Comments on the Economy
The economy continues to receive close coverage especially for unemployment trends, retail sales, and foreclosure rates. Consumers continue to closely monitor spending and many have made the decision to build up savings and emergency funds. Also, consumers are paying down credit card debt, installment loans, and other personal debts. In each of the last six months overall consumer debt continues to fall. While this is a positive trend and the commitment to save is also commendable, the drop in consumer spending is likely to have deleterious effects on efforts to re-grow the national economy. Consumer spending makes up about 70% of the overall Gross National Product (GNP), a slow down in this sector hinders the recovery of the economy overall and delays improvements in the rising unemployment rate. Locally in Kearney we have seen an increase in both unemployment and underemployment, but the effects in Kearney are nothing compared to some areas of Michigan and California both of which are seeing unemployment rates rise to over 15% in certain areas compared to Kearney’s rate of about 4%. In Kearney, retail sales continue to increase although at slower rates than we have seen in the past ten years.
The Federal Reserve is pursuing a low interest rate environment in an attempt to revive the economy by encouraging banks to lend and consumers to spend. However, currently consumers and businesses are very reluctant to spend or borrow money because they are fearful of the tremendous financial stresses seen over the past 24 months and have seen the value of retirement funds in mutual funds and stocks drop severely. Some recovery in these assets has been apparent since March but much of the consumer base remains wary and unconvinced that a genuine recovery is under way. Our loan demand has been weak this year due to this uncertainty.
The long term effect of this low interest rate policy by the Federal Reserve is not known. A review of economic history seems to indicate that a period of deficit spending by the Federal Government can lead to serious inflation and much higher interest rates when the Fed tries to control inflation. An example of this result is the time period from 1980 to 1982 when interest rates soared to unsustainable heights. Rates on bank certificates of deposit increased within this time period from about 6.25% to as high as 19%. The collateral damage was borrowers with variable rate loans who rapidly saw loan rates above 21%. Ultimately this led to the collapse of the savings and loan industries due to financial disintermediation and a severe interest rates mismatch. The Fed is well aware of the risks of a repeat of that time period and will be cautious and measured when the economy improves making withdrawal of the amount of the liquidity now washing through the banking system crucial.
The Fed has several tools available now to adjust the amount of funds in the banking system that they did not have twenty years ago. The current rate of deficit spending is unprecedented within that past 60 years and this is resulting in enormous amounts of federal debts being financed. At some point, the danger is that this excessive federal borrowing will crowd out business and consumer needs making borrowed money very expensive indeed. In summary, the Federal Reserve will need to be either very lucky or very skilled to avoid a bout of inflation, and more than likely both for the sake of the country. This has led to a large amount of skepticism about the wisdom of additional government spending on health care and government operated services.
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Courtesy NNB, Douglas C. King
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