US debt trends and policy implications

U.S. Debt

a) According to the Bureau of Economic Analysis, the U.S. personal savings rate was just over 4% for the fourth quarter of 2009. This represented a slight increase over the previous quarter. The trend line since the first quarter of 2008 shows that personal savings rates in the United States have been increasing for the past two years, following a period of two years where savings rates decreased steadily to just over 1% (BEA, 2010). Net saving as a percentage of gross national income, however, has been on a steady decline, with recent quarters showing negative net savings (BEA, 2009).

b) There are a number of possible causes for the decline in the savings rate. One is that access to credit has become easier, which in turn makes it easier for consumers to spend. It has not become easier to save. Another major contributing factor is that real wages have been declining over the long-term, having peaked in 2003 (Mandel, 2008). This compels either a sacrifice in lifestyle or increased borrowing, and Americans have chosen the latter.

c) Declining savings increases personal debt, which in turn increases personal risk. Bankruptcies increase, resulting in shocks to the financial system -- mortgage foreclosures in particular. Spending with credit has also fueled the trade deficit, as consumers spend much of their income on foreign goods, in particular oil which has a very low price elasticity of demand.

d) While the economic downturn has forced the savings rate back upwards, there are a number of policy responses that could impact the underlying problem of real wage stagnation. Real wages have stagnated in part as employers have been forced to spend more on benefits, especially health care. The new health care reform may result in lower employer spending on health care, allowing for real wages to increase. In addition tighter restrictions on credit, especially predatory lending, could restrict access to easy credit, possibly compelling consumers to save more.

2. a) the rising level of U.S. debt is not sustainable indefinitely. Our debt is backed by our economy, which while being the largest in the world is not infinitely large. In most countries, a rise in debt would have a series of economic consequences leading to the devaluation of the currency and a return to an equilibrium. This has not happened with the U.S. dollar because of a unique externality -- its role as the world's currency. However, that role itself dependent on a number of factors, including but not limited to domestic resources stocks, strong legal and political systems and sound economic policy. It is conceivable that a shift in these underlying qualities -- such as the decline in foreign confidence in U.S. accounting systems -- could signal a shift to other currencies such as the Euro as the world's default. Without that key externality, the U.S. dollar would be subject to collapse. This may take more time to occur with the dollar than with other currencies, but ultimately market forces will prevail, meaning that the U.S. debt situation is not sustainable indefinitely.