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Blog : The Squeaky Economy Greases the Wheels
by John Whitefoot on February 1st, 2008
The one good thing about a shaky economy is its overtaking Iraq as the most important issue. And with an election on the horizon, it’s not a surprise. Voters have this strange habit of coming to the forefront of Washington’s mind once every four years.
For penny stock investors this is even better news. Even if we are a fickle bunch that likes to cut and run whether times are good or bad. This past week was a good example of our fleeting ways.
On Wednesday the Federal Reserve cut the key interest rate for the second time in just over a week, to 3%, signaling that further rate cuts were possible. The financial markets rallied on the announcement but then closed out the day in the red.
Yup, the key interest rate dropped and investors rallied for less than 2 hours.
The latest cut was followed by cuts in banks’ prime lending rates. Why does this matter to penny stock investors? The Federal Reserve is hoping that by making credit cheaper, it will encourage more borrowing, giving the economy a much needed boost.
This raises two questions…will the rate cuts get money into the hands of businesses and consumers fast enough; and, could further interest rates actually hurt the economy?
Even if it does take a few months for rate cuts to impact the economy, at least there is a calming of nerves. And restored confidence could encourage lenders to ease their loan restrictions and encourage consumers to…consume.
Now, is it possible that further cuts could actually hurt the economy in the long run? It is indeed. Right now it looks as though the Fed will continue to lower interest rates. But how low will they actually go? One thing we know for certain is that no matter where they fall to, it probably won’t be low enough for most.
For example, in Japan, the benchmark interest rate is the lowest in the industrialized world at 0.5%. Fears of a recession reaching Japan has some politicians saying the Bank of Japan should just cut back rates to zero…immediately. The only option after zero is to ask the banks to pay us 0.5% to borrow. But I’m pretty certain the banks won’t go for that.
Here in the U.S. some think Federal Chairman Ben Bernanke's rate cuts are setting the stage for an even bigger recession down the road. In the early 2000s ultra-low rates created many of the problems we’re experiencing today. Injecting money into the system could stoke inflation…forcing the Fed to hike interest rates sharply in the near future.
In the early 2000s low interest rates meant lots of people who otherwise couldn’t secure loans…were getting them. Increased interest rates saw many defaulting on their loans…leaving the banks holding the empty bag.
On the other hand, lower interest rates are particularly good for penny stock investors. Small businesses (some of them penny stocks) number around 28 million in the U.S. These companies are hoping that the Fed’s rate cut will make it easier for them to borrow money.
Small companies are, by definition, vulnerable to a downturn in the economy because they need financing to grow. A lack of cash could prevent some from weathering a long economic slump.
For example, if the economy slows and consumers stop spending, businesses won’t borrow money to expand operations and make further investments.
Still, if you ignore the many fly by night penny stocks and continue to invest in financially solid companies with a proven track record, a short recession probably won’t impact you.
In addition a short recession would actually help weed out the riff raff and open up the door to strong investment opportunities…in both the near and long-term.