INSIGHTS: BUSINESS STARTUPS SOAR
GUEST COLUMNIST: Chris Edwards, director of tax policy studies at Cato Institute and editor of DownSizingGovernment.org. Reprinted with permission
With the health crisis and recession, many restaurants and other businesses have been hit hard. Some businesses, such as online retailers, have done well. Overall, the nation’s gross domestic product plunged in the second quarter of 2020 but bounced back strongly in the third quarter.
The rate at which Americans are launching new businesses provides another gauge of economic health. In the recession a decade ago, the number of startup businesses fell substantially and never fully recovered. Indeed, the U.S. startup rate has trended down since the 1970s, which is a concern because new businesses are a major source of jobs, innovation, and competition.
The Census Bureau tracks startups in its “business formation statistics,” which are tallied weekly and quarterly. The data include total “business applications,” which are calculated from requests to the IRS for Employer Identification Numbers. A subset are “high‐propensity applications,” which are applications the Census judges will likely become active businesses with payroll. Background on the data is here and here.
The chart shows that there were about 860,000 total applications per quarter in recent years, of which about 325,000 were high propensity. High‐propensity applications dipped in the first and second quarters of 2020 as the economy went into recession.
As startups were falling, business shutdowns were rising. We don’t have accurate, up‐to‐date data on permanent shutdowns, but various indicators suggest they have risen in 2020. We know that shutdowns rose during the last recession and that some cities and industries have been hit hard this time. A third or so of New York City restaurants may close permanently.
The good news is that we appear to have had a big turnaround in startups. The chart shows that high‐propensity applications soared to 537,000 in the third quarter. Apparently, Americans are opening or planning to open large numbers of startups. According to the Census data, applications for online retailers have gone through the roof.
The apparent upward spike in entrepreneurship is impressive, as we did not see such a jump during or after the recession a decade ago. As one of the experts behind the Census data, John Haltiwanger, noted, “One of the reasons we took so long to recover from the Great Recession is startups got clobbered and didn’t come back.” A Wall Street Journal news piece concurred, “The sluggish pace of new‐business creation in years after the [great] recession officially ended contributed to a slow recovery and unusually high unemployment.”
A share of the third quarter’s startup boom likely represents “entrepreneurship by necessity,” or people thrown out of jobs scrambling to find new sources of income. Others are likely seeing opportunities created by the health crisis, such as mask manufacturing. As one reporter noted, “because of the huge changes in economic behavior brought on by the pandemic, a lot of people have ideas for new businesses.”
Will the startup boom last? We’re now in another cycle of rising virus counts and mandated shutdowns. Also, the incoming Biden administration has proposed a range of anti‐market policies that threaten to undermine businesses and startups. Weekly data show that business applications are now down from the peak in August.
Nonetheless, the Census data provide hope that entrepreneurs are coming to the rescue of our battered economy. They are reallocating resources from declining activities to new areas of opportunity. They are helping the economy adapt and begin to grow once again. Let’s work to convince Biden and his team not to throw an interventionist wrench into the works.
ON THE ECONOMY: STOP IN THE NAME OF LOVE
John Dunham, Managing Partner, John Dunham & Associates
I’ve tried so hard, hard to be patient. Hoping you’d stop this infatuation. But each time you are together, I’m so afraid I’ll be losing you forever. Stop! In the name of love, before you break my heart. Stop! In the name of love, before you break my heart. Stop! In the name of love, before you break my heart. Baby, think it over. Think it over, baby. Ooh, think it over baby. These are the closing lines to Stop In the Name of Love, a 1965 song written by the songwriting and production team of Lamont Dozier, Brian Holland and Eddie Holland and recorded by the Supremes for the Motown label. It reached number one on the Billboard pop singles chart in March of that year.
A while back, we wrote in these pages about something else that was stopping, the velocity of money (https://guerrillaeconomics.com/the-speed-of-sound/). This is a kind of technical economic statistic that is calculated by dividing the GDP (in effect spending) by the money supply (generally a statistic that the Federal Reserve calls M2). This means that the velocity of money is the number of times that each unit of currency is used to buy something during the year.
To monetary economists, like those who run the Federal Reserve, the Velocity of Money is an extremely important concept. The equation M*V=P*T (Money Supply * Velocity = Prices * Transactions) is behind the theory that the Fed uses to regulate inflation. Increasing the money supply (all things being equal) should raise prices, and likewise, prices should fall as the supply of money contracts. When GDP is added to the equation, M*(GDP/M)=P*T would mean that GDP=P*T. So in effect, the Federal Reserve believes that increasing prices would increase GDP, all things being equal.
This belief is why the Federal Reserve has been raising the money supply in leaps and bounds for the last 90 years. With the onset of the COVID-19 depression, monetary expansion has been put in overdrive. Since the beginning of the depression, the Fed has increased the money supply by $3.624 trillion, or 23.5 percent. To put this in perspective, during the last recession, the money supply increased by just 13.2 percent.
All things being equal, the equation tells us that this massive increase in M2 should have led to large scale price inflation, but this has not happened. Why? Because the velocity of money fell to a historic low of just 1.1 in Q2. Simply put, there was no actual demand for all of the money being dumped into the economy.
This discussion shows that the velocity of money is not something that is independent of prices and the money supply. It is more a measurement that can rise or fall as the other variables change. Most importantly, V will rise if the number of transactions rises, and fall if the number falls. This is why V tends to fall during recessions. It will also rise if prices go up, or if the money supply is reduced. Likewise a huge increase in M2 will lead to a reduction in V.
Going back to the end of the Civil War, the velocity of money has never been lower. This means that either the number of transactions in the economy has fallen, prices have plummeted, or the money supply has been increased to unheard of levels. You can guess which of these is actually true.
The Federal Reserve’s presses have been working overtime, but there has been no impact on the economy. Monetary policy cannot create demand, it cannot create supply, it really cannot do anything to speed the economy because the Fed cannot control V.
Velocity is falling because the money supply is soaring and both prices or the number of economic transactions did not. This is another statistic that points to an economic collapse of a tremendous magnitude, and a policy reaction that is not working to correct it. Maybe its about time for the Fed to Stop! but not In the name of love but rather in the name of common sense.