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Never had the pursuit of happiness been so much fun.

For the better part of two decades, Americans abandoned economic logic, betting that a globalized economy characterized by cheap credit and rising asset prices had made savings accounts obsolete.

The U.S. household savings rate averaged 9.5 per cent in the 1970s and 11.6 per cent in the 1980s. Prudence snapped in the 1990s, when the average rate tumbled to 6.8 per cent. Over the first half the past decade, Americans essentially stopped saving altogether, as the average savings rate between 2000 and 2005 deteriorated to 2.5 per cent.

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It looks like folly now, but during those years, the incentives to shift to a consumption-based economy were too powerful to resist.

The economy was strong, which suggested the link between domestic savings and growth had been severed. The unemployment rate fell below 5 per cent for two years starting in December, 2005. The U.S. dollar was strong, making imports cheap. Interest rates stayed low because China and other Asian nations stashed much of their windfalls from the global economic boom in U.S. Treasuries. Low rates in turn generated demand for mortgages, keeping house prices high. Stock markets soared. Politicians cheered.

Some people predicted the good times would end badly – and they did. "The surprise is that it occurred so abruptly," Barry Bosworth, a senior fellow at the Washington-based Brookings Institution, says in his new book The Decline in Saving: A Threat to America's Prosperity? The United States is still struggling to get back on its feet. The unemployment rate is 8.3 per cent. Home prices have fallen more than 30 per cent from their peak in 2006.

Americans appear to have learned their lesson.

The household savings rate jumped to 5.4 per cent in 2008 and stayed above 5 per cent through 2010. Anecdotes of a cultural shift abound. Nathan Clark, a 35-year-old managing director at a financial firm in Chicago, says his real estate agent reports that McMansions are out. And Mr. Clark says friends who chased riches in New York and Los Angeles have returned home to his native Louisville, Ky., for a simpler lifestyle.

"My hunch and my hope is that there has been a change," Mr. Clark says. "I think it's more than a fleeting thing. I think it will last for a while."

The transition won't be easy. Personal consumption accounts for about 70 per cent of U.S. gross domestic product; a return toward the 62-per-cent average of the 1970s will be a blow to economic growth. Baby boomers who thought they would retire on the value of their homes and investments are dealing with a rude awakening.

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"The optimistic projections of just a few years ago about the economic well-being of future retirees now seem seriously dated," Mr. Bosworth writes.

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About the Author
Senior fellow at the Centre for International Governance Innovation

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.Previously, he was Report on Business's correspondent in Washington. He has covered finance and economics for a decade, mostly as a reporter with Bloomberg News in Ottawa and Washington. A native of New Brunswick's Upper St. More

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