Plutarch ancient Greek biographer (c. 46 – 120 CE)
Now do not get me wrong, I am all for making money and this blog is not meant to bash on those who are doing well. Furthermore I am not in the least bit pro-socialism, even after a close friend of mine spent more than a decade of my life trying to convert me from capitalism. Sadly he died and in large part due to the inadequacies of the social system in which he lived. No I am pointing out as the above quote states that massive inequality is the undoing of capitalism and that unless there is a change to the structural system in the United States trouble will ensue. Interesting that the quote dates back to 46AD. I guess nothing ever changes!
What I am referring to specifically is the inequality between the small business entrepreneur and the large multi-national business. The later has access to massive amounts of cheap capital while the former is unable to raise money and when they can the money is incredibly expensive. Now I understand that the less risky the loan or investment the lower the interest rate. This is a natural occurrence and I agree that investors should be rewarded according to the level of risk that they take. So for example if you plow your life's savings into starting a business and it works, you should be rewarded with large amounts of wealth.
On the flip of this, if you invest in a low risk investment such as Treasury bonds that have limited chance of default, then your reward or return on that investment should be minimal. The dichotomy comes when you have a small profitable company that has a rock solid history and is able to back the investment with collateral that is also rock solid but is penalized as the market shuns that investment class for the large corporation. Now a normal penalty would be in the range of 2 to 5 percent but currently that spread is anywhere from 10 percent to infinity (the company cannot find funding anywhere).
The reason for this is that the banks and the markets are open to plowing billions of dollars towards the likes of Apple and IBM (considered low risk) but not towards smaller businesses (considered high risk) in order to protect themselves from another financial catastrophe while they get their house in order from the last one. The amusing part to this is that never in my life has the spread been so wide and unless this spread narrows (money is made available to the small business) soon, the inequality will result in just the financial catastrophe that they are trying to protect against. It is like playing rugby or football and trying not to get hurt, it is a sure thing that you will get pounded. A better strategy is to get amped up and drive yourself into the opposition and surprisingly you come off the field intact.
As I mentioned in my previous blog on inequality, small business is the driver behind economic growth. They are also the driver behind employment. Cutting this class of business off from capital is tantamount to having two sets of rules to the same game. One set for the favorites and the other, a more onerous and unfair set, for the underdogs. This creates a false barrier to entry and allows the large corporation to benefit at the expense of the small business. In order to grow the economy you have to get the money that is being printed by the Federal Reserve into the hands of the small entrepreneur so that they can innovate, hire and grow us out of the malaise that we are in. Leaving it to the large corporations is not going to provide the growth that we need but that is just what is happening.
I spend my life investing and raising money and right now you can earn an amazing rate of return by doing your homework and investing in these rock solid small businesses. Typically loans to these businesses can range from 9 to 15 percent and in my view the risk of the investment is more than compensated for when you compare the returns that you can get in the market. Now to take this one step further if the banks loosened their underwriting criteria slightly and loaned these companies money at say 8%, they could then pass on those rates to their clients (you) in the form of a decent return on your CD, say 4% for a two year note. Now everyone is a winner. The sad part is that it is virtually impossible to get these loans from any institution and if they do lend the money they are certainly not passing along the extra income to the CD holder.
To take this one step further, the market is pricing these large corporations based on future earnings. The thought is that by lowering their borrowing costs their profits will improve. Furthermore as the economy is being trampled it is a prime time to reduce headcount and work on improved efficiency, so lay off workers and get those that remain to do more for less. Not a good equation as the result will be that these one off improvements to the bottom line will start to lose their impetus as time goes by. The result is that the expected profit gains will not be met and the market will suddenly sell off. Unless you get people hired, growth will stagnate and there is just so much you can do to your balance sheet before the effects are felt on the income statement. A fundamentally sound market is based on sound economic fundamentals and continued weak employment numbers will eventually undermine everything.
P.S.
Now I don't like to tout myself and my products in this blog (which is why I have put this after the blog post), but the example above is exactly what Fixed Rate Deposits does, issue loans to small low risk businesses so that they can grow, helping them stay afloat and hire people while passing along a good rate of return to the prudent saver so that they can make some money on their deposits. A win all the way around. So if you are sitting on some cash and want to earn a good rate of return on your money and reduce your risk to the market let me know and I will send you a brochure to review.
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