Paradox of thrift

WASHINGTON " Americans are hunkering down and saving more. For a recession-battered economy, it couldn't be happening at a worse time.

Economists call it the "paradox of thrift." What's good for individuals " spending less, saving more " is bad for the economy when everyone does it.

On Friday, the government reported Americans' savings rate, as a percentage of after-tax incomes, rose to 2.9 percent in the last three months of 2008. That's up sharply from 1.2 percent in the third quarter and less than 1 percent a year ago.

Like a teeter-totter, when the savings rate rises, spending falls. The latter accounts for about 70 percent of economic activity.

When consumers refuse to spend, companies cut back, layoffs rise, people pinch pennies even more and the recession deepens.

The downward spiral has hammered the retail and manufacturing industries. For years, stores enjoyed boom times as shoppers splurged on TVs, fancy kitchen decor and clothes. Suddenly, frugality is in style.

Grace Case, 38, of Syracuse, N.Y., is a self-described recovering creditaholic. For 13 years, she charged it all " cars, clothes, repairs, vacations. She'd make only the minimum card payments to sustain her buying spree for her and her family, which includes her husband and two children.

But after being laid off 21⁄2 years ago from her job as an accountant, she landed another accounting job that cut her salary from $60,000 to $40,000. It was impossible to meet minimum payments on her card balances.

Now, the Cases are on a strict budget. They take "staycations," grow their own vegetables, buy only used cars and pre-pay cell phones. Case hasn't used a credit card in two years. And she's saving more.

"It's really a liberating feeling," she said. "If you want something, you have to have the money for it."

Many economists think the savings rate will keep rising, perhaps as high as 6 percent or more.

So where's the money going? To savings accounts? To debt reduction?

No one knows for sure. But Robert Frank, Cornell University economist, says it doesn't much matter.

"For economic purposes, paying off debt and saving are the same," he said. "Incurring debt is negative savings; paying down debt is savings."

He sees a long-term behavioral shift. He calls the spending of the past decade or more unsustainable.

"The only way people were able to (spend heavily) was by harvesting cash out of their home equity, which was just an illusion," Frank said.

The ripple effect has been brutal. The economy shrank at a 3.8 percent annual rate in the final three months of 2008, the worst showing in 26 years. The biggest reason was that consumer spending fell for a second straight quarter, something that hasn't happened since the 1990-91 recession.

Analysts believe the hard times will persist in 2009 as consumers, squeezed by layoffs and tighter credit, delay purchases of cars and other big-ticket items.

Some experts say consumers have been so shaken by how fast their wealth has shrunk, so burned by credit card debt, that they might not resume their robust spending for years, if ever.

"People are not saving; they are building financial bomb shelters," said Mark Stevens, who runs a management consulting firm, MSCO, in Rye Brook, N.Y.

Matthew Conrad, a financial manager at Complete Wealth Management in Orange County, Calif., says he knows of people who drive a BMW or Mercedes and eat macaroni and cheese for dinner several nights a week. That suggests some are making an awkward shift from free-spending habits and are reluctant to give them up.

Today's consumers might even start to rival their penny-pinching, Depression-era grandparents.

"The generation that lived through the Great Depression was very conservative in their spending and aggressive in savings," said Scott Hoyt, senior director of consumer economics at Moody's Economy.com. "I think we're going to have a set of consumers who are moving in that direction because they don't have that much faith in their assets."

CHICAGO (AP) " Americans who are feeling frugal and able to squirrel away regular savings should think as hard about where to stash it as many did about stocks when the market was hot.

While the risks of losing a big chunk of its value aren't as great as with equities, savings choices include a broad array of options in terms of rates and access to the money.

"People have to shop around," said Greg McBride, senior financial analyst at Bankrate.com. "There's a big difference in settling for average versus snagging a higher return by shopping around."

Here are the best rates available in various parking spots for cash, along with some other observations about the different options:

SAVINGS ACCOUNTS

Savings accounts are easily accessible and are guaranteed for up to $250,000 by the Federal Deposit Insurance Corp. However, rates traditionally are minimal " with annual percentage yields typically less than 3 percent and often under 1 percent. The average rate on a traditional bank savings account, generally known as statement savings, currently is 0.4 percent.

A good alternative for more competitive interest rates is to open an online account. The top-yielding online accounts available nationwide are Bank of Internet USA and Dollar Savings Direct, which recently offered yields at or just above 3.5 percent.

MONEY-MARKET ACCOUNTS

Money-market accounts " bank products, as opposed to mutual funds " are among the safest places to keep cash but also have low rates. Bankrate.com listed the average national rate on money markets recently at 0.54 percent, or 0.81 percent with a minimum of $10,000 invested.

CDs

Short-term bank CDs are FDIC-insured up to $250,000 per person per institution and generally offer higher yields than the other basic options. But you have to pay a penalty for early withdrawal. Bankrate.com says penalties of three months' interest on CDs are common of two to 18 months, or six months' interest on terms of two years or more.

Three-month CDs currently yield an average 1 percent, with the top yield available nationwide now 2.25 percent. Those rates may fluctuate daily; check Bankrate.com for the latest.

Longer-term CDs pay better but may not be appropriate for emergency savings that may be needed sooner because of the penalties. Six-month CDs yield an average 1.29 percent, with the maximum yield available nationally at 2.95 percent; with a one-year CD it's an average 1.63 percent and a maximum 3.25 percent.

A way to avoid locking up all your money in CDs is to set up a "ladder" of CDs with staggered maturities and then roll over each CD when it matures.

People need to be focused on four things before making any savings choices, says Stuart Ritter, a certified financial planner for T. Rowe Price in Baltimore:

1. Make sure you either have or are building an emergency fund.

2. Be sure to have the insurance you're supposed to have: health insurance, renters or homeowners insurance, and life insurance if someone else is dependent on your income.

3. Save faithfully for retirement, especially if you have a match.

4. If you have high-interest debt, work on paying that down.