08/ 01/ 2008
The economy is in the doldrums, and so is small business owner optimism. The NFIB Small Business Optimism Index has been 10 points below its average level all year and hasn’t shown any sign of rebounding. Last September, the Index was seven points higher, but it began a steady decline once the Fed started cutting interest rates and warning of recession.
The Small Business Response
The percentage of owners with unfilled job openings is historically very low, and only 2 percent plan to increase employment in the coming months, down from 14 percent last September. These numbers anticipate an unemployment rate headed toward 6 percent. That’s not bad, but it will feel bad compared to the 4.5 percent we experienced a year ago.
The Federal Reserve has cut its policy interest rate by 3.25 points--to 2 percent--since September. Ultimately, this should stimulate the economy by encouraging borrowing and spending. However, the lag between rate cuts and spending changes is often characterized as "long and variable." So far, small business owners have been reducing their capital spending since the Fed rate cuts. Hiring has also slowed, with net additions to employment turning negative (owners let go of more workers than they hire, on balance). In addition, owners have been trimming inventories by reducing orders for new inventory and meeting current sales out of existing inventory. In recent months, virtually all job growth has been in education, healthcare and government jobs.
The Bad News Effect
Federal Reserve officials have acknowledged that inflation is becoming worrisome but expect that a slow economy will keep firms from raising prices. So far, this has not been the case. Last September, only 9 percent of all owners reported raising average selling prices (net of those cutting prices). Most recently, 23 percent reported raising prices (again, net of those cutting prices). This indicates strong "street level" inflationary pressures.
The media is loaded with bad news about the economy. The University of Michigan survey of consumers reported that 90 percent of U.S. consumers thought we were in a recession at the beginning of the year--even though unemployment was at historically low levels and employment near the record high originally set in 2000. But consumers also reported hearing bad news about the economy at the most frequent rates in the 50-year history of the survey. If everyone--including business owners spooked by the Fed announcements and consumers scared by media reports of "trouble"--cuts back on spending in anticipation of a recession, the economy will indeed slow down, even though current economic conditions don’t warrant such actions.
Fed interest rate cuts have contributed to dollar weakness. Europe has not cut rates, so investors prefer earning Euro interest rates and are selling dollars to get Euro-denominated assets. A weaker dollar helps to raise oil prices--so that oil revenues can buy the same amount of real goods and services in Paris, where oil producers shop. Import prices also rise, contributing to inflationary pressures. The highest percentage of owners since 1980 reported that inflation was now their No. 1 business problem, more so than taxes or weak sales.
With the economy weak and inflation strong, the second half of the year will be difficult to navigate, especially if the housing industry remains weak. Keep as much powder dry as you can.
This article is from the August/September 2008 issue of MyBusiness.
