Why the Economy is Not Improving

There is an old saying on Wall Street, “Don’t fight the Fed.”  This means it is a bad idea to sell and short stocks when the Federal Reserve is lowering interest rates to spur the economy and it is a bad idea to buy and especially to go on margin when the Federal Reserve is raising interest rates.  The reason is that the Federal Reserve has enormous power to control the rate of economic growth through their control of interest rates and the money supply.  When they add money and lower rates it is easier to get loans and loan rates fall, allowing people to borrow money and start new businesses or expand current businesses.  Likewise, they can take money out of the economy and raise interest rates.

The Federal Reserve has been keeping rates low for several years now.  They have also been doing what is called “Quantitative Easing.”  This is essentially creating money out-of-thin-air and then using that money to buy Treasury and mortgage securities.  The goal here is to keep interest rates low to spur the housing market.  This is why housing loan rates have been at historic lows for many months now.

The trouble with doing this for too long is that it becomes inflationary.  They are creating money – IOUs for goods and services – for which no goods and services were produced.  For money to have real value someone needs to do something to earn it – make a table.  Raise a cow.  Build a house.  What the Federal Reserve is doing is creating money without anything of value being created to earn it and then using it to buy government debt and mortgages.  At first this does not have a major effect on the value of the dollar – it is a small amount of unearned dollars – but eventually it leads to inflation.

As in Japan during the 1980’s, the Federal Reserve has been keeping interest rates at zero and flooding the market with dollars, and yet those dollars aren’t being used to create loans to start businesses and create jobs.  The reason is that there is little interest in creating jobs.  This is due to a variety of reasons:

1.  Employers have learned to do things more efficiently with fewer employees.

2.  The new healthcare law, the Affordable Care Act, will make it very expensive to hire new employees because the employer must provide healthcare if there are 50 or more employees and the healthcare required is very comprehensive and therefore very expensive.  In fact, the healthcare law is causing employers to lay off employees to drop below the 50 employee cap or convert employees to part-time to reduce the number of “full-time” workers.

3.  The effects of the Affordable Care Act on individuals is yet unknown, creating uncertainty.  As people are starting to get quotes for individual health insurance through the exchanges they are getting sticker shock.  They are seeing premiums rise by 100% or more for coverage with higher deductibles and a very limited doctor network.  Businesses are worried that this will have a big effect on consumer spending, so they are not hiring or expanding.

4.  Bond buyers are very leery.  During the GM bailout bond holders were strong-armed and forced to go to the back of the line beyond the union pension plan.  Not knowing how they will be treated in the future, there are fewer people willing to buy bonds and provide businesses with the capital they need to expand.

5.  Taxes were raised on the top income earners.  This reduces the incentive for these people to take on additional jobs and work longer hours, which in turn means fewer hours for staff and other businesses that support them.

6.  Workers have little incentive to return to work, having had extended unemployment benefits that are competitive to wages.  These workers are now shifting to the Social Security disability system.  With fewer people working, there is less being produced, making everyone poorer.

These issues could be corrected fairly quickly.  For one, the Affordable Care Act could be repealed, eliminating a huge amount of uncertainty that is weighing on the market and removing disincentives for businesses to grow.  The unemployment system and the welfare systems could be changed from agencies that hand out checks into services that match workers with jobs, getting more people back to work.  Sadly, a large segment of the population is unengaged with current issues and therefore don’t see the hole that is being dug.  It is unlikely that the youth of today will ever be able to dig themselves out.  No amount of printed money will lift the economy so long as these fundamental issues remain.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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