Analyze Cash Flow The Easy Way

Analyze Cash Flow The Easy Way

Posted: Jan 17, 2007
Richard Loth


If you believe in the old adage, "it takes money to make money," then you can grasp the essence of cash flow and what it means to a company. The statement of cash flows reveals how a company spends its money (cash outflows) and where the money comes from (cash inflows). (To read more about cash flow statements, see What Is A Cash Flow Statement?, Operating Cash Flow: Better Than Net Income? and The Essentials Of Cash Flow.)


We know that a company's profitability, as shown by its net income, is an important investment evaluator. It would be nice to be able to think of this net income figure as a quick and easy way to judge a company's overall performance. However, although accrual accounting provides a basis for matching revenues and expenses, this system does not actually reflect the amount the company has received from the profits illustrated in this system. This can be a vital distinction. In this article, we'll explain what the cash flow statement can tell you and show you where to look to find this information.

Difference Between Earnings and Cash
In an August 1995 article in Individual Investor, Jonathan Moreland provides a very succinct assessment of the difference between earnings and cash. He says "at least as important as a company's profitability is its liquidity - whether or not it's taking in enough money to meet its obligations. Companies, after all, go bankrupt because they cannot pay their bills, not because they are unprofitable. Now, that's an obvious point. Even so, many investors routinely ignore it. How? By looking only at a firm's income statement and not the cash flow statement."

The Statement of Cash Flows
Cash flow statements have three distinct sections, each of which relates to a particular component - operations, investing and financing - of a company's business activities. For the less-experienced investor, making sense of a statement of cash flows is made easier by the use of literally-descriptive account captions and the standardization of the terminology and presentation formats used by all companies:

Cash Flow from Operations: This is the key source of a company's cash generation. It is the cash that the company produces internally as opposed to funds coming from outside investing and financing activities. In this section of the cash flow statement, net income (income statement) is adjusted for non-cash charges and the increases and decreases to working capital items - operating assets and liabilities in the balance sheet's current position.

Cash Flow from Investing: For the most part, investing transactions generate cash outflows, such as capital expenditures for plant, property and equipment, business acquisitions and the purchase of investment securities. Inflows come from the sale of assets, businesses and investment securities. For investors, the most important item in this category is capital expenditures (more on this later). It's generally assumed that this use of cash is a prime necessity for ensuring the proper maintenance of, and additions to, a company's physical assets to support its efficient operation and competitiveness.

Cash Flow from Financing: Debt and equity transactions dominate this category. Companies continuously borrow and repay debt. The issuance of stock is much less frequent. Here again, for investors, particularly income investors, the most important item is cash dividends paid. It's cash, not profits, that is used to pay dividends to shareholders.

A Simplified Approach to Cash Flow Analysis
A company's cash flow can be defined as the number that appears in the cash flow statement as net cash provided by operating activities, or "net operating cash flow", or some version of this caption. However, there is no universally accepted definition. For instance, many financial professionals consider a company's cash flow to be the sum of its net income and depreciation (a non-cash charge in the income statement). While often coming close to net operating cash flow, this professional's short-cut can be way off the mark and investors should stick with the net operating cash flow number.

While cash flow analysis can include several ratios, the following indicators provide a starting point for an investor to measure the investment quality of a company's cash flow:

Operating Cash Flow / Net Sales: This ratio, which is expressed as a percentage of a company's net operating cash flow to its net sales, or revenue (from the income statement), tells us how many dollars of cash we get for every dollar of sales.

There is no exact percentage to look for but obviously, the higher the percentage the better. It should also be noted that industry and company ratios will vary widely. Investors should track this indicator's performance historically to detect significant variances from the company's average cash flow/sales relationship along with how the company's ratio compares to its peers. Also, keep an eye on how cash flow increases as sales increase; it is important that they move at a similar rate over time.

History of Free Cash Flow: Free cash flow is often defined as net operating cash flow minus capital expenditures, which, as mentioned previously, are considered obligatory. A steady, consistent generation of free cash flow is a highly favorable investment quality – so make sure to look for a company that shows steady and growing free cash flow numbers.

For the sake of conservatism, you can go one step further by expanding what is included in the free cash flow number. For example, in addition to capital expenditures, you could also include dividends for the amount to be subtracted from net operating cash flow to get to get a more comprehensive sense of free cash flow. This could then be compared to sales as was shown above.

As a practical matter, if a company has a history of dividend payments, it cannot easily suspend or eliminate them without causing shareholders some real pain. Even dividend payout reductions, while less injurious, are problematic for many shareholders. In general, the market considers dividend payments to be in the same category as capital expenditures - as necessary cash outlays.

But the important thing here is looking for stable levels. This shows not only the company's ability to generate cash flow but it also signals that the company should be able to continue funding its operations. (To read more about cash flow, see Free Cash Flow: Free, But Not Always Easy, Taking Stock Of Discounted Cash Flow and Discounted Cash Flow Analysis.)

Comprehensive Free Cash Flow Coverage: You can calculate a comprehensive free cash flow ratio by dividing the comprehensive free cash flow by net operating cash flow to get a percentage ratio - the higher the percentage the better.

Free cash flow is an important evaluative indicator for investors. It captures all the positive qualities of internally produced cash from a company's operations and subjects it to a critical use of cash - capital expenditures. If a company's cash generation passes this test in a positive way, it is in a strong position to avoid excessive borrowing, expand its business, pay dividends and to weather hard times.

The term "cash cow," which is applied to companies with ample free cash flow, is not a very elegant term, but it is certainly one of the more appealing investment qualities you can apply to a company with this characteristic. (Read more about cash cows in Spotting Cash Cows.)

Conclusion
Once you understand the importance of how cash flow is generated and reported, you can use these simple indicators to conduct an analysis on your own portfolio. The point, like Moreland said above, is to stay away from "looking only at a firm's income statement and not the cash flow statement." This approach will allow you to discover how a company is managing to pay its obligations and make money for its investors.

Read more: http://www.investopedia.com/articles/stocks/07/easycashflow.asp#ixzz1hPqfkDZZ

How do investors "chase the market"? It this a bad thing?

	How do investors "chase the market"? It this a bad thing?
Generally, an investor "chases the market" when he or she enters into a highly priced position after the stock price has increased rapidly or become overpriced. An investor who exits a position after the security has lost considerable value also is said to be chasing the market. Both positions suggest that the investor chased the market by following trends unwisely. Many investors unknowingly chase the market and endure large losses as a result. During the dotcom bubble, for example, many investors sought to profit from buying shares of internet and technology companies that were doing well. The popularity of dotcom companies eventually dropped and the investors who had chased the market were left with big losses. Investors who chase the market typically make investment choices based on emotion rather than careful consideration of market trends using statistics and financial data. For this reason, this strategy has been widely criticized and most financial advisors warn against it For more on this topic, read When Fear and Greed Take Over and The Madness of Crowds. This question was answered by Bob Schneider.

Read more: http://www.investopedia.com/ask/answers/09/chase-the-market.asp?partner=basics122311#ixzz1hPJzapcB

How To Analyze Real Estate Investment Trusts

Posted: May 7, 2011

David Harper

Contact | Author Bio

ARTICLE HIGHLIGHTS

• A real estate investment trust is a real estate company that issues common shares.
• An REIT must agree to pay out at least 90% of its taxable profit in dividends.
• REITs are analyzed like stocks, but the depreciation of property is considered.

A real estate investment trust (REIT) is a real estate company that offers common shares to the public. In this way, an REIT stock is similar to any other stock that represents ownership in an operating business. But an REIT has two unique features: its primary business is managing groups of income-producing properties and it must distribute most of its profits as dividends. Here we take a look at REITs, their characteristics and how they are analyzed.

Tutorial: Exploring Real Estate Investments

The REIT Status

To qualify as an REIT with the IRS, a real estate company must agree to pay out at least 90% of its taxable profit in dividends (and fulfill additional but less important requirements). By having REIT status, a company avoids corporate income tax. A regular corporation makes a profit and pays taxes on its entire profit, and then decides how to allocate its after-tax profits between dividends and reinvestment; an REIT simply distributes all or almost all of its profits and gets to skip the taxation.

Types of REITs

Fewer than 10% of REITs fall into a special class called mortgage REITs. These REITs make loans secured by real estate, but they do not generally own or operate real estate. Mortgage REITs require special analysis. They are finance companies that use several hedging instruments to manage their interest rate exposure. We will not consider them here.

While a handful of hybrid REITs run both real estate operations and transact in mortgage loans, most REITs focus on the "hard asset" business of real estate operations. These are called equity REITs. When you read about REITs, you are usually reading about equity REITs. Equity REITs tend to specialize in owning certain building types such as apartments, regional malls, office buildings or lodging facilities. Some are diversified and some are specialized, meaning they defy classification - such as, for example, an REIT that owns golf courses. (For more insight, see 5 Types Of REITs and How To Invest In Them.)

Analyzing REITs

REITs are dividend-paying stocks that focus on real estate. If you seek income, you would consider them along with high-yield bond funds and dividend paying stocks. As dividend-paying stocks, REITs are analyzed much like other stocks. But there are some large differences due to the accounting treatment of property.

Let's illustrate with a simplified example. Suppose that an REIT buys a building for $1 million. Accounting requires that our REIT charge depreciation against the asset. Let's assume that we spread the depreciation over 20 years in a straight line. Each year we will deduct $50,000 in depreciation expense ($50,000 per year x 20 years = $1 million).

Let's look at the simplified balance sheet and income statement above. In year 10, our balance sheet carries the value of the building at $500,000 (a.k.a., the book value): the original historical cost of $1 million minus $500,000 accumulated depreciation (10 years x $50,000 per year). Our income statement deducts $190,000 of expenses from $200,000 in revenues, but $50,000 of the expense is a depreciation charge.

However, our REIT doesn't actually spend this money in year 10; depreciation is a non-cash charge. Therefore, we add back the depreciation charge to net income in order to produce funds from operations (FFO). The idea is that depreciation unfairly reduces our net incomebecause our building probably didn't lose half its value over the last 10 years. FFO fixes this presumed distortion by excluding the depreciation charge. (FFO includes a few other adjustments, too.)

We should note that FFO gets closer to cash flow than net income, but it does not capture cash flow. Mainly, notice in the example above that we never counted the $1 million spent to acquire the building (the capital expenditure). A more accurate analysis would incorporate capital expenditures. Counting capital expenditures gives a figure known as adjusted FFO, but there is no universal consensus regarding its calculation.

Our hypothetical balance sheet can help us understand the other common REIT metric, net asset value (NAV). In year 10, the book value of our building was only $500,000 because half of the original cost was depreciated. So, book value and related ratios like price-to-book - often dubious in regard to general equities analysis - are pretty much useless for REITs. NAV attempts to replace book value of property with a better estimate of market value.

Calculating NAV requires a somewhat subjective appraisal of the REIT's holdings. In the above example, we see the building generates $100,000 in operating income ($200,000 in revenues minus $100,000 in operating expenses). One method would be to capitalize the operating income based on a market rate. If we think the market's present cap rate for this type of building is 8%, then our estimate of the building's value becomes $1.25 million ($100,000 in operating income / 8% cap rate = $1,250,000). This market value estimate replaces the book value of the building. We then would deduct the mortgage debt (not shown) to get net asset value. Assets minus debt equals equity, where the 'net' in NAV means net of debt. The final step is to divide NAV into common shares to get NAV per share, which is an estimate ofintrinsic value. In theory, the quoted share price should not stray too far from the NAV per share.

Top Down Vs. Bottom Up

When picking stocks, you sometimes hear of top-down versus bottom-up analysis. Top-down starts with an economic perspective and bets on themes or sectors (for example, an aging demographic may favor drug companies). Bottom-up focuses on the fundamentals of specific companies. REIT stocks clearly require both top-down and bottom-up analysis.

From a top-down perspective, REITs can be affected by anything that impacts the supply of and demand for property. Population and job growth tend to be favorable for all REIT types. Interest rates are, in brief, a mixed bag. A rise in interest rates usually signifies an improving economy, which is good for REITs as people are spending and businesses are renting more space. Rising interest rates tend to be good for apartment REITs as people prefer to remain renters rather than purchase new homes. On the other hand, REITs can often take advantage of lower interest rates by reducing their interest expenses and thereby increasing their profitability.

Capital market conditions are also important, namely the institutional demand for REIT equities. In the short run, this demand can overwhelm fundamentals. For example, REIT stocks did quite well in 2001 and the first half of 2002 despite lackluster fundamentals, because money was flowing into the entire asset class.

At the individual REIT level, you want to see strong prospects for growth in revenue, such as rental income, related service income and FFO. You want to see if the REIT has a unique strategy for improving occupancy and raising its rents. REITs typically seek growth through acquisitions, and further aim to realize economies of scale by assimilating inefficiently run properties. Economies of scale would be realized by a reduction in operating expenses as a percentage of revenue. But acquisitions are a double-edged sword. If an REIT cannot improve occupancy rates and/or raise rents, it may be forced into ill-considered acquisitions in order to fuel growth.

As mortgage debt plays a big role in equity value, it is worth looking at the balance sheet. Some recommend looking at leverage, such as the debt-to-equity ration. But in practice, it is difficult to tell when leverage has become excessive. It is more important to weigh the proportion of fixed versus floating-rate debt. In the current low interest rate environment, an REIT that uses only floating-rate debt will be hurt if interest rates rise.

The Bottom Line

REITs are real estate companies that must pay out high dividends in order to enjoy the tax benefits of REIT status. Stable income that can exceed Treasury yields combines with price volatility to offer a total return potential that rivals small capitalization stocks. Analyzing an REIT requires understanding the accounting distortions caused by depreciation and paying careful attention to macroeconomic influences.

by David Harper, CFA, FRM

In addition to writing for Investopedia, David Harper, CFA, FRM, is the founder of The Bionic Turtle, a site that trains professionals in advanced and career-related finance, including financial certification. David was a founding co-editor of the Investopedia Advisor, where his original portfolios (core, growth and technology value) led to superior outperformance (+35% in the first year) with minimal risk and helped to successfully launch Advisor.

He is the principal of Investor Alternatives, a firm that conducts quantitative research, consulting (derivatives valuation), litigation support and financial education.

Read more: http://www.investopedia.com/articles/04/030304.asp#ixzz1hP7YdcJp

Why some US biz owners think it's time to sell

December 23, 2011 - 12:12PM

Tax savings are a big factor in Joel Lederhause's quest to sell a majority stake in DiscountRamps.com. Photo: New York Times

Looking back, Cyndi Finkle wishes she had sold her craft services company, Sunday Night Dinner, early in 2008 when the economy was booming. With a track record of 30 to 50 per cent annual growth for each of the previous five years, it could have been a compelling transaction.

At the time, however, she was not emotionally ready to part with a business she had started in 1997 and built into one of the largest suppliers of services to television crews and casts in Los Angeles. When her husband suggested selling, "I burst into tears and looked at him as if he were telling me to cut off my arm," Finkle said. "Then everything changed, and I realised he was right."

But the recession hit, and Finkle's annual revenue dropped sharply along with declining television advertising and production budgets — making it impossible for her to sell.

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"I've had to work really hard the last three years to save my company and get it back, a lot of times working for free," she said. "It was no longer about building it, it was about keeping it going until things got better."

Revenue for 2011 is finally back to 2008 levels, about $1.2 million, and Finkle is eager to sell. For one thing, she purchased another business, an art studio aimed at children, backed in part by a loan from the Small Business Administration. Moreover, the coming expiration of the Bush tax cuts means that by the end of 2012, the long-term capital gains tax rate will increase to 20 per cent from the current 15 per cent (unless Congress passes legislation extending the lower rate).

Failing to sell before the end of 2012, she said, could cost her tens of thousands of dollars, "and knowing that motivates me to sell in 2012".

Pipeline of owners ready to sell

Finkle is not the only small business owner looking to the new year as an opportune time to sell. There is a pent-up pipeline of owners who have had to put off selling in recent years because of the US economy. And now that many of these companies have at least one year of profits on the books, they are more attractive to potential investors.

"A lot of these companies are having record profits because they reduced their overhead in the downturn and now sales are coming back," said John D. Emory Jr., chief executive of Emory & Co., a Milwaukee-based investment banking company that specialises in selling businesses with $10 million to $100 million in annual revenue.

"A lot of owners have told me they want to start a sale process in the first half of 2012, hoping to complete the sale before the end of 2012. Many owners, especially the leading edge of the baby boomers, wanted to sell in 2008, 2009 or 2010 and would have sold in those three years had the economy stayed strong."

But how to attract buyers?

Those looking to sell are taking steps to appeal to buyers: trimming costs, diversifying revenue, upgrading financial statements and making the chief executive's role less essential. And they are braced for the sales process to take longer than they would like.

For most owners, the business represents their largest asset, and taxes constitute their largest single expense, said Mackey McNeill, a certified public accountant "The ability to negotiate the best possible selling price and to minimise taxes determines the owner's financial fate," McNeill said.

To illustrate the impact of the expiring capital gains tax cut, McNeill created hypothetical companies that would sell for $5 million and $10 million each, assuming typical values for equipment, depreciation, real estate, inventory and goodwill. According to her calculations, and assuming Congress does not act, the owner would save $150,000 in taxes by selling a $5 million company in 2012 instead of 2013. For a $10 million business, the savings would be $325,000. These assumptions cover both S corporations and limited liability corporations, McNeill said.

The tax savings are an important factor in Joel Lederhause's quest to sell a majority stake in DiscountRamps.com, a retailer of loading, hauling and transport equipment.

"We won't continue to grow 15 to 20 per cent a year unless we have some outside capital influx," Lederhause said. "We want some money to go into the company to accelerate its growth, and take a portion of our sweat equity off the table."

The company, which projects $22 million in sales this year, keeps about $6 million in finished goods in its warehouse, which limits its growth potential. DiscountRamps.com offers 11,000 different products, and keeps at least one of each item in stock. With an infusion of capital, Lederhause said, the business could grow to more than $100 million in five years by expanding its product lines into promising new markets.

To make the company more attractive to investors, he has focused on cutting costs and maximising profitability. As a result, gross sales have grown only 6 to 8 per cent in recent years, but profits have quadrupled. "The economy hasn't slowed our growth," he said, "and that's one thing that we can point to when we go out to potential investors."

Diversifying income streams

To prepare for the sale of PartyPail, an Internet retailer, Edward Hechter and his wife, Lisa Jacobson, co-owners, have diversified the company's revenue streams, added detail and structure to the books and cross-trained senior staff — all steps aimed at making the owners less integral to the business. "As a business owner, you should always be prepared to sell," Hechter said, not only to take advantage of an opportunity but to protect your family and staff in case you are incapacitated. Despite the recession, the company's revenue grew to $3.1 million in 2010, from $2.35 million in 2009 and $850,000 in 2008. Revenue of more than $4.4 million is projected for 2011.

Hechter says he believes that a clear investor presentation is critical to any acquisition. Members of his management team restructured the income statement to break out the profit or loss from each of the six e-commerce sites that PartyPail operates. They also refined the cash flow model to better project capital requirements and revenue. Finally, they started accruing annual expenses throughout the year and setting aside cash in anticipation of those costs to smooth out the financials and not have "bad" months when lump sums were deducted.

As part of a business survival plan, he has started inviting the marketing director and general manager into vendor and supply chain partner meetings, so they are more intimately familiar with how the business works. As a test of how well the company can operate without him and his wife in the office, they took six weeks away last summer, primarily on family vacations. The test went off without a hitch.

"I have a quote on my wall from my Grandma Tillie: 'Success is when opportunity and preparation intersect,"' Hechter said, referring to the possibility of selling his company. "There's no telling what will happen," he said, adding, "Business owners don't have the luxury of saying, 'I'm going to change jobs."'

AP

Read more: http://www.smh.com.au/small-business/managing/why-some-us-biz-owners-think-its-time-to-sell-20111223-1p7xb.html#ixzz1hP2H4LlQ

When to choose bankruptcy over debt management

By Steve Bucci

Dear Debt Adviser,
I have more debt than I can handle, and I am enrolled in a debt management plan. However, my expenses still amount to more than I bring home, and the debt management agent knew this going in. They calculated my debt payment as $344 with the program, and they never advised as to whether I should file for bankruptcy. Should I have filed for bankruptcy instead? If I file for Chapter 7, would I have to include all of my debt including personal loans? 
-- Shirley

Dear Shirley,
Slow down, Shirley! You have a lot going on here, so let's take things one at a time. First, you should not have been enrolled in a debt management plan if your income level does not allow for the monthly payment. Call the debt management agency as soon as possible, and ask to speak with a supervisor. Have them go over your case from start to finish. If a mistake as big as putting you in an unaffordable plan was made, other issues may have been overlooked as well. Find out if your payment can be lowered to what you can afford. Many agencies can offer a hardship debt management plan titled a "call to action," which lowers the interest rate on your credit card accounts to the lowest possible level. That may decrease your monthly payment enough to make the debt management plan work for you.

A reputable credit counseling agency will not enroll persons in a debt management plan unless the counselor has provided a spending plan that balances income and expenses. If you are having trouble meeting your monthly payment because you are not following the spending plan provided by the agency, then you have a decision to make. Either get back on track and spend only as the plan allows, or increase your income with a part-time job or other income source.

Second, as for bankruptcy advice, I'm not surprised the counselor didn't give you any. Only an attorney can give legal advice, and bankruptcy is a legal process. However, your counselor can and should go over the pros and cons of filing for bankruptcy and whether it would make sense for you to get a legal opinion for your particular situation.

Third, should you find you absolutely cannot afford to make your payment and want to explore bankruptcy, I recommend you contact an attorney who specializes in consumer bankruptcy. To qualify for a Chapter 7 filing (in which your debts are forgiven and not repaid) your income must be below the median income for your state.

You would typically include all your debt in a bankruptcy filing, but you can file a reaffirmation document for a particular debt(s) if you have a good reason for doing so. You and your attorney will have to sign the reaffirmation document that states you can afford to repay the debt and it will not be an undue hardship on your post-bankruptcy budget to continue to pay the debt you would like reaffirmed. Typically, unsecured debts would not be included in a reaffirmation, which would include personal loans. Most reaffirmations would be for car or mortgage loans. I'm not sure why you would want to reaffirm a personal loan, but if you can convince the court and your attorney that it would be in your best interest to do so, you could file a reaffirmation for the debt.

Lastly, you wanted to know if you should have filed instead of going on a debt management plan. My answer is that if the debt management plan can be made to work, you are usually better off. A bankruptcy can stay on your credit report for up to 10 years. A poor credit report may affect your ability to get a decent apartment, home or insurance for years to come. If you have no other way out, then you may have no choice but to file. Just be sure you consider all the potential ramifications before you decide.

Read more: When To Choose Bankruptcy Over Debt Management | Bankrate.com http://www.bankrate.com/finance/debt/choose-bankruptcy-over-debt-management.aspx#ixzz1hOvuZp5p

What America Can Learn from the Greece Financial Crisis

Written by Lewis E. Lehrman
Thursday, June 30, 2011

Observations on the Greece financial crisis and what America can learn:

1. Greece is only one example of an irresponsible, reckless, insolvent government, which is spending itself into bankruptcy. There are dozens of such countries, both developed and emerging.
2. Central bank and commercial bank credit financing of the government budget deficits in every country leads to inflation. This mechanism leading to inflation is subtle but pervasive and inevitable.
3. The solution to the problem is to prevent governments from requiring their central banks and commercial banks from creating new money and credit to finance government spending.
4. In the case of America, the budget deficit and the balance of payment deficit affect the entire world because the world is on the paper dollar standard. The dollar is the official reserve currency of the world. These US deficits are financed by the Fed, the commercial banks, and foreign central banks with new money and credit which cause the depreciation of the dollar. The vast new Fed created credit of QE1 and QE2 floods the world banking system with excess dollars, causing world wide inflation.
5. Greece is the concrete lesson for American public finance. Central bank and commercial bank financing of the government budget must be restricted or, even better, prohibited.
6. The best institutional restriction on undisciplined Federal Reserve discretion to finance the budget and balance of payments deficit is to establish convertibility of the dollar by statute to a fixed weight of gold and to end the official reserve currency role of the dollar.
7. When the dollar is convertible at a fixed parity to gold, then if the Fed and the banks create too much money and credit, causing inflation, the American people can protect themselves by turning in their undesired dollars for gold at the fixed parity. Since the Federal Reserve and the banks would be required by law to redeem the dollars in gold, the banks must then reduce the expansion of credit, tending to reduce inflation.

The gold standard, in a word, is democratic money. The sovereign American people should regulate the quantity of money and credit, not the Federal Reserve, a government agency. Gold is also the money of the Constitution as stipulated in Article I, Sections 8 and 10. Thus, the monetary system must be regulated by a democratic people, and not by economists manipulating the currency at the Federal Reserve Board and the Treasury.

http://www.thegoldstandardnow.org/the-lehrman-gold-standard-articles/533-greece-financial-crisis-solution

Why The Fed Can't Be Counted On To Save The Economy

Written by Jim Powell - Forbes
Wednesday, December 21, 2011

The Federal Reserve was established in 1913 supposedly to maintain economic stability, but it presided over America’s worst depression (1930s), the worst peacetime inflation (mid-1960s to mid-1980s) and probably the worst asset bubble and bust (early 2000s to the present). In addition, there have been 18 recessions or depressions during the Fed era, generally the result of prior inflations.

How could such a problematic track record be possible? The Federal Reserve was billed as an improvement over the gold standard. For starters, maintaining economic stability is at best a central bank’s second priority after doing whatever might be necessary to support government financing activities in war and peace, which can conflict with the goal of maintaining economic stability. Moreover, there are congressional directives, such as the Employment Act of 1946 that makes the Fed responsible for achieving “full” employment.

Over the years, the Fed has been directed to achieve more and more conflicting priorities, including economic growth, price stability, interest-rate stability, financial market stability and exchange?rate stability as well as government funding and full employment. Multiple objectives have made the Fed’s behavior more unpredictable, because nobody knows what the top priority is going to be – or for how long. Consequently, it’s more difficult for people to make decisions \about business and personal finances.

Read Full Article http://www.forbes.com/sites/jimpowell/2011/12/20/why-the-fed-cant-be-counted-on-to-save-the-economy/