In my WSJ op-ed in November 2001, and many other places since, I argued that in spite of sharp reductions in Fed funds rates, monetary policy was actually very tight. Because banks has systematically withdrawn from lending to business customers. Between then and May, 2004 bank business loans totaled minus $230 billion. How? By collecting $230 billion from business customers than they loaned to business customers every week for three and a half years.
This is why we had a slow, jobless recovery over that period. Big companies borrow money from the bond market; small companies have to borrow from banks. Small companies make up more than half of GDP and create 3 of every 4 new jobs.
Over this period we had a half a recovery, because only half the companies in America had access to credit.
As a result, the Fed had to push market rates much lower than would have been necessary. The result was a recovery dominated by large companies and the mortgage market, both of which are driven by fed funds and T-bill rates.
Since last May this is all changed. The mortgage refi game is over. Banks are lending to businesses again. Loans have increased by $63 billion since May. This is giving small companies a dramatic increase in working capital and drop in cost of capital that is not being reflected in (rising) fed funds rates.
Implications.
GDP, employment, and profits will grow faster than economists think this year, the mirror image of the jobless recovery that preceded it.
Fed funds rates could increase a great deal without stopping the recovery.
The surprising productivity gain of the past 5 years has been accomplished by big businesses alone. Now small companies are getting the working capital they need to make the IT investments to duplicate those gains. Add increased availability of broadband (new telecom act this year; I am on the working group) and cheaper, more scalable technology; the result is a small business led productivity jump.
Together, these factors mean small company profits will grow faster than big company profits. Small cap stocks will outperform large caps this year by a wide margin. (This is why I have a long position in US small cap stocks at the moment.)
Moral of the story:
is it is misleading to make judgments about the economy and investing, or to set monetary policy, by thinking about big public companies alone. When you dig under the numbers, the US is a two-cylinder economy. They both need to work for us to really grow.
John
