In fundamental shift, consumers are saving rather than spending

WASHINGTON — The continuing decline in consumers' use of charge cards and other forms of credit reflects an underlying weakness in the U.S. economy that most of the government's recovery plans fail to attack head-on. And it suggests a fundamental shift in the way Americans save and spend that is likely to act as a drag on the economy for at least several years.

Beset by rising unemployment, declining wages and persistent credit-tightening by banks, consumers are pulling back. Although some economists welcome the trend after years of open-handed spending, the belt-tightening is almost certain to have a negative effect on the U.S. economy, in which about 70% of gross domestic product comes from personal consumption.

A government report issued Wednesday shows that consumer borrowing is still falling. The monthly credit balance numbers from the Federal Reserve are considered volatile, and May's decline was much smaller than earlier this year. But analysts said the trend was likely to remain downward.

"Consumers were living in a fantasy world for much of the last decade," said Lyle Gramley, an economic advisor with Soleil Securities Corp. and a former Fed governor. "The financial crisis has been an enormous wake-up call."

The contraction in consumer borrowing and spending may have been inevitable.

Many Americans had been using their credit cards and years of home equity borrowing to cover expenditures that exceeded their incomes. The personal savings rate, which had been at or near double digits during much of the 1970s and '80s, dropped to 1% or lower starting in 2005.

But over the last two years, personal income has been stagnant or declining. The recession has wiped out 6.5 million jobs. Millions more workers are fearful of being laid off.

Moreover, the home equity borrowing that many families have used to cover expenses has been choked back by the credit crisis and the plunge in home values. Average home equity per household was estimated at just under $50,000 earlier this year, less than half of what it was in early 2006.

After falling sharply last year, personal spending showed signs of leveling off this spring as government payments and tax cuts put more cash into Americans' pockets.

But consumer expenditures remain soft, especially for automobiles and other big-ticket items; many people are clearly intent on socking away money. The personal savings rate jumped to 6.9% in May, the highest in 15 years.