Saving, Debt, and Risk

So true
Funny how it seems
Always in time, but never in line for dreams
--Spandau Ballet

A basic problem facing any individual involves allocating inflows of scarce economic resources (also known as income). Two general possibilities exist: resources can be consumed in the present, or they can be saved for future consumption. Saving is the difference between income and consumption.

Individuals interested in elevating their current standard of living can consume more and save less. Increased consumption reduces resource stocks that can be applied towards future consumption. The lower the level of saved resources in the present period, the greater the dependence on future income in order to maintain today's standard of living.

Proposition 1: Lower levels of saved resources increase the risk of a lower future standard of living.

It is possible to further elevate current living standards if resources can be borrowed from others. Borrowed resources are consumed in exchange for a promise to pay back lenders' original quantity of lent resources (principal) plus usually some additional resources (interest) in the future. Borrowing depletes resource stocks that can be applied towards future consumption. In fact, saving is now negative because consumption exceeds income. Because of the obligation to pay back resources that have been consumed, borrowers are not only dependent on a future income, but on an increasing income in order to maintain the standard of living experienced today.

Proposition 2: Negative levels of saved resources (debt) magnify the risk of a lower future standard of living.

Over the past few decades in the U.S., saving has been declining. Debt at individual and aggregate levels have been increasing geometrically. While reduced saving and increased debt have increased current standard of living, risk of a lower future living standard has increased as well.

Accepting a lower standard of living means less consumption and more saving. Maintaining our standard of living means increasing future income at a rate that at least matches our negative savings.

Matching our negative savings with more income seems a tall order when debt is increasing geometrically.