By Edward R. Jenkins Jr., CPA
For the past several months, government agencies, the domestic financial press, and many financial pundits have been trying to put a brave face on significantly bad economic data that will drastically affect business opportunities for at least the short term.
The essence of this dim view is the conflicting problems of inflation and a credit crunch. The public policy solutions to these two problems are antithetical: the Federal Reserve typically tightens credit to combat inflation, but tightening credit while credit markets are precarious can cause significantly worse problems. The business community seems to be in a Gordian knot from which it will be very difficult to escape cleanly.
The primary sources of our current inflationary environment are varied, some of which include the following:
-- When the dollar was stronger, the U.S. used to be able to pay for imported goods with dollars. The U.S. currency is no longer the currency of choice, so that means the U.S. is now buying much of its goods and services with relatively lower-valued dollars. This makes foreign goods (most of our day-to-day items) and services much more expensive.
-- The cost of imported goods are also going up as a result of higher oil costs. That’s in addition to the paralyzing cost at the pump for domestic transport. Finally, much of the manufactured goods are now made of, or contained in, plastics and synthetics that use petrochemicals. So that means even the plastic wrap on domestic roast beef is more expensive.
-- The economic booms in less-developed countries (resulting from our outsourced manufacturing jobs and some services) has increased disposable income in those countries. Those citizens are now competing more aggressively for oil and consumer goods in the global marketplace, driving up prices.
The difficulties behind the credit crunch are just as problematic. With the subprime mortgage crisis, the press covered about $100 billion of a potential $600 billion credit problem. What the press is not talking about yet is the auto loan portfolio - an 84-month loan does not make sense for a depreciating asset - and cued up behind that is the credit card portfolio. Some financial institutions actually compete for customers that miss payments to tap the lucrative fee and interest acceleration clauses.
The fundamental problem that underlies the credit crisis is unrestricted consumer spending. During some quarters, personal savings rates have been negative in the U.S. If households stop their credit-fueled spending ways as a result of tightening credit and higher prices, spending will slow, which then puts commercial loan portfolios in trouble. The lack of solid personal savings restricts the ability of entrepreneurs to fund the start-up of new businesses. Since new businesses are usually the generator of new jobs, this could be a bigger problem than anybody is talking about.
Assuming we only have a recession from this troubling confluence of events, the economic circumstance detailed above will leave a mark on business transformations in the near future. Here are some of the possible outcomes:
-- Depending upon immigration policy and its effect on wage rates and labor availability, transformations that bring more manufacturing back to the United States could become attractive. Also, many companies minimized their risk assessments when analyzing the benefits of moving production abroad to cut costs. Volatility overseas could revise that thinking.
-- Financial distress will create opportunities to consolidate industries that are ripe for consolidation. Deals that were previously too expensive could become viable at the right price.
-- Companies that serve vibrant export markets will continue to enjoy brisk business as a deflated dollar continues to make their products attractive in the global market. Transformations that acquire additional access to foreign markets could continue to be attractive for that reason.
-- A deflated dollar may make deals that let foreign manufacturers produce in the United States continue to be attractive. Foreign manufacturers, therefore, could continue to have access to U.S. markets and not lose money in their home currencies.
-- Undercapitalized companies will have a higher likelihood of becoming targets as their viability is challenged.
-- As companies experience economic difficulty, their advisors may play more significant roles. Compliance and due diligence procedures will become even more important as pressure mounts to make deals.
The list could go on. Time will be the true measure, so we should all care-fully watch to see how the national economy holds up over the summer.
As things change, we will discuss how those changes are affecting the area of business transformations.
Edward R. Jenkins Jr., CPA, is managing member of Jenkins & Co. LLC in Spring Grove. He is also a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at edwardj@wemanagetaxes.com.
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