Is the Federal Reserve good or bad for business?

[Howard_Roark]

I have been a huge fan of Ron Paul for a few years now and agree with almost everything. The only thing I don't fully understand is the Federal Reserve, and I've come to realize this is at the very heart of his beliefs and that I must try to understand this.

I believe that what sets this country apart is businesses, from sole proprieterships to medium and large companies like Wal-Mart. There is no question, the US is the reigning unrivaled world champion of businesses.

So my logical question is, if the Fed has existed since 1913, has it helped or hinder US businesses? Namely, under and inelastic commodity backed money supply would businesses be better or worse off?

[bobbyw24]

How the Federal Reserve hurts small businesses and what you can do to fix it

Thu, Jul 16, 2009

Bailout, Federal Reserve

Note: The below is an updated take on a post I wrote and published this in early October 2008 under the title, “The Super Easy Guide to Understanding The Financial Crisis.” Stick with it. When you understand how the Federal Reserve hurts small businesses, you will understand why it is so important that we urge our State Representatives and Senators to support HR1207 and S604 . These are the precursors to legislation that would allow U.S. Citizens, through the Government Accountability Office (GAO), to “Audit the Federal Reserve” (Can you believe that we can’t do that now?)

Yesterday, The Fox News Show “Freedom Watch” dedicated all conversation to the topic of the Federal Reserve. Shelly Roche from ByteStyle.tv was a guest on the program and mentioned our group, Small Business Against Big Government. Aside from being very excited and grateful for the mention, it made me want to do more educating about the Federal Reserve. Thus, the below. I hope you (1) enjoy it (2) share it with others (3) call your Congressional Reps and Senators to voice your support of these measure.

The below is intended to be something you can share with employees and co-workers, so please identify someone you can share it with today.

In October 2008 you probably watched what was going on in Washington and on Wall Street – all these bankers and congressmen running around, the hand wringing, the panicking, the gyrating markets, the claims that we’re heading into a depression, screaming for a bailout – and you thought:

What the devil is going on?

What is this crisis exactly, and why could it cause another depression?

Depressions are marked by mass unemployment and a sputtering economy. As Frank Chodorov put it, “A depression is a halting of production. Production stops when people cut down on their consumption.” People want to work, but can’t find it. People want to borrow money, but no one lends. People can’t pay their debts. They lose their homes, their cars, their businesses, their jobs.

Do you know why depressions happen?

Depressions happen because resources get put to bad uses – really bad uses – and the dislocation between supply of and demand for goods and services leads to a painful restructuring or unwinding from the excesses of earlier times.

People have gone to work in industries that provide “goods and services” that other people no longer want. For example, a few years ago everyone and his dog, it seemed, was becoming a real estate agent or mortgage broker. Today? No demand for that. These people have had to find something else to do. In a depression a lot of people are looking for something else to do all at the same time.

There are causes for these resources being misallocated (a bigger, better word to describe “put to bad use”), but that discussion goes beyond the scope of this discussion.

The issue now is that there’s a real fear that resources have been so terribly misallocated that the resulting adjustment is going to plunge us into another Great Depression.

Apparently – the politicians told us – this Depression was inevitable. That is, unless the government were to intervene. Or so says the government.

But what specifically was happening then, during the adjustment process, that caused this fear of economic crash and resulting depression? What might happen to cause mass unemployment, mass poverty, and why would it happen at that moment?

I’ve been asked this question by people who don’t follow markets or the economy much, and so I resolved to write something that would help explain “how we got here” the best I can.

So, here it is. My attempt to explain in “common folks language” what’s happening right now and why it’s freaking everyone out.

I’ll leave out the numbers and instead stick to broad outlines and discussions of economic cause and effect. Buckle your seat-belt.

Here is the core thing you have to understand about our situation at that time.

We were experiencing a credit crunch of monumental proportions in the credit markets. The credit markets are the places where borrowers and lenders meet up to exchange money for promises. A borrower takes money from a lender, and in exchange for that money gives a promise – to pay back the money with interest.

What’s a credit crunch?

Simply, it’s a state-of-affairs where and when people and companies – especially companies – that need to borrow money (and in a normal market would be able to borrow money) can’t borrow money.

Lenders just aren’t lending, and instead are holding onto their money.

How do you know when a crunch is on? Do you have to ask the lenders? The borrowers?

No. Just watch interest rates. You see the signs of a credit crunch anytime interest rates suddenly go way up (and I mean, way up, like a rocket taking off to the moon).

Why do they go up in a crunch?

Because there’s not enough of the money to go around for everyone who wants it, so the people who are “selling money” have a lot of potential customers bidding for it.

Here’s a somewhat lame but illustrative example. Let’s say you have a ticket to see Britney Spears in concert at a show that seats 100,000 people. It cost you very little – 10 bucks – because no one wants to see her and there were a ton of seats available.

There’s a lot of supply of seats/tickets, and very little demand.

But then you hear that the venue has been changed to a 50 seater. Well, all of the sudden the supply of seats is down, in fact, they’ve all sold out, so now each ticket is worth a little more.

You’re thinking about selling your ticket.

But then Britney gets laryngitis, and a couple of hours before the show they announce a replacement – a surprise performance by Miley Cyrus. Well, everyone wants to see Miley, so suddenly those 50 seats are in very high demand.

Now there’s a lot of demand, and very little supply.

Everyone wants your ticket, and you sell it for $100 bucks.

That happens with money, too. When demand is low and supply is high, interest rates are low. When demand is high and supply is low, interest rates are high.

For a few weeks in September and October short term interest rates – specifically, the rates at which banks lend each other money overnight – shot up by around 200%.

See, lots of people wanted to borrow money from lenders. And the more time that goes by that they want to borrow, but can’t, the more they’ll need to borrow, and the more desperate they become.

The crunch borrowers experienced was primarily in short-term money that companies needed to borrow.

This kind of debt is called “commercial paper” but the name is really not important to our discussion; you will now understand it when you read about it.

What is important to our discussion is that you understand what happens to a company when it can’t borrow short-term money when it needs it.

Notice I said need to borrow, not want to borrow. When a company needs to borrow, bad things happen if it can’t.

Many companies borrow money for short periods of time to cover expense or pay for things they need immediately, like inventory or payroll, because don’t have the cash right now.

They can get a short-term loan because they’ll have the cash later. Owing to the fact that they will have the cash later, someone will lend them the money they need right now and get paid back, with interest, a little later.

So the big worry was that there was a shortage of this short term money for borrowing, and it was putting companies under so much pressure that they might have to shut doors, stop delivering services, and lay off people.

How is that exactly?

I mentioned that people use this short term money to stock up on inventory for sales they expect to make in the future, or to meet payroll.

If you don’t have product to sell because you can’t finance it, then you can’t make a sale, can’t turn a profit, can’t pay your people, your rent, your long-term debt, your light bill, etc.

What happens if you can’t pay your people?

They can either work for free, or they can try to get another job. Either way, it’s a hardship. Their mortgages have to be paid. Their kids have to eat. It’s incredibly disruptive. Mass layoffs means mass defaults on consumer debt (they have credit cards and cars that they bought on credit), which means consumer lenders tighten credit, too. And it spirals downward.

So there’s this problem with this short term debt being unavailable.

There’s a second reason people need new short term debt. They need it to pay off the old short term debt they have now.

See, in the business world, people often don’t “pay off” debt with cash in their bank account – there isn’t any cash there. They pay off one loan by going and getting another. This is called “rolling over” debt.

In a normal credit market people “roll over” short-term debt all the time.

For example, a company will borrow some money for a month or so and then a month later, instead of paying it off, they roll it over by borrowing more money to pay off for the old money.

But what happens if it comes time to roll the debt over, but you can’t get a new loan to pay off the old one?

Well, you have to pay off the old one with the money you have in the bank account, If you have any at all.

And what if there’s none there?

Well, you’re shafted.

And that’s what was happening.

People couldn’t roll over their debt, and they couldn’t get cash for their short term needs.

So they were being threatened with having to close their doors and lay people off, all because they can’t roll over this debt.

These are often great companies, profitable companies, companies with customers and demand for products, but they aren’t able to get “grease in their gears” to keep their production engines turning.

So we knew what was happening. But why did it happen? Why couldn’t good companies get short term debt?

Well, like we said before, because lenders weren’t lending.

But why weren’t they lending? Did they have the money? If so, why did they hoard it? And if they didn’t have money to lend, why not? Where did it go all of a sudden? Why do lenders get afraid to lend?

There are two reasons lenders get afraid to lend.

1 – They’re worried they won’t get their loaned money back.

2 – They’ve also borrowed money, and they’re worried they’ll have to pay back their own debts so want to keep their cash in their own account.

When you borrow money, it doesn’t come without strings attached. There are certain ways you agree to run your business and certain standards you agree to keep. There are also collateral values you agree to maintain so that in case you don’t pay the loan back the lender can take over something of value, sell it, and recover all or part of the loan loss.

Well, as to #1, a lot of defaults were happening, so banks were getting burned and were worried about future loan defaults.

But something else was going on. Even on loans that were getting paid back, the assets (the stuff they’ll take from you and sell if you don’t pay for your loan) backing the loan were dropping in value as collateral.

Now as to #2, the people the lenders borrowed money from didn’t want to give the lenders any additional money(and in many cases were asking for money back) because they see these loans going bad, and this collateral losing value.

So both of those things were going on.

Borrowers and lenders both became INSOLVENT.

Insolvent is an opaque word for a pretty sinister state-of-affairs. Being insolvent means you are unable to meet your debt obligations. You owe more than you’re worth and you can’t pay your loans back. Insolvent means “negative net worth”. It’s de facto bankruptcy.

Who wants to loan money when the person receiving it (the counter-party) might not be able to pay it back and whose collateral is so cruddy, losing value, that you might not be able to recover any of it?

You’re scared witless that you’re going to lose your money if you lend it out. So you’re hoarding it.

The threat and fear of insolvency (fear of permanent and/or significant loss) among counter-parties caused hoarding by lenders.

But, you ask, why were companies suddenly becoming insolvent?

The problem was two fold – DEFLATION and ASSET VALUE WRITEDOWNS (which is really just a form of DEFLATION).

Don’t get overwhelmed by those words. They’re easy to understand.

Deflation:
Deflation is an ugly word that means what it sounds like. Deflated tires are tires that have lost air. An economy experiencing deflation is an economy that is experiences a price drop on the stuff in the economy.

Rapid and sudden deflation is also known as a “bust”.

The housing market busted. Housing prices plummeted. Banks that lent against homes, using those homes as collateral, saw the value of that collateral plummet. Who wants to make a loan in an environment like that?

Writedowns:

http://www.sbabg.org/2009/07/16/how-the-federal-reserve-hurts-small-businesses-and-what-you-can-do-to-fix-it/

[Zippyjuan]

If the following from the article is true, why don't we have high interest rates right now?

We were experiencing a credit crunch of monumental proportions in the credit markets. The credit markets are the places where borrowers and lenders meet up to exchange money for promises. A borrower takes money from a lender, and in exchange for that money gives a promise – to pay back the money with interest.

What’s a credit crunch?

Simply, it’s a state-of-affairs where and when people and companies – especially companies – that need to borrow money (and in a normal market would be able to borrow money) can’t borrow money.

Lenders just aren’t lending, and instead are holding onto their money.

How do you know when a crunch is on? Do you have to ask the lenders? The borrowers?

No. Just watch interest rates. You see the signs of a credit crunch anytime interest rates suddenly go way up (and I mean, way up, like a rocket taking off to the moon).


If the Federal Reserve (and Treasury) did not try to add liquidity to try to ease this credit crunch, would it have gone away faster by itself? Or should a "well run" money manager have added even more money to try to ease the creadit crunch and help out small businesses borrow again?

[bobbyw24]

YouTube - Ron Paul: Opening Statement on Federal Reserve role and Consumer Protection 07/16/2009 (http://www.youtube.com/watch?v=y6Gl88b9DUg&feature=player_embedded)

[Chester Copperpot]

I have been a huge fan of Ron Paul for a few years now and agree with almost everything. The only thing I don't fully understand is the Federal Reserve, and I've come to realize this is at the very heart of his beliefs and that I must try to understand this.

I believe that what sets this country apart is businesses, from sole proprieterships to medium and large companies like Wal-Mart. There is no question, the US is the reigning unrivaled world champion of businesses.

So my logical question is, if the Fed has existed since 1913, has it helped or hinder US businesses? Namely, under and inelastic commodity backed money supply would businesses be better or worse off?

Its the head vampire for all those other problems we have that are unconstitutional.

[Toureg89]

both. depends on which business you own.

[Chester Copperpot]

both. depends on which business you own.

yeah true.. I forgot about that.. if youre a bank its GREAT for business

[AlexMerced]

If the following from the article is true, why don't we have high interest rates right now?


If the Federal Reserve (and Treasury) did not try to add liquidity to try to ease this credit crunch, would it have gone away faster by itself? Or should a "well run" money manager have added even more money to try to ease the creadit crunch and help out small businesses borrow again?

Interest Rates arn't too high cause the the fed is paying interest to the banks on the reserve, so in this case the fed can monetize debt freely without worrying that the bank will use the increased reserves to increase the money supply cause they'd rather just take the free money from the interest.

Although... if the fed ever wanted banks to lend again, they'd have to turn off this interest fire hose which would result in such an unleashing of bank reserves that it could only result in hyperinflation.

Some rates are high now thought, like credit card rates and such, other rates are still being manipulated by other means.


This video is a pretty damn good explanation of the federal reserve: YouTube - How Bernanke Is Using the Printing Press to Win Friends and Influence People | Robert P. Murphy (http://www.youtube.com/watch?v=BARmYUkdQUE)

[osan]

So my logical question is, if the Fed has existed since 1913, has it helped or hinder US businesses? Namely, under and inelastic commodity backed money supply would businesses be better or worse off?

The answer is "it depends".

It depends on the business in question - on what side of an invisible fence you find yourself. Consider the financial services sector for a recent and rather good example. If you are Goldman Sachs, the Fed has been very good for you. If you are Lehman Brothers, the Fed leaves something to be desired.

The Fed is a privately held quasi-governmental agency that in actual effect answers to nobody. Most of what they do is carried out in secret and they hod he purse strings of not only the nation, but of the world.

The Fed has been up to its jaundiced eyeballs in pump and dump scams since its inception, beginning with the depression of 1920 and running through to the great housing scam of the early 21st century.

For those businesses with the inside track on what the economy is going to do, the Fed has been great. For the rest, the vast and overwhelming majority, it has been an unqualified disaster.

[dean.engelhardt]

In the short term, artifically low interest rates are good for business. In the long term it becomes a disater. Manipulation of interest rates promotes poor busniess decisions and eventually the businesses that would prosper under a true cost of money are starved of capital.