves identically, foreign capital flows and current account balances will be affected. Exactly how depends on the change in investment.

First, household saving behavior does not seem to have changed in any fundamental way. What has changed to a degree is the trend in asset values. Households have consumed some of the increase in asset values in about the same way they always have.

My second tentative conclusion is that the behavior of households, though perfectly sensible and responsible for households as a whole, has led to a situation in which the United States as a whole is saving too little of its national output. U.S. domestic investment has not suffered, because capital has been flowing into the United States from abroad. However, at some point the U.S. net international investment position will stop becoming ever more negative. U.S. saving will then finance a larger fraction of U.S. domestic investment and, perhaps, repurchase some U.S. assets now held by international investors. There is no reason why this adjustment should be difficult or disorderly, but it will require that U.S. consumption outlays expand more slowly than U.S. GDP for a time. 

Perhaps the most straightforward way to raise national saving--although not a politically easy one--is to reduce the government’s current and projected budget deficits.  To the extent that reduced government borrowing allows more private saving to be used for capital formation or to acquire foreign assets, future U.S. output and income will be enhanced and the future burdens associated with demographic change will be smaller.

The Center for Retirement Research (CRR) has developed a National Retirement Risk Index to measure the share of working-age households that are in danger of being financially unprepared for retirement. Their findings are sobering.  They report that almost 45 percent of all such households are “at risk” of falling well short of the amount estimated to be necessary to maintain the household’s pre-retirement standard of living.  Younger households are particularly vulnerable, as are low-income households and those with neither a defined benefit pension nor a 401(k) plan. 

Another risk has to do with household saving behavior. In the U.S., the personal saving rate has been declining for more than a decade. During the 1980s, it averaged 9 percent. This July, it was all the way down to minus 1 percent. Frankly, it's hard to see how it could go much lower. So the risk is that a sustained rise could occur, which would put a real crimp in consumer spending and therefore in overall economic activity. Though there's some uncertainty about why the saving rate has fallen into negative territory, I strongly suspect that part of it is related to the growth in consumer wealth over the last several years both through rising housing values and through rising stock values. Therefore, the more recent softening in both of those sources of wealth may provide a bit more impetus for a reversal in the saving trend; in other words, it is conceivable that people will shift gears and try to build up savings the old-fashioned way, by spending less. Whatever its source, the very low—in fact, negative—saving rate represents a downside risk for the economy, with the chance of sizeable drop-off in consumer spending likely to be bigger than a surge in spending.

To reduce its dependence on foreign capital, the United States should take action to increase its national saving rate. The most direct way to accomplish this objective would be by putting federal government finances on a more sustainable path.

The low real interest rates throughout the world over the last several years suggest that the most important factors underlying the recent increase in the U.S. current account deficits have been shifts in the desired net savings by the rest of the world. Reductions in desired U.S. net saving may have played a role as well. But if a fall in U.S. desired saving was dominant, interest rates would have risen, not fallen.

Another risk to output growth is the current low savings rate in the United States. For the last three quarters of 2005, the personal savings rate was negative. That means that personal consumption spending exceeded disposable income. So while businesses have be en improving their balance sheets as a result of strong earnings growth, consumer debt has been increasing. The picture for government savings is not any better due to the current large federal budget deficit. Combined, strong consumer and government demand have caused imports to exceed exports, resulting over time in the large U.S. trade deficit, now approaching 7 percent of nominal GDP. To finance this trade deficit, foreigners have acquired large holdings of U.S. securities.  At some point, the domestic savings rate will need to increase to reduce this trade imbalance. Many economists expect that the transition to a higher savings rate will occur smoothly, but with an imbalance of this magnitude, there is a chance that a rapid transition could lead to a downturn in the economy through a sharp falloff in consumption.