Watching The FED
If you go to the FED's website, you will find a four part definition of what the FED does. But in a layperson's nutshell, the FED's primary job is to control inflation and keep the economy from overheating by managing the money supply.A Vision
I'm trying to get inside of the head of the Federal Reserve Board. It's a little murky, but I'm starting to make something out...yes, it's coming in now:
"Stocks are overvalued - can a 'bubble' be far off?"
"American consumers are spending (read: borrowing) too much - the Wealth Effect could create a credit bubble."
"Unemployment is too low - payrolls will be getting out of hand, creating inflation any minute now."
Obviously, I'm no clairvoyant. But I do watch the FED. I talk with some of their people, and I listen to what they say. As a small business owner and as The Small Business Advocate, what I hear and what I see from the FED concerns me very much.
FOMC
Approximately every 6 weeks the FED's Federal Open Market Committee (FOMC) meets to discuss, among other things, whether to raise, lower, or leave unchanged the Fed Funds Rate (the rate banks pay for overnight use of funds) and the Discount Rate (the rate banks pay for short term loans directly from the FED), two key weapons in the FED's arsenal that it uses to control money supply.
For over 2 years I have conducted what I call our FED Watch show on the morning of the FOMC meetings. During these shows I have interviewed a number of top notch economists from the private sector, and at least three members of the FED organization. One of the questions I have asked all of these experts is this: In its 86 year history, has the FED's job ever been more complex than it has been for the past two years? The unanimous answer is "no".
Overtime For The FED
While the FED has long been a model for many other countries' central banks, in recent years it seems to have become the de facto central bank of the world, if for no other reason than that the U.S. has been the economic Atlas that has almost single-handedly held up the world economy. The "Asian Contagion" sent economic tsunamis around the world during 1998 and parts of 1999, and the sheer strength of the U.S. economy probably averted a global recession, or worse.
There are four groups that deserve significant credit for creating the environment that enabled the U.S. to assume the Atlas role:
1. The FED. No question, first Paul Volker, the immediate past FED Chairman, and now Mr. Greenspan and his FED's policies, have contributed to the economic environment in which opportunity can be created and flourish.
2. Technology. The technology sector pulled off the "hat trick" by creating:
a) amazing new applications and capabilities;
b) almost unbelievable (especially for the FED) increases in productivity;
c) unprecedented investor opportunities.
3. Small business. Twelve million net new jobs between 1992-97; 800,000 new businesses in 1999. You and me. One job at a time.
4. American consumers. The strong economic condition of the U.S. economy in the past decade gave us the confidence and the cash/credit to buy stuff. Our stuff , their stuff, a LOT of stuff.
Safe Harbor
Thankfully, the unprecedented economic growth of the U.S. economy provided a safe harbor for capital and goods, and kept the global marketplace from collapsing. And as long as the world's economies were ailing, the FED focused much of it's attention on the problems abroad and treated worrisome indicators here at home with benign neglect.
This Just In
Wait! I'm starting to get another FED vision. Must have missed something earlier. Yes, there it is.
"Things have settled down overseas - we can start tightening down on the U.S. economy."
Be not deceived. Those worrisome indicators in the U.S. economy were pushing Mr Greenspan's comfort envelope all during the "Asian Contagion" period; he just couldn't risk killing the goose that was laying the eggs the rest of the world needed.
Goose? What Goose?
Thanks in part to the four elements listed above, including the FED lowering interest rates 3 times (75 basis points) in the last half of 1998, other economies around the globe have begun to rebound. Good news? It depends.
With those pesky contagions sort of cured, the FED is now turning its attention to some of those worrisome indicators in the U.S. economy that, while handy as a shirt pocket only a year or so ago, now have popped up on Mr. Greenspan's radar screen as targets of opportunity.
The Weapon Of Choice
Between June 1999 and March 2000, the FED raised interest rates five, count them, FIVE times, for a total of 125 basis points. If you do the math, you will see that's 50 basis points more than they doled out in '98.
The Targets
• Irrational Exuberance in the stock markets, which had recently provided the world with some very rational confidence in the strongest economy and currency in the world.
• Conspicuous Consumption by the U.S. consumer, which had so recently represented a dependable and critical outlet for ailing countries' exports.
• Wealth Effect, which is the belief by Americans that they are so well off financially that it's OK to spend money on stuff, even if we have to borrow the money.
Three targets, five shots. Since it seems the FED's ordinance does not seem to be causing the intended results, many observers are predicting more rate increase shots being fired across our marketplace's bow this year. One of our economist friends, Gary Shilling, author of Deflation, says the FED "will keep raising rates until it gets someone's attention." That someone is actually two: the stock market and consumers.
Unintended Consequences Or Collateral Damage
Notice that in my visions I didn't see any FED concerns about small business. You know, the little engine that could, and did contribute so much to the strength of our economy.
We're the folks who, unlike the IPO crowd, borrow most of our non-earnings capital from banks, who have this habit of charging interest. And their rates are typically based on a floor of 3% above the Fed Funds Rate. With the Fed Funds Rate currently at 6%, after the five 25 basis point increases of late, that puts bank Prime Rate at 9%.
As you probably know, Prime is the rate banks charge their BEST customers. Unfortunately, many small businesses don't fall into this category, and consequently, we become all too familiar with the term, "Over Prime", as in 1 over Prime, 2 over Prime, or the dreaded 3 over Prime, and the prohibitive 4 over Prime.
Most small businesses can blend 8% money into their cost of doing business, but once interest gets to 10% and more, the cashflow screws start tightening and small businesses start failing. Or they don't get started at all.
I believe small business is becoming "collateral damage" from the FED's past rate increase salvos. In military terms, collateral damage is "unfortunate side effects" of an attack. I use the term here because I think small businesses are not the FEDs intended target, but we still get bombed.
Bubbles
As you saw in my vision, if you are the FED, you worry about bubbles. Actually, you worry about needles getting too close to those bubbles. The needles in question are the irrationally exuberant, record setting stock markets, and the conspicuous American consumers. The FED's primary targets.
But long before interest rate increases dull the stock markets' needle, 10 to 12 percent money will already be disproportionately hurting small business.
And long before consumer spending's needle is no longer a threat, the FED's actions will wreak havoc on the working capital, cash flow, and profitability of small business, the most impressive, but also most fragile sector in our marketplace.
Small Business Gets Punched
In the 1987 book, Secrets Of The Temple, How The Federal Reserve Runs The Country, author William Greider reports that former FED Chairman William Chesney Martin (Truman to Nixon), once joked that, "The FED's job is to take away the punch bowl just when the party gets going".
It's no party running a small business. We are often closer to failure than to success. Mr. Greenspan, we can live without punch, but we don't need to be punched. Until you discover the "smart bomb" to accurately get the attention of the stock market and conspicuous consumers, don't make small business part of the collateral damage.
Write this on a rock... The New Economy is real! The FED needs new models to manage the new economic dynamics so that small business owners, who represent 98% of all business in America, are not inadvertently and disproportionately harmed when the FED is trying to target other sectors of the marketplace.
