For many years, analyses indicated that consumer spending accounted for two-thirds of economic activity. Over the last three decades, easy and cheap credit, coupled with rampant consumerism, fueled spending and increased personal debt burdens to reckless rates. Saving and “doing without” was something that older generations did, not baby boomers and their offspring. To the right is a chart from the Federal Reserve Bank of San Francisco which traces the U.S. personal savings rate from 1960 to 2009. Note that even with the recent spike in savings to 4%, it is less than half of the pace that was saved during the 1960’s to 1980’s.

The leading edge of the post-war generation is now approaching retirement and those born at the 1957 peak of the post-war baby boom are 13 years away from tapping their IRAs. Unfortunately, retirement portfolios which have predominately been invested in the equity market over the last ten years have produced small returns. Beginning 10 years ago, if an individual invested away $10,000 a year, the total $100,000 investment is now worth $102,184. Just a few months ago, the returns would have been negative.

With almost no return on their equity investments over the last 10 years, baby boomers will have to save more for pending retirement or even reduce or pay down debt as retirement approaches.

The combination of increased savings and debt reduction may produce a seminal change in the U.S. economy. Reduced consumer spending should result in slower economic growth, thus impeding much of the recovery process. With a significantly increased saving rate, interest rates would remain modest for an extended period of time. Additionally, a rise in frugality would have an array of effects: state and local governments that relied upon sales tax receipts will see much lower than expected revenues. Retailer results, as well as revenues from durable and non-durable consumer good producers, would be lackluster for some time.

Ironically, it is possible for the stock market to rise due to the expansion of Price/Earnings multiples, even as corporate revenues and earnings decline. Stock appreciation may invite more risk taking even as theeconomic environment remains cloudy. However, stock gains would not erase the notion that there is plenty of cause for economic concern given consumer saving and retrenchment. Of course, this negative outlook is entirely based on the assumption that individuals save in order to better fend for themselves. Such is human nature. Our assumption, though, could be way off-base if the children of the sixties and beyond walk away from their debts and demand the government continue to bail them out. In doing so, saving and repaying debts may take a backseat to the new overarching culture of entitlement. If that is the case, the argument of consumers continuing to save and repay debts would be unsubstantiated.