Depression Era Thrift Is Back

It's an attitude that would have made World War II–era Britons proud. The economic state of the world has produced a grim new frugality in England, the likes of which haven't been seen since the end of food rationing in 1954. December retail sales showed same-store declines of 3.3 percent in what the British Retail Consortium said was the worst shopping season since it began keeping records in 1983. Sales would have been even more dismal if stores hadn't offered discounts that were the steepest (some slashed prices by 90 percent) and earliest in British retail history, according to a survey by PriceWaterhouseCoopers. In the same month, Britons bought 21 percent fewer cars than in the corresponding period of 2007, slashed their purchases of table water and champagne, and cut back purchases of clothing for the 14th month out of the last 15.

Among the few shops on High Street reporting increases: shoe menders, pawnbrokers and down-market discounters like the Aldi no-frills supermarket chain. The closing weeks of 2008 also saw the bankruptcies or financial collapse of no fewer than 10 big retail chains, from Woolworths to Zavvi, the former Virgin Megastores.

Applications for allotment gardens—small plots of land where city dwellers can grow their own food for a small fee—doubled in 2008 in cities like Warwick. On Amazon's U.K. Web site, bestsellers include "The Thrift Book," "Food for Free" and "The Penguin Handbook of Keeping Poultry and Rabbits on Scraps."

The shift to thrift is of course natural in hard times, as consumers worry about their jobs and shut their wallets amid the deepening gloom. This time, however, the clampdown on spending appears to be more than a sharp but temporary downturn of the economic cycle. In Britain, the U.S. and other consumer-driven economies, including Spain and Ireland, it seems to herald a much broader shift: the end of a way of life based on freewheeling consumption fueled by easy credit and the wealth effect of ever-rising asset values. Already, once spendthrift Americans have hiked their personal saving rate from near zero, where it's hovered for several years, to almost 3 percent in November. Merrill Lynch chief economist David Rosenberg expects the rate will soon rise to 8 percent and beyond, levels last seen 20 years ago. Just like overleveraged and undercapitalized banks, Rosenberg says, private households are now repairing their own balance sheets by spending less, saving more and paying off their debt. And just as in the financial industry, this is beginning to look less and less like a quick fix—and increasingly like a long-term change of habits.

Rosenberg and other economists who believe that thrift will be the new normal say long-term change will come on three fronts. First, the wealth destroyed in this recession looks likely to be so vast that it will force a change in behavior, much as World War II rationing or the Depression seared fears of scarcity into an entire generation. The second change is the death of a risky financial-sector business model that saw banks hand out ever more loans and pass them on to other investors as "assets." This in turn created huge floods of credit to pump into mortgages and other consumer debt, which bloated spending and real-estate values, but won't in the future. Third, because neither governments nor investors will tolerate a return to risky bubble-era practices, banks will have to relink credit to deposits and look more carefully where they lend. Bob McKee, analyst at Independent Strategy, a London investment consultancy, says this will slow down credit growth and funnel loans to companies that produce and invest, instead of to whiz-kid financial operations. All this is conducive to slow and steady growth—but not the huge run-up in asset prices of the credit-bubble era. It is therefore unlikely, says McKee, that asset values will return to their old levels and erase current wealth destruction any time soon.

The pressures forcing the new Age of Thrift are powerful: Americans alone watched their household wealth shrink by some $13 trillion in 2008, erasing a decade of gains. "In past deep recessions," says Peterson Institute economist William Cline, "households lost about 5 percent of their net worth, compared to 20 percent now." Losses are already twice as high as after the 2001 tech crash, and half as much as in the Great Depression. If the late era of stock-market gains created a "wealth effect" that made consumers feel rich and ready to spend, the collapse of wealth will produce the reverse.

The impulse to save Americans' credit-card debt is contracting, and outstanding mortgage debt declined for the first time in 56 years—despite mortgage-interest rates at or near historical lows. Eventually, some of those savings will flow back into stocks and houses. But the era of easy double-digit annual gains is over, says McKee. In a world where credit growth is no longer multiplied by leverage, he says, capital will be scarcer, profits no longer pumped up by exotic financial instruments and returns on investments lower.

The era of easy credit appears to be over, too: home-equity loans, by which Americans get cash from their banks against the value of the house they already own, have been virtually frozen. The U.S. also had the worst year for employment since 1945, losing 2.6 million jobs. Ditto for countries like Spain, which shed 1 million jobs in 2008 after the collapse of its own decade-long real-estate boom. Bank of America economist Holger Schmieding says these job losses are only the start and will get substantially worse in 2009. In Europe, he says, "the downsizing in the financial sector and other industries, including cars and machine tools, is only beginning." Rosenberg predicts the U.S., too, will lose another 3.5 million to 4 million jobs this year. Consumer confidence has been crushed. Never in 60 years of record keeping have American households been as pessimistic about their personal finances, says Richard Curtin, director of consumer research at the University of Michigan.

Signs of retrenchment are everywhere. Consumer spending is down all across the developed world. In the fourth quarter of 2008, U.S. retail sales had their worst decline in four decades of record keeping, including a 36 percent drop in auto sales year to year. Since peaking in June 2008, discretionary spending has been dropping at an annualized rate of 15 percent. That's all the more astonishing, as consumers have had a windfall from a more than 50 percent decline in gasoline prices since then. Even online spending growth crashed from 75 percent in 2007 to a nearly flat 2 percent in 2008.

In historically thrifty countries like China and Germany, high saving rates have already drifted even higher. Chinese are becoming ever more tightfisted as millions of laid-off workers return to their home villages from the coastal factories. The numbers are notoriously unreliable, but anecdotal reports suggest that China's savings rate of 20 to 30 percent is creeping even higher. For September 2008, the People's Bank of China reported that private deposits stood at 20 trillion yuan ($2.92 trillion), more than five times the value of outstanding consumer loans and mortgages. In Germany, an export-dependent economy that saw industrial orders collapse in November, the savings rate has hit a 15-year high of 11.4 percent of personal income and is expected to rise to 12.5 percent next year, according to the German Bundesbank.

Wealth destruction, job losses and precautionary saving mean consumers aren't just cutting spending but shifting it as they economize. In Hong Kong, upscale restaurants seem unusually empty, while cheap street-market eateries are even more crowded than usual. In Britain, food retailer Sainsbury's reports sales of budget items like stewing meat (the cheapest cut) tripling in just a year. Timpson's, a British repair-shop chain, says repairs of shoes and watches have jumped in the last few months. "We're seeing a whole new type of customer in the shops, people who never even thought of repairing things," says company chairman John Timpson. "A make-do and mend mentality is taking hold." Andy Bond, CEO of Asda, another supermarket chain, has compared Britons' increasingly frugal habits to the post– World War II rationing era.

With spending unlikely to recover fully as Americans and Brits are forced to save again, discount companies like Asda, Wal-Mart, JetBlue and McDonald's look set to outperform their upmarket competitors for many years to come.

Companies will no longer be rewarded for raising maximum amounts of capital and leverage. Instead, those that have solid equity, patient shareholders and big wads of cash, ridiculed as boring during the bubble, will be at an advantage. Cash-rich companies can afford to be patient with suppliers and customers they judge to be sound but struggling to pay their bills. This is how many deeper-pocketed German exporters came out of the Russian ruble crisis with big gains in market share against French or Italian competitors.

There are, of course, many economists who will tell you that consumer spending will rebound and bring the economy back up with it. Rosenberg says that rebound will be much smaller than usual both because of the long-lasting poverty effect of lost home values and depleted retirement accounts, and because the flood of subprime and other easy credit that fired up pre-bubble consumption won't return any time soon. He expects U.S. saving and consumption rates to return to the relatively conservative levels of the early 1990s, when U.S. consumer spending was 65 percent of GDP instead of the 71 percent it hit in 2008. That will effectively suck about $1 trillion each year out of shops, restaurants, airlines, hotels, automakers and home construction. The shrinking of America's massive net imports of consumer goods will hit factory economies like China as well as their suppliers (such as Australia for commodities and Germany for factory equipment).

Judging by the sharp declines in orders for exactly these products—not just consumer goods but also the commodities and machines used to produce them—this painful adjustment appears to be underway. In the future, says McKee, "emerging markets with outdated development models that are overly dependent on production and exports of tradable goods will suffer." Power will flow to those markets able to build a domestic consumer society and a vibrant service sector, he says. In this world, India and Brazil are more likely to succeed than China or Asia's other factory economies.

Global growth will eventually return, but it will no longer be fueled by consumers in the U.S. and other Western economies. Because of slower growth in the U.S. and other parts of the West, it will likely remain below the long-term trend of 5 percent for many years to come. That's not least because the opportunity to claw back power from the markets will not be lost on politicians around the world, empowering, rightly or wrongly, a return to more government intervention and redistribution, with higher taxes and lower profit shares.

While the shift to thrift will be scary as it courses through the global economy, it will ultimately be a good thing. "A world of thrift is by far more productive in lending to companies for investment and productivity growth," says McKee. Debt will grow more in line with the economy. Capital will be scarcer, but it will be invested more productively. Profits will be lower as a share of national income, but they will be more stable. It's a more boring, slower-growing world. But it's also a more sustainable one, with fewer imbalances, deficits and nasty economic surprises. Until someone inevitably invents the next big bubble, that is.

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