by: Issues: May / June 2006. Tags: Strategy. Categories: Strategy.

“Look at or into the personal savings habits of Canadians and you’ll see a few distant early warning signs. Those habits are unlikely to change anytime soon, which is why executives should take note and act.”

Executives do not typically pay much attention to personal savings. Pity! How much people save or, in Canada’s case, how little, has important implications for running a business.

Personal savings is the forgotten business condition. It may be about to make a rather noisy appearance. Personal savings is a technical concept. First, what it is not: personal savings is not what people have accumulated over time in bank and other deposit accounts, certificates, receipts, common stocks, preferred stocks, bonds and other more exotic financial instruments. Rather, it is the difference between what people take in and spend over a period of time, usually a quarter of a year or a year.

Because personal savings refers to an amount of money over a period of time, it is called a flow economic variable. It is to be distinguished from a stock economic variable like the money supply, which is an amount at a particular point in time. In other words, you could say that your consumption of calories in a day is a flow variable, while your body weight is a stock variable. The amount of money that people have accumulated over time is the sum of successive years of personal savings.

It is an understatement to say that saving does not inspire Canadians in 2006. Generations of financial prudence are seemingly out the window. Astonishingly, household savings relative to disposable income, one of the best measures of personal savings, is now likely marginally negative — meaning that, as a nation, we Canadians are spending on consumption beyond income after taxes. (Consumption includes spending on durables like cars and appliances, semi-durables like shoes and clothes, non-durables like food and gasoline and services — that is, everything from the dentist and the bank to the gym and the hairdresser.) Only the Americans and the Australians match our profligacy among major nations. In contrast, in European countries like France and Germany, the personal savings rate is close to 10 per cent. The generation of Canadians that learned the savings habit as young adults in the Great Depression of the 1930s — wherever they are — must wonder what has become of us.

Just because personal savings is negative, of course, does not mean that all Canadians are in the financial hole. Quite the contrary! Many individual Canadians, particularly those over 50, are huge savers, but these folks are more than offset by the younger crowd, who are spending — to use a term that surely applies — like drunken sailors.

You cannot spend beyond your intake without dollar for dollar adding personal debt. Chronic personal financial excess has now left Canadians with record personal indebtedness. Fortunately for the Canadian economy, the aggregate improvidence of the Canadian people is offset by the savings of Canadian corporations in the form of retained earnings, and by governments in the form of surpluses, so that Canada does save albeit well below what is desirable for our long-term prosperity.

Why Canadians have lost the personal savings habit is something of a puzzle. After all, we were double-digit savers not that long ago. As usual with complex and important economic issues, there are a variety of factors at play. I have always liked this quote from Alfred Marshall, the great British economist and, in many ways, the founder of modern microeconomics: “People must be warned off by every possible means from considering the action of any one cause…without taking account of the others whose effects are commingled with it.” This is great advice for so many issues that cross an executive’s desk.

First, to consume is to experience immediate pleasure; to save is to defer it. Not too surprisingly, human DNA is wired with a preference for the immediate over the deferred. In a straight-up contest, saving almost always loses to consumption.

Second, the subject of economics can be summarized in three words: “Incentives affect behaviour.” A lengthy period of the lowest interest rates in generations has greatly reduced the financial incentive to save; Canadians have responded accordingly and overspent.

Third, those low interest rates have spurred a spectacular boom in housing demand that has in turn caused housing prices to explode. Many Canadians feel that their house equity, plus capital appreciation in their stocks and bonds, is all the savings they need. If housing prices and/or the financial markets get into serious trouble, look out below.

Fourth, a generous social safety net that includes high-quality universal health care, old age payments and supplements, the Canada/Quebec pension plan, welfare and unemployment insurance plays an important role in Canadian personal savings. Without this kind of backup support for standards of living, Canadians would surely save more. Canadians may be in for a cold shower when they discover that government does not come close to meeting their expectations. My own view is that no one will regret a disciplined and aggressive lifetime savings program.

Fifth, another factor is intergenerational savings. The generation preceding the boomers were good savers. Knowing that your inheritance prospects are good takes the pressure off putting together your own nest egg. So does a sound pension plan.

Sixth, the human capacity for denial is virtually unlimited. You cannot beat having lots of savings when bad things happen. I have never met someone who, when confronted with a big problem, said I wish I had less money. But all too many of us deny the reality that bad things can happen; it is a short step from there to spending everything you earn. Pollyanna was probably not a good saver.

Finally, demographic developments like the two-wage-earner family lead people to think they can get away with saving less. Two incomes spread the financial risk and create the impression you can spend excessively without fear.

Executives should pay attention to the savings data.

  • Negative savings is no way to enter a downturn. The less savings people have when the economy forces them to cut back, the deeper will be the cuts across our economy, and that likely spells a deeper-than-typical downturn. We do not have much experience with zero-savings slowdowns, but my bet is it will not be pleasant look for lots of surprises, almost all on the downside. Executives would do well to do some thinking now about the next downturn. They should be developing plans for something beyond run-of-the-mill.
  • Executives from industries where revenues are heavily dependent on consumer spending should be particularly sensitive to the possibility of downturn.  It will not take much of a hiccup in the economy to send zero savings/highly indebted consumers to the spending sidelines.
  • Savings is the money that funds investment in plant, equipment, machinery, research and development.  Investment is the key to productivity and efficiency.  We cannot go on like this indefinitely: the burgeoning demand for savings to finance investment will inevitably put upward pressure on interest rates. The lack of personal savings tells me executives should be preparing for a world where capital costs them more, and considering what they would do about it.
  • The less personal savings people have the more dependent they are on government.  If our current approach to saving persists, pressures on the public purse are going to do nothing but grow. This is not an environment in which executives should, therefore, expect material tax relief. Executives who are hoping that declining taxes will contribute to their bottom lines should think again.
  • Exchange rates are determined by myriad factors.  That said, it is hard to make a case that negative personal savings would be positive for either a currency’s value or stability. Our imprudent attitude to saving is just one of many reasons why executives should be sensitive to their exposure to the Canadian dollar. My own view is that hedging has much to be said for it. Why give hard-earned profits away to currency fluctuations when coverage is available at a not-too-bad cost?

Personal savings is something of the Rodney Dangerfield of economics: “Can’t get no respect.” But it is worth executives’ time and attention. Personal savings data offer important insights into the course of the economy, consumption, investment, interest rates, taxes and the currency.

About the Author

John S. McCallum is Professor of Finance at the I. H. Asper School of Business, University of Manitoba, and former Chairman of Manitoba Hydro. Contact John.McCallum@umanitoba.ca.