They may become harder to find in the near future.
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The M1 money multiplier has been under 1.0 for a long time. In the 2008-9 downturn it dropped below 1.0 and hasn't recovered. How can we sustain any growth without getting M-1 back to "normal"? All the money the Fed flooded us with didn't get spread around, and they have pretty much run out of liquidity. So where are the long-term growth stocks going to come from?
Hold on while I dust off my college economics books. Then let’s define some terms for those without my extensive pile of books in a closet.
“M1 money” is Federal Reserve-speak for all the currency in circulation. That means notes, coins, traveler’s checks, and quick-turnover bank accounts, such as checking accounts.
The money multiplier is a result of our banking system in which banks don’t have to hold $1 on-site for every $1 they lend. Instead, a bank can effectively divide every dollar of its capital into multiple dollars of loans — appropriately called a fractional banking system.
Just how many dollars of loans can be generated for every dollar of capital determines the money multiplier and has been a significant driver of the country’s (and the world’s) economic growth over the past several decades.
Back in the mid-’80s, the M1 multiplier was around 3 — meaning that for every dollar of capital, a bank could create $3 in loans — but the figure slid to 1.5 before the financial crisis, when it crashed to 1. Since then the multiplier has been struggling to regain 1.
There are several reasons this might happen. The Fed could increase the required reserve level — how much capital a bank needs to hold in reserve to support its loan portfolio. This is what I’d call a supply-side reduction of the multiplier, because the bank regulator is reducing the potential supply of loans. Central banks can use this tool to cool off an economy if they don’t want to increase interest rates.
On the other side of the equation — and the reason I think we’re seeing such a weak multiplier these days — is a low level of demand for loans. This happens when businesses aren’t certain they’ll see better days ahead. Why borrow to expand a business if there aren’t going to be sales to support it? This isn’t some cornfield in Iowa — savvy business owners don’t just build something in the hope shoppers will come.
As to how we can increase the multiplier and return to “normal” growth levels, well, that’s an excellent question, and I’m afraid I don’t have any concrete answers. Some people would argue that regulations and high taxes are choking off the entrepreneurial spirit, and that could be a part of it.
However, looking at the results of the companies we follow, I think there is a pretty strong trend of weak sales growth, while any earnings growth is coming from cost-cutting. This trend seems to point to weak consumer demand as part of the problem.
If I’m right, that part may be more difficult to solve. I think we’re seeing the limits of consumer balance sheets. Consumers have become too levered to support further borrowing, which would become consumption beyond their means.
In fact, we’ve seen a sharp decline in household debt as a percentage of GDP (gross domestic product)* and a rise in savings rates over the past seven years, both of which would imply tighter belts and less money available to grow businesses’ sales — nicely corresponding to the period during which the money multiplier has been below 1.
To me, there’s an argument to be made that American consumers are going through a balance-sheet recession. They overspent going into the financial crisis and are now working to get things straightened out. And that overspending took place over the course of 20 years, so there was a lot to fix.
The solutions to this problem are time and saving, the latter of which is difficult when wage growth is barely keeping ahead of inflation — and for certain items, notably healthcare and education, wages have been left in the dust.
I don’t think we’ll see a rebound in the money multiplier until businesses feel confident that their investment in growth is justified, and I don’t think we’ll see that happen until consumers feel they’ve right-sized their balance sheets enough to start spending robustly again.
That doesn’t mean there won’t be growth companies, however, but they will be fewer and farther between because we won’t benefit from Warren Buffett’s rising tide of broad economic growth – and there will be losers. The term “creative destruction” comes to mind.
The companies that are able to grow in this economic environment are the ones that have strong balance sheets and are able to invest in marketing and innovation to take sparse consumer dollars from their competitors (Amazon.com seems to be doing this pretty well these days) or those that create completely new markets for their products (both in the U.S. and abroad).
You’ll also be able to find growth in companies that help other companies do business better and more efficiently, since, in a low-growth world, it’s important to make the most of every sales dollar a business can attract. Companies such as Splunk (helping make sense of the flood of data companies gather) or Ultimate Software (helping small businesses automate the back-office activities so the owners can focus on serving customers) fall into this category.
While I don’t have an easy or quick solution to the country’s tepid growth, it doesn’t mean there isn’t growth to be had. An economy as big as the United States’ is too diverse and dynamic to measure with a single metric like GDP, and there will be companies, sectors, and regions that boom while others shrink. The trick will be to dig below the headlines and find the companies doing what it takes to survive, or even thrive, in the current consumer spending environment.
*Gross domestic product is defined as the tottal value of goods produced and services provided in a country during one year.