Just read interesting article on role the Federal Reserve (Fed) in US and their counterparts in other countries are impacting business negatively.
We all know that cranking up the printing presses creates money out of thin air. That’s normally, inflationary, which is why politicians like it. Politicians love to spend money. If politicians think they might have to pay it back they want to pay it back with cheaper dollars.
Printing money drives down the cost of capital. Low cost capital encourages companies to expand faster than economic need dictates…think about all the money invested in the oil and gas industries in recent years. Production in US has doubled in the last 6 years…but demand has not doubled.
Creating wealth in the past always started with saving money. Governments are trying to change that with the printing press. It’s working on the mass population.
Now individuals, businesses, and countries can borrow money and make purchases with very little down. They don’t even need the assets to “back” the money they have borrowed. Money creation, done relatively slowly, creates inflation. Done very rapidly, like the world is experiencing now, and money creation can be deflationary before it becomes inflationary.
When the cost to borrow money is almost nothing, it encourages speculation. Today, most major corporations have plenty of working capital to invest, but are they investing it wisely? Or just spending money? Even stock buybacks can be costly if companies are buying their own stock at inflated prices.
Interest rates used to be set based on actual demand for capital. Now they appear to be based on the whim of the Fed and other governments.
Fed has Created at Least 2 Financial Market Bubbles
First is the above mentioned capital that has flowed into gas and oil industries. $5 trillion in last decade, most financed with junk bonds and spent by relatively small, Texas based, oil and gas companies. This is primary reason Texas has created as many new jobs as the rest of the country combined.
Today, these smaller companies are feeling the effect of lower gas prices. It is starting to spill over to the larger oil and gas companies. Chevron lost over $2 BB in oil and gas operations last quarter. Last time it saw loss like this was 20 years ago.
Share buy back programs coupled with sharply lower oil and gas prices are having serious impact on these companies. Oil and gas companies either have to borrow more or reduce dividends or share buybacks. Either will cause a drop in share prices.
Second, Fed’s easy money policy has greatly increased subprime auto lending. Almost the same as the subprime lending in housing market 10 years ago. People bought houses they couldn’t afford. Now they are buying vehicles they can’t afford. When bubbles burst, assets lose value…a lot of value..value that takes years to recover. Some is never recovered.
One company has $26 BB in outstanding auto loans, $21 billion of which are subprime. And that’s just one of several companies with billions in subprime auto loans. Moody’s expects 27% of these subprime auto loans to default. That effectively wipes out the projected profit margins.
Combine greedy lenders with irresponsible buyers and it’s a recipe with serious repercussions.
The housing subprime crisis occurred when people lost jobs and the stock market lost lot of value in 2008. Today stock market is close to all time high and employment is rising. Even average incomes are increasing…yet, loan defaults are high already.
Something is badly wrong in the underwriting and funding of new car loans.
What’s It All Mean?
Right now everything is good. When auto loans can’t be repaid, or oil and gas companies can’t repay loans we will have deflation short term. I will start to reduce prices on both new and used cars. It will likely also reduce demand for gas.
When defaults occur credit dries up quickly…for consumers or businesses.
Fleet sales by auto manufactures to rental car companies account for 25% of new car sales. Rental companies dispose of vehicles within 1-2 years. As people default on their auto loans the auto manufactures, rental car companies, used vehicle sales, and those holding the loans will all be negatively affected.
Is All of this Just Conjecture?
No. January 2015 inflation hit negative territory…deflation. (Measure used was Consumer Price Index including food and energy.) By June we had barely climbed out of negative territory.
The Fed’s printing press policies rather than creating instant inflation are creating deflation in select industries and creating deflationary conditions in others.
How about the rest of the world? Europe is in deflation, Japan spent couple decades in deflation. Asia saw deflation in 2013 and is now facing deflation again.
None of us can impact the government. Each of us, as individuals, or companies, can increase savings and reduce or re-structure debt. Restructure leases and contracts, whether on buildings, equipment, with vendors, cell phones, or internet services.