Buckle Up: Why Entrepreneurs Should Be Scared of the Shifting US Economy

9 Aug

Pinching PenniesEntrepreneurs, who might otherwise be somewhat anathema to worrying about macroeconomic trends, need to pay attention to what is happening in the US economy at the moment.  The changes that are just beginning to take shape in the form of a weaker dollar and tighter credit, will affect their ability to successful negotiate an “exit” for their business, and even more importantly, find customers for their products and services.

The New York Times editorial staff have outdone themselves today with an excellent analysis of the sticky situation in which the Federal Reserve find itself (“A Weak Dollar and the Fed“).

A declining dollar is a source of inflationary pressure because it can boost the cost of imports. So if the Fed tried to rev up the economy with a rate cut at the same time the dollar is falling, it could end up provoking even more inflation. That would be a drag on economic growth rather than a boost. In an extreme case, it could result in a toxic combination of weak growth and high prices that is a central banker’s nightmare.

How did the Fed lose room to maneuver? The answer is rooted in the Bush administration’s misguided economic policies.

The stage is set. Essentially, the US could find itself in the very difficult situation of having both a weak dollar (meaning that for you, the average customer, things like traveling abroad, buying imported cars, electronics, etc. is going to be more expensive) and rising inflation (meaning that your savings start to lose their value more quickly, because the things you like to buy are getting more expensive. This results in a net loss of incentive to save, because that car/laptop/iPod are going to be more expensive, and the value of your savings less, one year from now than the difference of those two today).

The only lasting way to fix the imbalances — and reduce that borrowing — is to increase America’s savings… It would also require revamping the nation’s tax incentives so that they create new savings by typical families, instead of new shelters for the existing wealth of affluent families…

Stymied by what it won’t do, the administration has gone for a quicker fix — letting the dollar slide. A weaker dollar helps to ease the nation’s imbalances by making American exports more affordable, thus narrowing the trade deficit.

But to be truly effective, a weaker dollar must be paired with higher domestic savings.

Just as I mentioned above, however, greater domestic savings is going to be hard to stimulate in today’s market. The choice the country faces, it seems, is to improve the incentives for domestic savings to overcome these growing challenges. That is because doing the opposite, or staying the course, has even uglier consequences:

Otherwise, the need to borrow from abroad remains large, even as a weakening currency makes dollar-based debt less attractive… Among other ills, it could lead to a deterioration in American living standards as money flows abroad to pay foreign creditors, leaving less to spend at home on critical needs. Or, it could lead to abrupt spikes in interest rates as American debtors are forced to pay whatever it takes to get the loans they need.

“Yes,” you’re saying, “we get it. The future looks grim. But what does it mean for me as an entrepreneur?”

It has an impact in two important ways:

  • Exits are going to be harder: The businesses that you were hoping would acquire your startup are going to have a harder time borrowing money (at a good price) to finance the deal. Private equity-style takeovers are attractive only when they can be properly leveraged (as in, they can borrow a lot of money cheaply, and invest only a small amount of their own cash). If US consumers are feeling a squeeze on their pocket books, they are less likely to be investing in the stock of your company at IPO, reducing your ability to do so.
  • US customers are going to start pinching pennies: As it becomes apparent to consumers that a weak dollar has real implications on what they can afford to buy, they may well choose to spend less, say, on things like social network premium memberships or bio-fuels and expensive eco-friendly cars, and more on the things that they need or enjoy, but now cost more: say, Chilean produce. Or Sony laptops.

There is one distinct upside to a weaker dollar: international exports.  If you are lucky enough to be in the position of producing a product or selling a service overseas, it will be easier to do so because the cost will be relatively lower for the customer.  Unfortunately, and I say this with no real knowledge or justification, my hunch is that the majority of US entrepreneurs are not currently in this position.

And if you believe what I was beginning to say in a post late last week (“Will a Debt Crunch Drive Smart Minds Away From VC, Entrepreneurship?“), it may well be harder for startups to find quality talent.

But what do you say? Is this view of the economy too dark? Is my projection on how these trends will affect entrepreneurs exaggerated?

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One Response to “Buckle Up: Why Entrepreneurs Should Be Scared of the Shifting US Economy”

  1. tony August 9, 2007 at 8:58 pm #

    You should write shorter posts! Geez, I don’t have attention span 🙂

    Anyway, good timely post, and I’ve been thinking about this too. But really a shrinking economy doesn’t help anyone – except if your business model is based on free stuff! It’s a pretty major trend anyway (see chris anderson’s latest book project he’s working on, or zecco). As long as ad dollars keep coming in, which they will, we’ll all be OK.

    As long as we’re not reckless.

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