Will the Fed Destroy Small Businesses with Interest Rates?

It’s no secret people are hurting from high prices. Whose dinner table is safe from this discussion?

Many of our staples are now taking a larger chunk of what I bring home from work. Our grocery bill jumped 40% and we have scrambled on cutting costs to make it through. Summer camps that used to be for certain now had to give way for getting to and from work.

Yes, doom and gloom abounds.

And not just at home. Small businesses face these same decisions.

Should you cut costs? Or is it time to double-down to build your customer base?

My wife says we’re in a recession. But I’m a guy who reads economic reports every day. I can tell you we’re not there…yet.

I think there’s plenty of underlying strength in the economy. Even the Federal Reserve is spooked on how hard it’s made their job.

Before I explain that, let’s look back to get perspective.

What is the Fed doing?

The Fed was created to ensure enough money is in the system to work smoothly. Before its founding, businesses boomed and busted regularly.

A few influential businessmen wanted to make things more stable. Out of the kindness of their hearts, of course.

So now, banks can loan more out of their reserves than what they’re required to hold. The Fed will repurchase those notes overnight so the bank can get back in balance.

The Fed does this for the government, too. Congress can pass a spending bill beyond their means to pay. The Fed purchases Treasury bonds to make up the difference.

It’s how they got the name “Lender of Last Resort.”

They apply this to the broader economy, too. Remember when “Helicopter” Ben Bernake bought all the Treasuries he could? He thought it would avoid another Great Depression. It may have, and it racked up a bill that’s coming due.

After him came Janet Yellen. Business owners from underserved communities confronted her governors. They needed cheap capital to grow their businesses. So she continued lowering interest rates.

But Jerome Powell sees the writing on the wall if inflation continues rising. He’s been taking the tough medicine by raising interest rates. It’s now less attractive for banks to loan money they don’t have.

He’s also unwinding the balance sheet. This means the Fed isn’t going to prop up demand for the government’s liabilities.

He tried to head this off before in 2018. Then President Trump demanded Powell back down so spectacular growth could continue.

So we’ve enjoyed the party for many years while more money was in the system. After all, an economy is healthy when money is flowing. But we haven’t looked at what money policy is built around.

How does a normal market work?

A normal market self-corrects to solve its own problems.

When people have more dollars than needs, they start looking for upgrades. Sellers see more interest for their premium products. So, they raise their prices to accommodate.

This can sound greedy, but it helps them build up a reserve. They use this to prepare for downturns or invest in more space/inventory to sell even more.

And if this expansion is big enough and the market growth is sustainable? There are loans and investor dollars to cover the cost and build it faster.

This self-reinforces for a while. Greater reach needs more employees to service the demand. Those employees now have paychecks they can use to buy more goods and services.

But after a time, customer demand is satisfied. Or prices are out of their range. Consumers will either substitute or delay purchases.

Those companies with high prices will start to lower them so money still flows in to pay for the new capacity. Those who overinvested may layoff employees. Or sell their shiny new capacity to someone else…who will lay off employees.

Prices continue lower with fewer people getting paid to make or do things. Which means fewer buyers. At some point, enough people resume buying to restart this cycle.

How do small businesses fit here?

Within that cycle, small businesses form out of a need that larger businesses aren’t meeting. A frustrated employee could branch off with an offer his former employer won’t touch. Or maybe they can do something better, faster, or cheaper.

As they find their footing, many small businesses rely on bigger ones for work and raw materials. The successful ones scale from here.

They figure out more ways or better partnerships to get what they need. During this growth, small businesses can get loans quickly to cover payroll gaps, buy materials, or install new equipment.

So when the Fed raises its target rate, it’s more expensive for businesses to do their day job.

Now, this doesn’t affect the internal workings of single-person LLCs like mine. Especially ones providing services. But it does become a pain for my target customer.

I’m not frightened about my prospects, though. There were massive investments in innovation over the past decade.

More small businesses are popping up with more new offerings than previous generations. This means there are more substitutes, more ways to scale, more choices. More places for money to flow.

The more money flows, the more sustainable the economy becomes.

This trend has become so powerful there are still over 10 million unfilled jobs. 4.2 million people still change jobs every month because the opportunities are there. And more than 4 million people made the leap to create their own businesses in the last 2 years.

What most analysts miss is how this shift in capital flows changes the power structure. Sure, borrowing from banks may become too expensive. But there are other businesses and investors more interested in your success.

Does it matter if Powell threads the needle?

The bad news comes from stock market investors wringing their hands. Maybe the Fed will raise rates until the economy breaks. Maybe they pivot back to Bernake’s old playbook at the first sign of weakness.

Bottom line: it doesn’t matter how hot the market is. Small businesses always have to offer value for the money they receive.

And that’s not discussed at the dinner table.

Yes. Companies will right size their operation while money is more expensive.

But life finds a way. The shoots of new growth are beginning to show, even if rocks are being stacked on the soil. It’s time to ignore those year-old video sales letters predicting a market collapse. The coming opportunity is upon us.

If you’re a small business, this is the time to find your best customers and focus on making them happy. Alternative financing and wider customer acquisition will come when your strong base attracts it.

Eventually, the market will come back into balance. So find relationships to help your business succeed and focus on improving them. Meeting their needs better than anyone else will sustain you even in a downturn.

Do you need help finding that next step to add value for your best customers? Book a call with me today!