Contented voters borrow to buy the American dream

NEW YORK - If there is an economic message from the US mid-term elections, it is that American voters are content. They don't want to change their politics too much, and they evidently don't want to change their economics either. If there is a surprise for the British visitor to the States, it is how small a part economics seem to have played in the elections. Americans did not raise the issue as voters and American politicians did not raise the issue from their side: everyone is content.

It's easy to see why. For the ordinary American the long seven-year boom has continued to roll. A few weeks ago it seemed as though the collapse of the stock market might bring it all to a shuddering halt. But now there is a renewed confidence in the economy which has been reflected in a reasonable stock market recovery. A couple of months ago Alan Greenspan, chairman of the US Federal Reserve, said: "It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress." Americans seem to disagree.

But there was a figure from the US economy this week that really did disturb me. For the first time since the 1930s families have become dis- savers: they are spending more than they earn. The savings ratio has been falling steadily for about six years, but it has only just last month gone negative. America is still "an island of prosperity", but only because people are borrowing to keep it that way.

Of course, in another sense the US has been living above its means for most of the 1980s: it has been running a very large current account deficit. This has ballooned in the past four months as exports (particularly to Asia) have been weakening and imports (particularly from China) rising. So far, the rest of the world has been content to finance the boom by buying dollar assets and investing in the US. These investors have done very well: probably better than if they had made their bets in any other country.

It is true, too, that the quality of investment in the US has been very good by world standards. A shortage of savings, coupled with a highly- competitive financial system, means those savings have to be used well. Businesses (in the UK as well as the US) often complain of the pressure the market puts on them to produce high returns on capital. But that simply means capital is being used efficiently.

The alternative - little pressure for decent returns - leads to poor investment decisions. Japan has wasted much of the country's high savings by investing in projects which prove near worthless. Savings have simply been destroyed. Russia, where there has been no market discipline at all to invest wisely, has similarly destroyed savings. Over-saving tends to lead to over-investment - and hence bad investment.

But eventually, things have to adjust. The widening US current account gap has left America vulnerable to a change in global sentiment. Foreigners don't need to pull their money out of the States. All they need to do to change things is to stop putting it in.

What might be the trigger for such a change? It suddenly struck me that a change in US domestic savings habits might be just such a trigger. The US nationally can run a deficit while the rest of the world is prepared to fund it. But US families can't run a deficit for long without running into difficulty. People are different from countries. While a family can dip into deficit for a year or two - that happened in Sweden in the early 1990s - they can't for very long. Lenders become concerned, the families stop being credit-worthy, and individuals become frightened. It's not much fun to be in debt.

Even in the US there must be limits to the extent to which people want to go on running up their borrowings, even with the prospect of continued low interest rates and maybe lower ones to come.

It's become pretty evident in the last couple of weeks that there will be another downward lurch in the global trend in interest rates, and that it will last for some months at least. In Europe the process is confused by the need to converge on a single interest rate for the euro countries, so there will be some rises. But here in America everyone expects the next move in interest rates to be down. And it would be astounding if the next move in UK rates were not down too.

But the case for cuts in interest rates in Britain and, as far as they can happen, on the Continent is to cut the cost of borrowing for companies, not for individuals. We don't need individuals to borrow more in Britain; we need to take pressure off the company sector.

In the US it's different. We've reached the stage where to continue to sustain demand, ordinary Americans have to go deeper and deeper into debt. I guess they will for a while. But the deeper the debt the more savage the reaction when it becomes clear that interest rates won't fall any further or even, perhaps, start to go up again .

At the moment the popular mood in Europe and North America is that economic problems can be coped with providing central banks keep cutting interest rates. Avoiding recession is seen as a policy choice. Provided rates are dropped fast enough, recession need not happen. But suppose in the US that individuals choose (or are forced to choose by lenders) to cut their borrowing even if there is a fall in interest rates? The level of demand cannot be sustained.

For now Americans are confident, cheerful and content. The election showed that. Economists may fret about the sustainability of the boom, the current account deficit, the fact that nearly one-third of the world economy is in recession, and so on. High earners on Wall Street are certainly aware of the fragility of their pay packets. But most ordinary people have not yet taken on this message. If they had they would not be plunging deeper into debt - and they would not have voted for no change.