Overview
The National Bureau of Economic Research (NBER) reported that the recession officially ended in June 2009.[1] Yet the annual rate of economic growth remains below a long term average of 3.0 percent. While it may be tempting to think that all businesses have shared equally in the pains of a slow recovery, it is not an accurate view. Many practitioners believe that big businesses are growing faster than ever because they can leverage their large scale to grow faster in markets outside the United States. However, such globalization patterns do not increase GDP. In the past monetary policies could be counted on to stimulate economic growth for all businesses. As shown in this article that is no longer the case.
In 2016 the FED’s Chair Janet Yellen presented a paper at a Federal Reserve Bank of Kansas City symposium in Jackson Hole, Wyoming, entitled “The Federal Reserve’s Monetary Policy Toolkit: Past, Present, and Future.”[2] The Chair stressed that the proven way the FED had stimulated economic recovery and growth from past recessions was to reduce its lending rate to member banks (i.e. discount rate). Specifically, the discount rate, which is the rate that the FED charges member bank to borrow funds in the short run to maintain required reserves, dropped an average of 4.3 percent for the last three recession recovery cycles. Similar rate changes exist for the federal funds rate which is the rate that banks charge each other for short-term loans to maintain required reserves.
If the United States economy had gone into recession in March 2017 when the discount rate was 1.50 percent and the FED followed their previous recovery rate policies, the discount rate would have been lowered to -2.8 percent. With inflation at two percent the real or adjusted discount rate would have been -4.8 percent. There are no precedents to predict what rational economic behaviors would have been for banks, businesses, and households.
In addition, the FED acknowledges that uncertainties exist on multiple levels, which include how to increase the current discount rate of 1.75 percent to 5.0 percent or higher, how many asset purchases would be needed to maintain the unemployment rate at or near 5.0 percent in a future recession, how phasing out interest rates on bank reserves and asset purchases would affect bond markets and bank liquidity, and how fiscal policies and shocks from worsening economic conditions in other countries would affect the effectiveness of U.S. monetary policies. How should practitioners plan for these uncertainties?
This article postulates that the ineffectiveness of the FED’s expansion policies requires businesses to adapt their business tactics and strategies. At the heart of the matter large businesses have already adapted to the Global Information Age by focusing on Intangibles and Goodwill asset investments which are not bank financed. While the FED and its member banks still assume that lower interest rates will increase business investments, practitioners can no longer rely on physical capital expansions to stimulate economic growth. Small and mid-size businesses are encouraged to understand what large companies, such as the S&P 500 companies, have done and adapt their Global Information Age investment and expansion strategies to increase their growth. More than a dozen suggested actions and strategies are discussed below.
Why the FED’s Monetary Policies are Ineffective
In 2017 it is easy to focus on the uncertainty facing businesses and the national economy from the Trump Administration’s proposed fiscal policies. These policies include reducing taxes, increasing government spending for infrastructure projects, eliminating regulations, and replaces the Affordable Care Act. In a period of such fiscal change the only certainty is that market conditions will not remain the same. In such a period monetary policies can be seen by practitioners as a way to provide economic stability and stimulate economic growth. In 2016 Larry Summers determined that monetary policies contributed to secular stagnation growth in the United States.[3]
Historically, the FED’s most effective tool has been its ability to reduce the discount rate to engage a change cycle that ends up stimulating economic growth. Unfortunately in 2017 the FED does not have this monetary policy tool available to stimulate the U.S. economy. Figure 1 provides a view of an annualized federal discount rate for the last 20 years.[4]
The discount rate averaged 4.0 percent from 1990 to 2017 and since 2008 the average has been 0.78 percent. The FED historically pushed the discount rates up during periods of economic growth and then decreased the rate to stimulate the economy out of recessionary economic conditions. The FED did this in 2001 and in 2008. In the 2001 recession the FED was able to move the rate from 6.00 percent to 1.33 percent and promote economic recovery. In 2008 the FED moved the rate from 6.25 to 0.50. While reasonable people can disagree about the length and extent of the recovery since the Global Financial Crisis (GFC) there is little doubt that the current discount rate of 1.75 percent cannot be effectively lowered.
With historically low FED discount rates since 2009 many economists and practitioners ask why bank financed physical capital expansion has not stimulated economic growth? Two reasons are postulated in this paper: (1) banks did not know if household savings would rise with low interest rates, and (2) large businesses have changed their asset management investment profiles and their priorities for bank financing.
Since 2008 banks interest rates offered to household savers has remained within 0.5 percent of the FED’s discount rate. With low interest rates households have not historically increased their savings account balances. Traditionally, banks do not increase their loans without additional savings because such actions reduce their liquidity ratios. In retrospect the period from 2009 to 2015 turned out to be historically different. Savings account amounts increased with low interest rates. Banks discovered that they no longer needed to raise interest rates to increase savings amounts from an ageing demographic base in the Global Information Age. Banks used the unexpected additional deposits to buy back stock, pay dividends, increase cash balances, and acquire other institutions.
With regard to bank/business lending for physical capital expansions a schism occurred in 2008-2010. In this period businesses went to their banks to access credit lines to sustain the downturn and were denied access. Business/bank relationships have been tenuous since then. Do you remember the case where McDonald’s went to its bank and was told no additional credit was available for a proposed investment in their restaurants? The Great Recession can be characterized as the period when businesses lost trust with bank financing. Since then businesses have financed capital project expansions using their own cash, long-term debt, and equity financing. Compustat data for the S&P 500 companies from 2008-2015 shows that Goodwill and Intangible assets have risen to 17 percent of corporate assets while Plant and Equipment has remained close to 1.3 percent.[5] With bank financing tied to physical capital expansions the connections between banks, businesses asset management, and economic growth are broken.
A Business Actions List for consideration in 2018-2019
While the previous section focused on how the actions of the S&P 500 companies and the FED led to stagnant U.S. economic growth, this section suggests what small, mid-size, and large companies can do to offset the downside of ineffective monetary policies and improve business growth when monetary policies are ineffective.
Small corporations should carefully examine alternatives to bank financing of future expansions. Corporations deemed small business (in general, net after-tax income of $2.5 M or less) should carefully review all financial advantages afforded by the Small Business Administration (SBA). The SBA is a focal point of the Trump Administration, and it will receive greater funding and visibility. There are numerous programs including, but not limited to: (1) SBA 7(a) loans; (2) SBA 504 loans; (3) Certified Development Company loans; (4) CapLines loans; and (5) Export Working Capital loans. Further, and not directly related to the SBA, are other government financing methods to both small and large corporations. These include, but not limited to: (1) Industrial Revenue Bonds; and (2) business and industry loans through the U.S. Department of Agriculture which can be broadly defined.
Practitioners of all medium and small sized businesses should also assess how to better leverage bank relationships as S&P 500 companies have since 2009. Specifically, large corporations have connected the availability of increased cash in banks to cheaper long-term debt financing. Why should not all businesses follow this trend?
Practitioners should also be concerned that increases in cash positions by large businesses and banks signal that an economic downturn is increasingly likely. So time may be limited. Recessions are cyclical. The duration between the last five recessions was six to nine years. The current recession clock started in July 2009 according to the NBER. In 2017 the United States economy is well within the duration range. While there is no certain date for the next recession, uncertainty is rising. In 2018-2019 the recession clock will pass above the duration range.
If a recession occurs and the FED maintains low discount rates, end strategies for small and mid-sized companies must include acquisitions by large companies. The following list of actions is appropriate for small to mid-size business managers to consider and discuss as paths to improved business growth and increased acquisition value:
- Increase Total Corporate Goodwill Value
Increase return on equity (ROE) to 15 percent or higher. Using the DuPont System, practitioners can determine what processes the business does well and which need improvement. The DuPont equation is:
ROE = (net income / sales) * (sales / assets) * (assets / equity)
or said differently:
ROE = net profit margin * asset turnover * equity multiplier.
- Increase Intangibles
Insure that any copyrights or patents are filed and up to date. Review, and if necessary, enhance legal protections to preserve and safeguard projected account receivables.
- Hedge Commodities
Companies should consider hedging commodities to assure raw material prices and adequate supplies.
- Work harder on Customer Satisfaction
It is imperative that smaller companies gain customers since they translate into increased Goodwill. Strategically prepare for this now by rethinking and reconnecting with those factors that drive customers to your company.
- Push Innovation and Product/Service Extensions to engage in Global Supply Chains
Examine core business competencies and conceptualize how to extend utilizing current output with only minor changes. Are there any industries that can successfully use your products and services as interim outputs?
- Enhance Strategic Business Models
Examine the possibilities of entering new markets with new products and services through alliances or mergers and acquisitions on a global level. It is a very good time to acquire these extensions, but at prices that reflect the potential for U.S. and global economic downturns.
- Expand Long-Term Debt Financing Positions in 2018-2019
As S&P 500 companies have done seek available bank funding to finance long-term debt.
- Return Off-shore Monies to U.S. Banks
Renegotiate banking relationships with better credit terms and investment opportunities for off-shore monies returning to the United States. Small to medium sized businesses can determine the benefits from lower corporate tax rates and allocate available funds to high priority capital projects in the United States. In a shifting trade deficit, practitioners can expect more on-shore opportunities, specifically in holding accounts.
- Increase accumulated Cash Positions
Make plans to accumulate more cash for a recessionary cushion. Practitioners should revisit tactics to determine how to improve short-term revenue collection and credit targets and enhance cost spending controls. In effect practitioners should seek to lower their exposure to a problematic national downturn. Revisit cash management with banks based on new controls and accounts payable management processes.
- Leverage Equity Positions
Seek equity positions to increase owned shares. Buy back as much stock as possible when overvalued equities reset. With a refocused cash management position this increased liquidity should give poised practitioners a chance to foster growth during a financially weak period.
- Expect increases in the value of U.S. Currency against other National Currencies
Bet against the U.S. currency to take advantage of poor monetary transmitters. The FED cannot reduce interest rates to reduce the value of the U.S. dollar relative to other currencies. Furthermore, the FED’s tools cannot reverse potential effects of a changed domestic policy from a shifting federal government agenda.
- Consider strategic Job Relocations
Relocate jobs to rust-belt states to take advantage of shifting tax and perspective identifies. In a recessionary crisis, the supply of labor will present practitioners with renewed opportunities in capital and labor markets. Market opportunities will differ by state.
- Analyze 2018-2019 Industry Opportunities
Reassess defense, healthcare, and infrastructure construction industries. The FED will not be able to stimulate the economy, but fiscal spending priorities are likely to stimulate higher growth sectors/industries that practitioners can penetrate by partnering with established business entities.
Considerations and discussions of these actions are important first steps. Practitioners will choose different paths to meet their specific situations. Regardless of the paths taken the effectiveness of the actions should be judged on improved future business growth rates and future acquisition values.
Conclusion
A shifting domestic agenda presents practitioners with a realistic and rapidly approaching economic scenario. The U.S. economy faces serious existential questions regarding risk and volatility against a poorly positioned FED and continued ineffective monetary policies to stimulate economic growth. Trade, immigration, and geo-political decisions, the U.S. currency, and the recession clock combine to present practitioners with an increasing level of downside risk. Practitioners who take advantage of pre-recession financing opportunities, recognize the risks ahead, map out the consequences of key monetary and fiscal policy actions, and solidify their equity-based positions and liquidity through cash management are more likely to succeed in this economic environment. In a real sense, it is better to adapt strategies and act today than be dependent on the Federal Reserve tomorrow.
[1] CNN Money, accessed July 10, 2017 on http://money.cnn.com/2010/09/20/news/economy/recession_over/index.htm
[2] Yellen, J (2016), The Federal Reserve Bank of Kansas City Designing Resilient Monetary Policy Frameworks for the Future Symposium: “The Federal Reserve’s Monetary Policy Toolkit: Past, Present, and Future”, accessed January 15, 2017 from https://www.federalreserve.gov/newsevents/speech/yellen20160826a.pdf
[3] Summers, L., Secular Stagnation and Monetary Policy”, Federal Reserve Bank of St. Louis Review, 98(2), Second Quarter 2016, pp. 93-110.
[4] ”FRED Discount Rates INTRDSTUSM 193N.” Chart. St. Louis Federal Reserve Bank, accessed April 20, 2017, https://fred.stlouisfed.org/series/INTDSRUSM193N
[5] Compustat, S&P Capital IQ, North America, Fundamentals Annual, accessed on June 15, 2017.
