Small Business in the U.S.

We all know the pandemic/recession is hitting small businesses hard. Less understood is how their problems affect others. This analysis by Bain’s Macro Trends Group explains how a deeper small business downturn could flow through the rest of the economy.

• While Bain still projects a relatively robust recovery, the absence of fiscal support threatens this scenario and could result in a double-dip recession centered on small businesses.
• Small business accounts for almost 50% of US employment and over 40% of GDP.
• Falling revenues at small personal-service businesses leave many unable to survive without the support which is now expiring.
• Unemployment claims will begin rising again if more small businesses announce permanent closures.
• These businesses represent a significant chunk of retail frontage, leaving property owners vulnerable.
• Larger firms that service small businesses will suffer as their client base contracts.

Bain says new businesses will eventually emerge as the economy recovers, but the closures will still cause a near-term drag on economic activity. They advise anyone dependent on this sector to consider how they would mitigate the effects of widespread closures and bankruptcies.

US Economy

• The August durable goods orders figure was disappointing. However, capital goods orders, a proxy for business investment, showed robust growth.
• The dollar amount of capital goods orders hit the highest level since 2018.
• According to Homebase, small business recovery has stalled.
• The largest decline in credit/debit card spending has been among Americans with the best credit scores.
• Texas-area factory activity accelerated this month, according to the Dallas Fed survey.
• Overall, the regional manufacturing indicators point to robust factory output in September.
• High-frequency data indicate improvements for restaurants and airlines, but hotels are still struggling.
• US consumer confidence rose sharply this month, according to the Conference Board. The improvement was well above market consensus.
• US home price appreciation accelerated in July.
• The nation’s trade deficit in goods hit a new record as imports recovered faster than exports.
• According to Morgan Stanley, CapEx plans have recovered, But small business spending is lagging.
• Small business employment remains depressed.
• Many US hotels are in trouble

• Copper and industrial metals prices are an indicator of economic strength.

• Here is Bloomberg’s industrial metals index.

Debt

“There is no means of avoiding the final collapse of a boom brought about by credit expansion.”

—Ludwig von Mises

Economic recovery is coming, we are told, because the economy has found a new equilibrium. We are supposedly adapting to the new-normal pandemic world, with monetary and (some) fiscal stimulus filling any gaps. Except that’s not what the data say.

Last week I laid out the case that US government debt would be $50 trillion by 2030. That was using straight-line CBO projections and the 2008 recovery pattern for government revenue, plus adding in off-budget debt which averages about $269 billion a year. USdebtclock.org is now projecting off-budget deficit to rise by over $1 trillion this year. Most of my feedback didn’t dispute the amounts; the disagreement was whether so much debt is a serious problem.

Today, rather than just stating that the recovery will be slower, I make the case for a much slower recovery, thus much higher debt by 2030. Note first, I’m not saying there will be no recovery. I am simply postulating it will look like the slow recovery from the Great Recession, unless the government makes it worse, which is a nontrivial possibility.

I have written for ten years that I believe the biggest issue we face economically is that we sit at the end of a long-term debt cycle. I could be wrong, but I think it’s the root cause of our economic illness.

Debt is spending that happens today and needs to be paid back tomorrow. When borrowing gets too large relative to one’s income, stress builds, there is less money available (income after expenses is less, as is one’s ability to borrow). As a result, the economy slows. Debt becomes too large; it chokes economic growth and ends in some form of default and restructuring. The system gets cleared and a new cycle begins.

We have all experienced short-term debt cycles. They typically end in recession. But few of us have experienced a long-term debt cycle—the last one peaked in the mid-1930s.

To be fair, there are reasons to think a $50 trillion debt load is “manageable.” It depends on what you consider “manageable” is. Maybe survivable is a better word. But it will clearly slow or kill GDP growth. Think Japan and Europe.

Even the CBO’s optimistic projections show tax revenue barely covering “mandatory” entitlement spending and net interest in the next few years. Congress will have to either find more revenue or make big cuts to “discretionary” spending—which includes most of what we think the government does: defense, diplomacy, regulation, etc. That could get ugly.

However, the CBO projections are likely wrong. Their borrowing cost estimates depend on interest rate assumptions that have been unreliable, to say the least. The government’s interest costs have been mostly lower than expected because interest rates were lower than planned.

I’m not sure many people understand that amusement parks, airlines, hoteliers and restaurants cannot stay in business at 50% capacity (or even 75% in the case of restaurants).

As it stands, the US Chamber of Commerce said that 25% of small businesses have already shut down. Another survey by Ipsos concluded that two-thirds are still nervous about leaving their homes; 59% say they intend to remain locked down on their own until signs emerge that the virus is “fully contained.” A YouGov/CBS poll concludes that 85% of American households say they wouldn’t get on an airplane even if they could. That’s why the industry needs a bailout!

A Washington Post/University of Maryland poll shows that only 56% of consumers across the nation intend to shop at the supermarket, which I suppose is a bullish data point for delivery services, but that’s about it. Just 33% say they are comfortable entering a retail store. And a mere 22% say they are willing to dine in a sit-in restaurant.

Disney said this week it is laying off 28,000 workers. American Airlines and United Airlines plan to cut 31,000 workers. Today’s disappointing unemployment report shows that we have a long way to go. Even though the unemployment rate went down to 7.9%, that was largely due to a drop of almost 700,000 in the labor force. We have regained just over half the jobs lost between February and April. The pace of gains, both total and private, slowed for the third consecutive month and looks to get slower.

There will be a recovery. Those hundreds of thousands of entrepreneurs who have closed their businesses. They’ll open new ones. But not in six months. Where will they get capital? It’s one thing to bail out airlines with multiple billions of dollars. What about the local bakery with 15 employees? Where do they get the capital to reopen when the time is right? And you can repeat that story a million (or more) times.

Which brings us back to my conclusion: That which can’t go on, won’t. We can’t keep piling on debt at this rate forever, and we can’t repay what we have.

Inflation

Inflation has been driven by demand this year.

Credit Markets

Over the long run, bond yields are driven by demographics.

The Fed

The Federal Reserve’s latest pledge to generate higher inflation instead generated a lot of scoffing, since it hasn’t been able to do so despite years of trying. Michael Lebowitz and Jack Scott say the Fed actually can spark inflation if it wishes. It would mean digging deeper in the toolbox to employ “direct lending.” This is thought-provoking and a little scary.

• The Fed’s problem is it can’t create money directly. It needs banks to make loans which then multiply the money supply.
• With most debt unproductive, the Fed must create more debt at lower interest rates to sustain growth. Inflation is necessary to sustain this process.
• COVID-induced defaults and higher savings aggravate the situation because lower debt reduces the money supply and produces deflation.
• If the Fed can’t convince banks to make inflation-generating loans, one alternative is to bypass the banks with “helicopter money.”
• Another option is for the Fed to lend directly to borrowers. Unlike commercial banks, it need not concern itself with making profits.

We know the Fed needs to produce inflation, and we know its current policies are ineffective. Escaping this trap will require some kind of new strategy. Lebowitz and Scott think direct lending will be the solution. It is not allowed under current law but laws can change or be creatively reinterpreted.

COVID Update

Chapter 11 Filings:

Retail closures:

Market Data

• Speculative accounts have been hedging their portfolios by shorting index futures, especially the Nasdaq 100.
• We’ve had quite a few stocks with 400%+ gains at some point this year.

• The Russell 2000 index has massively underperformed the Nasdaq Composite over the past decade.

• Options markets have priced in a significant election-related risk.

• How will the outcome of the US election impact the currency market?

All content is the opinion of Brian J. Decker