For years, we have heard that aging baby boomers will place a tremendous strain on our economy after retiring. However, the problem is not limited to the United States, as the populations of Japan and Western Europe are also aging rapidly. With much of the world's wealth held by people in the United States, Western Europe, and Japan, there will be a tremendous strain on savings worldwide due to the fact that retired people typically save less than younger people.
Over the next 20 years, the median age in Japan will increase from 43 to 50, while Italy's median age will increase from 42 to 51. The United States does not look nearly as bad, with an increase from 37 to 38 (Source: World Population Prospects, 2005). However, our savings rate is already dismally low, even though the vast majority of baby boomers have not retired yet. For years, the United States has been relying on capital flows from Europe and Japan to finance our huge trade deficit. As savings rates decline in these countries, it will be more and more difficult for them to keep financing our trade deficit.
The Japanese have long been regarded as a nation of thrifty people, saving significant amounts of their income. Yet their savings rate has declined from 25% in 1975 to less than 5% today, and is projected to decrease to a mere 0.2% by 2024 (Source: How Aging Will Reduce Global Wealth, 2005).
Why are savings so important to our economy? At first glance, it appears that savings hurts the economy. If consumers save rather than spend their income, current sales for stores, service establishments, and manufacturers will decline, putting a damper on jobs and income. However, this is only a short-term effect.
Over the long term, these savings are used to make investments, which finance modernized equipment, new construction of homes and factories, and research and development of new products. These investments, in turn, create more jobs and more income.
Savings in our country come from three sources - individuals, businesses, and the government. Personal savings as a percentage of disposable income have continued to hover at historically low levels, 0.9% in 2005 (Source: Bureau of Economic Analysis, 2006). The government is running large deficits that are expected to increase rather than decrease in the future. As the population ages, retirees will put even more strain on the federal government's resources.
It is quickly becoming imperative for individuals to dramatically increase their savings and for the government to control the federal deficit. On an individual level, this should serve as a wake-up call to reassess how much we are saving. If you'd like help with this assessment, please call.