By Edward Lambert
Net profit rates are an important driver in the business cycle.
Net profit rate = corporate profit rate - Fed rate
According to the equation, the basic cost of money should be less than the profit return on money.
The key is to have a positive, stable and moderate net profit rate. So if the Fed rate is rising, net profit rates would decline unless corporate profit rates were rising to offset it.
According to the equation, if corporate profit rates are falling and the Fed rate is rising, net profit rates can cascade downward fast. So the key is to raise the Fed rate when corporate profit rates are rising. Then the Fed rate can stabilize the net profit rate in an appropriate range that is balanced for the economy.
The Fed rate has stayed low since 2009. The consequence is that net profit rates hit all-time highs. The Fed rate let net profit rates get up really high…too high…so much so that price pressures for firms are weak, and inflation is low.
But corporate profit rates have been falling since 2014. And the Fed is saying that they will raise the Fed rate. The result would be faster falling net profit rates.
The conclusion is that the Fed really should not, cannot and won't raise the Fed rate now. Net profit rates would fall even faster. Unless they want to risk a cascading downward effect on the net profit rate.
Like I have said for years, the Fed should have been raising the Fed rate while corporate profit rates were heading to all-time highs in order to balance the economy. But this dynamic was missed by many.
The Fed cannot raise the Fed rate now. They missed the boat.