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Gerard Baker is United States Editor and an Assistant Editor of The Times. He joined in 2004 from the Financial Times, where he had spent over ten years as Tokyo correspondent and Washington Bureau Chief. His weekly oped column appears on Fridays


GERARD BAKER: Little saving grace for the US

The day that American consumers stop spending and start saving again could bring serious problems for US growth.

Sixty-five years ago, as the Great Depression intensified, unemployment soared and wages collapsed, Americans were forced to draw down their meagre savings to keep their living standards from dropping into free fall.

The desperation to stay afloat was reflected in a negative national savings rate that lasted until economic conditions began to recover later in the decade.

Since then, the US has never seen another period of aggregate private sector dissaving - until now. For two months this autumn, the nation's savings rate dropped into negative territory again, as spending outstripped individuals' incomes.

In the 1930s, of course, the disappearance of thrift was a reflection of economic crisis. In 1998, the same phenomenon reflects an age of almost unparalleled prosperity.

Far from being forced to run down their savings in the late 1990s, Americans are choosing to do so. Because their stock of wealth has increased by so much in the past five years they no longer feel the need to keep saving. Asset values, most obviously those of equities, have risen so much that Americans cannot in fact spend their accumulated wealth fast enough. In spite of the rundown in savings, household net worth continues to rise.

While the 1930s "prodigality" was a tragic necessity for many Americans, the collapse in US savings in the past year or two has some economists alarmed. They see it as the ultimate example of late-cycle excess. Negative or even just very low savings are unsustainable, they argue, and two dangers arise from the current unusual state.

First, at some point, consumers will seek to rebuild their savings. That is simply the flip side of saying they will stop spending. And since consumer expenditures have been the driving force behind the acceleration in US growth in the past three years, that spells problems for the sustainability of the expansion.

Second, the low savings rate underlines more dramatically than ever the dependence of the US economy on the equity bull market of the mid-late 1990s. If stock prices fall to anything approaching more normal valuation levels, consumers' need to rebuild their personal balance sheets will be all the greater.

These concerns cloud the economic outlook for the US and the world in the next year.

The collapse of savings has been one of the most striking phenomena of the US economy in the 1990s. In 1993, the savings rate was just below 6 per cent, historically a figure that was already quite low. But since then it has declined steadily every year to the current level of just below zero.

The methods of calculating savings rates have changed, making straight comparisons, even over the past decade, difficult. This year, for example, the government's statisticians made an important change. Mutual fund distributions paid out of capital gains are no longer counted as part of income. This seems a sensible move - while dividends are still regarded as income, it seems odd to count capital gains - even if paid out in distributions.

Since savings are measured as the residual between total income and expenditures, the reduction in income that this change produced - about 1 per cent - led to a fall of a similar size in the savings rate.

Demographic factors clearly have something to do with this decline. Different age groups save at different rates. The higher the proportion of elderly in the population, for example, the lower the savings rate is generally considered likely to be.

But in the US the move away from thrift seems to have been more directly tied to the value of the stock market. The main demographic feature of the past 10 years has been the arrival to middle age of the baby-boom generation.

Of course, the baby boom generation has been saving - only passively. The equity bull market of the past few years has raised household net worth to a record multiple of six times disposable income, up from five times income just four years ago.

According to calculations by David Wyss, chief economist at DRI-McGraw Hill, households spend about 2.5 per cent of any additions to their wealth. The rise in the net worth to income ratio in the past four years has cut the savings rate by about 3.75 percentage points, he estimates.

This has meant that consumers have not only been able to finance their longer-term savings needs. It has also meant they feel able to take on a much higher level of debt.

The average household now has debt equal to its annual disposable income; excluding mortgages, debt is still more than a fifth of income - both record figures.

The danger is obvious - at some point, faced with the approach of retirement, many baby boomers will decide they need to rebuild their savings base and pay off debt.

Furthermore, a stock market correction would expose the true vulnerability of their personal balance sheets.

But there is another factor that could make the economic consequences worse.

The great concentration of the increase in wealth in the past few years has been among the top 20 per cent of income earners. And this has been the sector of the population that has been the most eager to spend and the most willing to acquire higher levels of debt.

It seems inevitable that, at some point in the next few years, these big winners from the 1990s stock market will either decide, or be forced, to retrench. When that happens the remarkably successful US economy will need to find another growth engine to stay airborne.

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