Anti-bailout people: your reality check is in the mail

anigbrowl

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Mon Sep-29-08 05:53 PM
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Anti-bailout people: your reality check is in the mail

Tomorrow is the 30th of September. So?

Well, it's the end of the month. So?

So, it's also the end of the third quarter. So?

So, the business cycle is broken into quarters. Meaning that regular businesses borrow the money they need for day to day operations - supplies, payroll, electricity and so on - in monthly or 3 monthly cycles. That's why typical invoices offer 30 or 90 days to pay, depending on the kind of business - because that's the window most businesses use for short-term debt.

Shouldn't these companies be avoiding debt, you say? Well, that sounds nice, but that means keeping a minimum of 3 months' operating expenses in the bank at all times - money which is more productive when it's actually at work in the business. Big order from a new customer - what if you don't have the cash flow to buy the supplies needed to fill that order? You lose the business.

This is the commercial paper market, and this is how most businesses operate. The big capital is invested in long term things, like factories or delivery vehicles or machinery or warehouses. Operating expenses are financed with short-term debt which allows a business to smooth out its cash-flow requirements and put more energy into actually doing business rather than constantly rewriting its financial plan every time something changes. Businesses draw on their lines of credit, and in order to extend credit, banks (or some large businesses in other sectors) issue short-term securities called commercial paper, which are in turn bought by people willing to loan out their money for a short period - when the commercial paper matures, you get the purchase price back with interest.

Well, like I said tomorrow is the end of the quarter. Which means that paychecks are going out, suppliers have to be paid, bills and taxes settled and so on. And for many, perhaps most businesses, that will mean reviewing their cash flow and adjusting their line of credit for the last quarter of the year - which sees the onset of winter, and includes the big annual retail events of Thanksgiving and Christmas. This is the most expensive time of the year for a lot of people, and the most critical time of the year for the retail sector. It's the time to gather in the harvest, store it in a granary, and buy supplies for the cold days ahead. And although few of us actually farm any more, that ancient pattern still shapes our economy, because ultimately it's subordinate to the cycle of the earth going around the sun.

So?

So a lot of people are going to have to renew their credit lines between tomorrow and Wednesday. But thanks to the situation on Wall street, the cost of borrowing money is currently sky-high - ESPECIALLY in the commercial paper market. In fact, last week buying and selling of commercial paper froze up for 12 hours. In other words, the credit cards of American businesses (and those in Europe, Japan and many other places) stopped working briefly, until the Fed injected some money into the system.

Tomorrow night is going to see a lot of pressure on the commercial paper market, because businesses have to roll over their short-term debt. And they're going to want to draw on their credit more than usual, because they need to start planning for the end-of-year expenses. This time, it's going to cost them more to borrow that money, which means the cost is going to get passed on to their customers and employees.

Of course, some businesses may not be able to sell any commercial paper, or may face difficulty in renewing their lines of credit. Which means they'll suddenly find they're insolvent. Which means their employees may not get paid on time, or may get laid off. Or they won't be able to pay the money they owe to other businesses for supplies or utilities. Or state taxes. Et cetera.

So, all you folk who are celebrating the bailout today and planning to dance around the flames if Wall Street collapses, enjoy yourselves. Celebrate now. Revel in your ideological purity. It'll give you some good memories to cherish: because that's all you're likely to have if the economic system hits a brick wall in this quarter. There may not be Turkey for Christmas this year, because there may not be enough money available to get them from the farms to the stores. That applies to Tofurkey too, for any vegetarians out there.

The economy is set up to fall off a cliff this week, and almost none of the people here and on Free Republic who are celebrating seem to understand how it actually functions. But in the coming weeks, you are probably going to find out what happens when an economy seizes up and goods and services suddenly become unavailable.