The Paradox of Thrift

The measure of economic activity in a nation is termed the "Gross Domestic Product" - GDP for short. "Gross" meaning total, "Domestic" meaning provided within a specific country, and "Product" meaning goods and services. Since this post isn't a discussion of GDP, let's just focus on the "product".

Four segments of economic activity comprise GDP:

Consumption (people buying stuff) 

Investment (companies purchasing new machinery, buildings, more inventory, etc.)

Net Exports (exported goods and services minus imports)

Government purchases (buying tanks and missiles, paying salaries, etc).

Let's zero in on Consumption

The US is a "consumer driven" economy, depending upon consumption, or people buying stuff, for nearly 70% of its economic activity. That means nearly $14T of the $20T GDP is provided by US citizens buying blenders, furniture, washing machines, and whatever else will fit in your house. This high reliance on consumption is key because it shows that high consumption by US residents is fundamental to GDP growth, resulting in the "strong economy" we all love hearing about.

But here's the rub: while high consumption is collectively "good" for the nation because of the effect on GDP, each individual is better served by minimizing consumption to a reasonable level and diverting those funds to savings. Increasing funding for your TSP or IRA is far better for your personal economy than buying a $1200 leather jacket but, as a nation, skipping the jacket and saving the $1200 expenditure makes our GDP $1200 smaller, infinitesimally weakening our national economy. Smart personal consumption decisions - if done by broad sections of the population - slow our economy. And that's the paradox.

It's not a paradox you need to solve - understanding it is enough. Never fear - the US is stocked with millions of folks who prioritize consuming over saving. In fact the "personal savings rate" just hit its lowest point since 2007, so consumption is in no danger of going out of style.

The point is that understanding this paradox will allow you to both reap the reward of living in a nation with a strong national economy (propped up by the consumption of your neighbors) while making the smart investment in your growing personal economy through long-term investing.