Small Business Straight Talk - March/April 2010

Small Business Straight Talk

NFIB chief economist Bill Dunkelberg offers a straight dose of economic reality.

Bill Dunkelberg

Debtor Nation

This year is all about debt.

Sovereign debt, mortgage debt, consumer debt, commercial real estate debt, the notorious debt owed by Fannie Mae and Freddie Mac—these will continue to be the centerpiece of market concerns. Institutions will have no choice but to “’fess up” to the real quality of their assets (hint: it’s pretty low) as they abandon hope that a sharp economic recovery might help restore quality. Foreclosures will stay high.

So what else? Debt is causing problems on an even bigger scale: the federal government’s IOUs. The federal deficit is unsustainably high. So far, the U.S. Treasury has been able sell new bonds and roll over existing debt without triggering much of a rise in interest rates. That’s because of an increase in savings and a huge decline in private credit demand—fewer cars, mortgages and capital projects. The American consumer is socking away part of his or her paycheck, instead of buying new stuff and taking on loans.

Car sales are off by 40 percent and housing starts are running at 600,000 units, a small fraction of boom times. Spending and inventory plans among small firms (half of private GDP) are at 35-year lows. It adds up to hundreds of billions of dollars of potential credit demand sidelined. In simple terms, if a worker increases his savings from each paycheck to 5 percent from 1 percent, the pool of cash available to borrowers increases by about $400 billion, because banks have that money available to loan.  

Overwhelmed

But there’s weak loan demand. So instead of lending, banks invest in Treasury bonds, supporting low-cost Treasury borrowing. It won’t last. Eventually rates will rise amid competition for funds, slowing any nascent recovery.

Strong economic growth would mitigate some of the problems associated with debt for individuals, companies and governments. Unfortunately, that’s not likely to happen. Yes, pent-up demand should be substantial post-recession, and businesses will have to order more inventory. But while inventory needs and government spending will nudge first-half growth, in the second half consumers and businesses will continue to feel overwhelmed by deficits, huge reform legislation that few think will work, promised tax hikes at every turn and, yet again, more debt on which to pay interest.

And growth will fade.
 
Vote of No Confidence

The recent fall in economic activity was the worst since the Great Depression. At the bottom of the 1981 and 1982 recession, 47 percent of all small business owners expected business conditions to improve during the coming six months. Assuming the fourth quarter of 2009 was the bottom of the recent recession, the comparable statistic this time is 11 percent—a dramatic difference. Clearly business owners have no confidence that the economy is going to improve soon.

With that psychological backdrop, even people who have more money won’t feel like spending. Consumer spending will be disappointing because of low confidence and higher savings. “De-leveraging” will continue, driven in part by write-offs of uncollectible debts and greater savings. So the
recovery will fall short of the kind of explosive rebound that you might expect after such a sharp economic decline.

The biggest danger is that Washington—filled with people with no private market experience—will take it upon itself to create jobs through more misguided spending (“government job creation” is an oxymoron), exacerbating the current situation and making it harder for the private sector to regain its feet.