In economic speak, it's called the "paradox of thrift." When a consumer cuts spending in order to save, it helps him or her. But en masse, it also hurts the economy – and thus, consumers.
The issue is a standard test question in Economics 101, but it's also one with real-life consequences. The personal savings rate in the US has reached 5.7 percent – the highest since 1995. Less than a year ago it was close to zero. (The monthly rate averaged around 9 percent in the 1960s, '70s, and '80s.)
Economists expect even more saving as the jobless rate goes up and people prepare for possible layoffs.
No question, increased saving can have an immediate impact that slows the economy. It's one reason why President Bush urged Americans to shop after 9/11. But now saving should be encouraged – and not just among consumers.
In his proposed regulations to reinforce the financial industry, President Obama wants to raise the requirements for capital (assets held in reserve) and liquidity (cash on hand). This would make them more stable and better able to withstand times of stress.
Unlike after 9/11, personal wealth has plummeted. Now, people need to feather their nest eggs for retirement, college, and unforeseen needs – three important saving goals. They cannot become reliable consumers later, if they do not shore up their finances today.
Struggling Americans should not take it upon themselves to single-handedly "save the economy." This is what the $787 billion government stimulus is for – a mega-infusion to take up the spending slack. (A note of warning: Washington must get its own fiscal house in order once recovery is more secure and businesses and consumers have regained strength.)
In the longer term, saving benefits the economy because those dollars are used to fund business investments that also spur economic growth. And if America as a society is not spending beyond its means, then it's not borrowing like mad – and not relying as much on other countries to lend money for its borrowing habit.
A lasting shift to a higher savings rate could help make the global economy less vulnerable to a future economic nose dive (this is Mr. Obama's aim with his proposed capital requirements for the financial industry).
Greater personal saving in the US could also force big saver/exporter countries such as Japan, China, and Germany to encourage more demand at home, so that it's not just US shoppers holding up the world economy.
The transition to a more saving culture has searing, short-term costs: layoffs, foreclosures, bankruptcies. But eventually, it will create a more sustainable economy. That's less a paradox, and more a matter of what's best for America in the long run.