What if we all got money-smart?

By Liz Pulliam Weston

We personal-finance types constantly nag readers about spending too much and saving too little.

But what would happen if everybody suddenly took our advice? What if every household in America:

• Paid off credit cards in full every month and carried no high-rate debt?

• Had an emergency fund equal to at least three months' worth of expenses?

• Saved at least 10% of earnings for retirement?

• Paid off cars before trading them in?

• Bought only as much house as it could afford?

Surely we'd be better off?

Well, no, at least not at first. If consumers mended their profligate ways overnight, the economists I consulted agreed the immediate result would be nasty.

"That kind of sharp reduction in consumer spending undoubtedly puts us in a recession," said economist Scott Hoyt, senior director of consumer economics for Moody's Economy.com. "It would be very ugly."

By the numbers
Percentage of new-car buyers who still owe on their trade-in	24.13%
Average amount of negative equity	$4,495.12
Percentage of households that carry credit card debt	46.40%
Median amount owed	$2,200
Percentage of workers not saving enough* for retirement	67%
Percentage of households living paycheck to paycheck	28%
Percentage of households in some stage of foreclosure	2%

*Percentage of workers saving too little to replace 80% of their pre-retirement income, according to Hewitt Associates.

Sources: Edmunds.com, Federal Reserve Board, Hewitt Associates, ACNielsen, RealtyTrac.

Already-reeling car manufacturers would suffer another body blow, since about one in five new cars is sold to someone who still owes money on his or her trade-in. The dive in consumer spending could set off a global recession. The layoffs that are happening now would accelerate as U.S. demand for goods and services suddenly plummeted.

"Right now, you want people to be spending, not cutting back," said economist Jared Bernstein, director of the living standards program for the Economic Policy Institute and author of the book "Crunch: Why Do I Feel So Squeezed? (And Other Unsolved Economic Mysteries)."

After the bad, a lot of good

But eventually, some good things could happen. Among them:

• As our savings rate crept up, our nation wouldn't be so dependent on foreign investors.

• The typical retirement age would probably drop, increasing demand for workers and perhaps boosting wages.

• Homes, on average, would stay more affordable.

• The bankruptcy rate would probably drop.

• The economy might be less prone to financial crises -- although that, interestingly enough, might depend on consumers' willingness to bend some of the rules above.

One of the first victims of America's new frugality would be payday lenders, who currently have more outlets (22,000) than McDonald's and Burger King combined. With no one willing to pay triple-digit interest rates on short-term loans, the payday lenders would have to close their doors or stick with simple check-cashing services.

Next would be credit card companies, which would have to sharply retool their business models. Living on merchant transaction fees (usually 2% or so of each purchase) would be a sharp come-down after charging consumers 15% and more on their balances. Rewards programs ("9 reasons to love credit cards") might become a thing of the past.

To come up with the money to pay down debt and boost savings, consumers would have to cut back on their spending even more than they already have.

Nearly two-thirds of consumers in a July 2008 Nielsen poll said they had reduced their spending in response to higher gas prices, with half saying they're eating out less. That sharp cutback in discretionary spending has led to waves of store closings (including 600 shuttered sites for Starbucks) and even bankruptcies (retailer Mervyns and restaurant chain Bennigan's, among others), which has in turn boosted the unemployment rate.

(Where you spend matters, by the way. When you shell out $70 on a tank of gas, that money pretty quickly leaves the U.S. When you spend $70 at a restaurant, the money circulates in the economy much longer. Your cash buys food and drink made mostly in the U.S. and employs bartenders, bus staffers and waiters who live and spend in the community.)

A continued drop in consumer demand likely would put more companies and industries into a tailspin, Economy.com's Hoyt said, and the pain could spread beyond our shores. The federal government could offset some of the damage if it cranked up its own spending in the right ways, "Crunch" author Bernstein said. Big investments in infrastructure, for example -- repairing crumbling bridges, rebuilding roads, improving ports -- could employ vast numbers of people while speeding up commerce and lowering transportation costs for business.

Continued: The new new economy

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