The Paradox of Thrift

My housekeeper has a nicer car than me.

Now, granted, 75% of America probably has a nicer car than me. I’m driving a car that, while only four years old, looks like it’s going on 20 because my kids have utterly destroyed it. The entire backseat looks like a Jackson Pollock painting of assorted stains and magic marker doodling.

On the flip side, the car is paid for so I refuse to pay a single nickel to get it fixed up until my kids are older. I don’t even like paying to have it cleaned because I know that it will be filthy again by the end of the day.

So I wouldn’t necessarily find it odd that my housekeeper has a nicer car than me… except for the fact that she drives a black Mercedes-Benz (the only color a Mercedes should ever be!).

Now, I’ll never fault a person for having good taste in cars. I rather like Mercedes… and I might buy one for myself once my kids are at an age where bodily excretions are no longer likely to soil the upholstery.

But I’ve done the back-of-the-envelope math, and I also know that the monthly payment on that car consumes a huge chunk of her income. It’s phenomenally bad for her personal finances to own a Benz… but it’s great for the dealership that sold it.

And that brings me to one of the more interesting concepts in economics:

The paradox of thrift.

In a nutshell, it’s good for an individual family to be frugal. You have more savings to tide you over when times get tough, and you build wealth for the future. But if everyone gets frugal at the same time, the economy grinds to a halt and there’s less wealth for everyone.

(For the wonks out there, this is an extension of the fallacy of composition, the error of assuming that what is good for the individual must also be good for the group.)

I save a little over a third of my after-tax income. That’s fantastic for me and my family. We’re a lot less likely to get booted out of our house or be denied credit if or when we need it, and I’m able to sleep a lot better at night.

But if everyone did what I did, our economy would probably be back to the Stone Age. Every cable company would be out of business (I cut the cord years ago). And there wouldn’t be a lot of people shopping at the Mercedes dealership either.

The problem is, there are a lot more people like me these days, either by choice or necessity, which is a big reason why the economy has been stalled out in a slow-growth funk for the past decade.

Roughly 10,000 baby boomers enter retirement age with every passing day, and most of them aren’t even remotely close to prepared for it.

According to the Federal Reserve’s latest Survey of Consumer Finances, the median American household, with the head of the household aged 65-74, has a net worth of only $232,000, which would include home equity. (Interestingly, the same survey reported that only 53% of American households save any money at all; the rest apparently live paycheck to paycheck.)

$232,000 isn’t going to get you very far in retirement, as Rodney discussed in the October issue of Boom & Bust (he also offered some solutions to boost your personal savings, and I added an income gem to the model portfolio).

Assuming the standard 4% annual withdrawal, you’d be looking at an annual income of $9,280. The boomers know this, which goes a long way to explaining why their spending isn’t what it used to be.

But their children, the millennials, aren’t exactly big spenders, either. Entering their careers with mountains of student debt, they’re marrying and buying cars and homes much later in life than the generations that came before them.

Again, all of these people are doing the right things on an individual level. It makes sense to pay down debts and to save for retirement. But collectively, this tightfistedness throws a massive wet blanket over the economy… which is why we’ve had years of aggressive monetary policy by the Fed, and political movements to raise the minimum wage and to forgive student loan debt.

Now, I’m not here to bash anyone’s pet political issue. But let’s just say I wouldn’t expect any policy move to have much of an impact on consumer growth. Raising the minimum wage by a couple of bucks or forgiving some portion of student debt isn’t going to compensate for the retirement of 10,000 people per day.

So we need to set realistic expectations.

The economy has grown at about 1.8% per year since 2009. That’s probably about what we should expect for the next several years as well, and that’s assuming we have no major crises (on which point, I wouldn’t hold my breath if I were you).

So back to that whole “paradox of thrift” thing… I recommend you stay frugal and focus on debt reduction over the next few years.

It’s bad for the rest of us… but it’s a lot better for you.