The Fed needs to unfreeze the economy

Another Small Business Saturday just passed us, but the rosy TV commercials left out the credit crunch that is freezing over the economy. Small businesses can no longer rely on loans from their banks like they always could, and it's because the Federal Reserve has kept interest rates too low for too long. Even the rate hike expected at this week's Fed meeting isn't about to fix this.

What happens when the price of something is held artificially low? Economics 101 tells us that its supply shrinks — sellers aren't willing to part with what they have for less than it's worth. That truism is the story of the banking system's relationship with small business over the last seven years. Banks aren't willing to make loans that don't deliver the return worthy of their risk.

Interest Rates
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Why not raise the interest rate on those loans? Thanks to its zero interest rate federal-funds policy dating back to December 2008, the Federal Reserve has made sure they can't do that. Fed Chair Janet Yellen told Congress last week that the central bank is finally ready to allow its key interest rate to rise north of zero – but not by much.

The late Ronald McKinnon was the first to highlight this malfunction on the op-ed page of the Wall Street Journal in 2011. Interbank lending was broken, the Stanford economist argued, because large banks were unwilling to lend their excess reserves to smaller banks for a puny yield. Meanwhile, smaller banks "cannot easily bid for funds at an interest rate significantly above the prevailing interbank rate without inadvertently signaling that they might be in trouble." Since small companies traditionally develop and expand with the help of bank loans, especially from local institutions, this puts them in a credit crunch.

Small bank loans are currently 16 percent below their 2008 peak, according to the Federal Deposit Insurance Corp., while larger business loans are up 37 percent from that point. Small-company borrowers, once part of the lifeblood of the banking system, have had to turn to credit cards and other alternative lenders. A spate of websites have emerged over the last few years to fill what was once a niche and is now a mainstream marketplace for loans that come with interest rates several times what banks used to offer.

McKinnon predicted that because small business is the workhorse of American capitalism, without a fix to this banking mess, the economy would continue to struggle. He was right: Economic growth has averaged just under 2 percent since 2011 and wages have been flat. The unemployment rate has fallen to 5 percent from 9 percent but only about half of the job gains are well-paying, private-sector positions. Small business doesn't have its usual ally of the banking community by its side to thrive.

The Fed has flirted publicly with raising rates for several years without pulling the trigger, and it's highly unlikely that the quarter-point increase expected to be announced next week will be sufficient to get credit flowing to small business again. Net interest margins, the traditional measurement of bank profitability, historically averaged 4 percent with a 4.5 percent fed-funds rate. Today they are at 3 percent, so the fed-funds rate should have to go well beyond near zero to spark normal banking conditions.

The reason we hear Ted Cruz arguing for returning to the gold standard is that the Fed's gambit has backed the U.S. into a corner. If it keeps zero interest rates, the economy will continue to stall. But if it raises rates back to normal, interest payments on U.S. government debt will double and consume one-fifth of the total budget (more than military spending). The only way to avoid the debt-service crunch is to renegotiate with creditors like China for a payback plan with a fixed, long-term interest rate, but that's laughable under a paper money system.

President Obama and his allies in the economics profession have tried to deflect slow growth on theories of new long-term stagnation trends and a shortage in government spending. The real culprit is right under his nose at the Fed. The longer the zero or near-zero interest-rate policy rolls on, the less there will be to celebrate for small business.

Commentary by Rich Danker, founder of the Lone Star Committee, an independent organization dedicated to rapid response and issue advocacy supporting presidential candidate Ted Cruz.