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Policy astray

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The US economy, nearing mid-2022, continues to challenge small businesses. Inflation has risen to its worst level since 1981 and stock markets have plunged straight into a bear market. Mortgage applications have hit a 20-year low, house prices are still 20 percent all year and mortgage rates are rising. Energy costs are rising and food inflation is in double digits. After keeping interest rates too low and adding $6 trillion to its bond portfolio for too long, the Federal Reserve has finally decided to fight inflation.

Small business owners will agree, it’s time to fight, but why did it take so long? The answer is revealed by looking at the Federal Reserve’s mission: stable prices and full employment. Total employment is still about a million employees below its February 2020 peak. The government has focused on injecting a lot of money into the economy, sending checks to millions of consumers, granting free loans to millions of companies and providing generous unemployment benefits. In addition, there were moratoriums on student loans and rent payments, both of which helped support an overheated economy. The Fed kept interest rates historically low, so loans were cheap and credit was the “easiest” in 48 years, according to the NFIB’s monthly surveys. Only a percent or two said they didn’t get all the credit they wanted.

So millions of former workers who produced nothing had millions of dollars to spend. There wasn’t enough ‘stuff’ available to meet the demand, so prices started to rise quickly. Entrepreneurs complained that inventories were too low at 48-year high rates. Supply chains have been broken, hampered by Covid-related disruptions and labor shortages. Wages rose to attract workers. Employment eventually rose and the double-digit unemployment rates disappeared, but employment remained the focus of policy. The government dismissed inflation as temporary and kept its foot down, low interest rates and increased government spending.

Inflation has become the number one problem for small business owners (28%) and now ousts the lack of qualified workers (23%) in second place, followed by taxes and regulations. Thanks to the Fed, only 1% named credit problems as their biggest problem. Compensation costs are soaring as owners compete for short labor supply and energy costs are skyrocketing ($5 average gas cost). Oil prices are over $120/bb, and that affects so many products outside of fuel. Natural gas prices are also very high, affecting critical products such as fertilizers. The number of owners reporting lower income is greater than the number of owners reporting profits greater than 2 to 1. This is unlikely to change anytime soon as government policies reduce the amount of oil produced by US companies. The government is turning to Venezuela and Saudi Arabia, asking them to produce more oil to lower world prices instead of encouraging US production through policy changes.

The prospects for improvement are not good. Even if prices were to stop rising today, they are at a double-digit level higher than last year. Will prices fall? Will wages be lowered? If not, we are stuck at the current level as the new normal. Small business owners expect difficult times to come. Labor costs are usually reduced through employment cuts, not through actual wage cuts. Fifty-nine percent expect business conditions to be worse by the end of the year, with only 6% seeing better. The president said the best way to prepare for hurricane season was to get a virus shot. The storm is coming, hopefully the government has the right vaccines. So much for the policy. The Fed plans to fight inflation by raising interest rates and cutting spending (homes are hit hardest). With all the economic challenges ahead, it looks like the second half of the year will be a tough one.

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