The squeeze on American pocketbooks

Last year's negative savings rate was the first since the Depression.

Americans are working as hard as ever, but their paychecks aren't keeping pace with rising inflation. That means trouble for their pocketbooks - and for an economy that's fueled by their spending.

Indeed, after two years of a "jobless recovery" following the 2001 recession, the US economy now faces something equally unsettling: a "wageless recovery."

Several government reports this week tell the story. For the first year since the Great Depression, the personal savings rate went negative in 2005. Pay and benefits, meanwhile, rose just 3.1 percent last year - the lowest rate since 1996 and not enough to outpace a 3.4 percent jump in the consumer price index. Is there any relief in sight?

None came Thursday, as the government reported a decline in worker productivity for the closing months of last year, a trend that could limit future wage growth.

The outlook isn't all discouraging, but a four-year-old economic expansion is clearly struggling to maintain its momentum. The reason: Americans are being squeezed from both sides of the household ledger. On the income side, wage growth has been historically low for a period of economic recovery. On the spending side, energy prices and interest rates are higher.

Meanwhile, home-equity loans are no longer an easy way out. Soaring property values that turned many houses into two-story ATM machines appear to be flattening out or even falling.

"If the housing market softens ... American consumers will then have little choice other than to bring spending and saving back into more prudent alignment with income," said Stephen Roach, a Morgan Stanley economist, in a recent analysis. "The combination of a relatively jobless and wageless recovery puts tremendous pressure on American households."

Economists aren't expecting a recession. But since consumers account for more than two-thirds of the nation's economic output, the health of American wage earners is a central question mark hanging over this year's economy.

Other parts of the economy may help pick up the slack. With the world economy expanding, exports should contribute solidly to gross domestic product (GDP). And many economists expect to see businesses invest more of their record profits in new equipment and facilities. That, in turn, could mean more jobs and paychecks. Forecasters generally expect strong economic growth in the first few months of this year, after hurricanes and slower consumer spending dragged down GDP growth to a 1 percent annual pace for the last three months of 2005.

Indeed, the Federal Reserve remains more concerned about possible inflationary pressures than about economic growth falling below a normal pace of about 3 percent. Earlier this week, the Fed moved to constrain those pressures for the 14th time since June 2004, bringing its short-term interest rate to 4.5 percent. Another rate hike is considered likely in March.

Thursday's productivity report did little to assuage concerns about inflation. For years, unexpectedly strong gains in output per hour - a productivity bonus - helped the economy grow without upward pressure on prices.

By becoming more efficient, companies have more cash flowing to their bottom line. Productivity can accelerate economic growth and raise living standards. In the current expansion, it has created record corporate profits. But a lower than normal amount has gone into pay raises. And now, the pace of improving efficiency appears to be slowing down, at least temporarily.

The productivity rate actually fell for the fourth quarter of 2005. Meanwhile, the cost of labor per unit of output rose by 2.4 percent for the year, up from 1.1 percent in 2004.

Fed policymakers could take that as a sign of inflationary wage pressures starting to build. They would rather see wage hikes matched by productivity gains.

Ken Goldstein, an economist at the Conference Board, a business research group based in New York, sees the current trend as a pullback of productivity to a more typical pace.

"We can't be above average all the time," he says. But the slower productivity growth means it will be hard for wages to rise this year faster than inflation.

"Somebody's going to get squeezed here in 2006," Goldstein says, referring to workers and businesses. "It's possible they could both be squeezed."

Not everyone in the economy is feeling that pinch. Many sectors are expanding.

"Things are starting to pick up," says Andrew Van Tassle, who works at Message Level, high-tech firm in Boston that provides e-mail security. He says he hopes to see a pay raise this year, as the start-up wins more customers.

After a slow patch in 2002 and 2003, the economy is creating about 2 million jobs a year. Meanwhile, global competition seems to be holding a lid on wages. Even as the unemployment rate has fallen to 4.9 percent, salary hikes haven't been as robust as in tight labor markets of the past.

Along with rising energy prices, these factors help explain why America's personal savings totalled negative 0.5 percent of income last year. It's a sign of thinner wallets, but it doesn't necessarily mean that Americans have stopped funding their 401(k) plans.

The rate compares broad measures of disposable income and spending. But on the income side, it fails to factor in pensions and capital gains. When those are included, says economist Ed Yardeni of Oak Associates, an investment firm in Akron, Ohio, the idea that Americans are living beyond their means is "more of a forecast than it is a reality."

According to Federal Reserve data, American households had a total net worth of about $51 trillion as of last fall. That's up from $40.7 trillion in 2001. The median family net worth - assets minus liabilities - has risen from $61,300 in 1992 to $86,100 in 2001.

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