2 Reasons Companies Are 'Still Cutting Back on Fixed Investment'

by: TradingHelpDesk

How many months does it take for the lowest Fed rate on record to create a sustainable economic recovery?

According to the Fed, it’s more than a year but probably less than 18 months.

That’s the only conclusion that can be drawn from the latest Fed statement which last week saw the US federal funds rate maintained in the 0.0% to 0.25% band for the 12th successive month.

Although the latest release dated December 16th came to the same monetary decision – rates on hold - it did not share the same wording as recent statements. Slowly but surely more upbeat and optimistic sound-bites have emerged including “economic activity has continued to pick up”, “financial market conditions have become more supportive of economic growth” and “deterioration in the labor market is abating”.

It sounds promising until the reader digs deeper into the statement. Then the bad news flows with the Fed commenting, firms “remain reluctant to add to payrolls” and are “still cutting back on fixed investment”.

Still cutting back on fixed investment? That means firms are still not willing to invest when interest rates have been their lowest level ever, for a whole year. Think about it. The US economy has been flooded with fiscal and monetary stimulus; low rates, high government spending and sector specific bail-outs - and businesses are still are not willing to invest in projects that could create new streams of economic wealth and new jobs.

There are two reasons for this. First, much of the government support has been thrown at fundamentally flawed industries and companies – vehicle manufacturers and ‘bubble’ banks. The bail-outs were designed to save these failed companies. Chucking money at failed businesses is not a good use of capital. The reason why these businesses faced collapse is because they failed to put their capital to good use in the past.

The government solution: To pass these same businesses and in many cases the same management teams more capital.

The second reason why firms are not investing (in the economic sense) despite the low fed funds rate is that the banks are not passing on the low lending rate to businesses and consumers. The banks are generally hoarding cash, rebuilding their weak balance sheets or using the low rate to fund their own speculation in financial markets – thus the amazing rally in the prices of risky assets since March 2009.

So we are likely to have another few months, maybe six, of ultra-loose rates until inflationary pressures can no longer be ignored. Then, mid-way through 2010, we could be as close to the next contraction in economic output, Q3 2011, as we will be from the last, Q2 2009.