Two Economies, And One Isn't Doing Well

The recent data on the economy is improving, which might lead you to believe that it's only a matter of time before the country is running on all six cylinders. But there are really two economies out there: a public economy and a private economy. And the private one is still hurting.

Public Economy. By the public economy, I mean the federal government and publicly traded companies. What links these two is they have access to public money.

• The federal government can simply create money by running huge deficits (with the public's money) to juice its activity. Consequently, the federal government continues to expand, and those who do business with it also continue to see their revenues expand.
• And public companies, thanks to Fed policies, have access to huge amounts of investor cash. With interest rates being held at record lows, investors are pulling money out of CDs, money markets and other short term instruments and throwing it in the bond market in search of yield. That has allowed many good, and not so good, companies to refinance their debt and raise new capital. Thus, they're flush with cash, which is great for these firms.
• It has also allowed the "too big to fail" banks to rake in tons of money by essentially paying nothing for deposits and either investing or loaning out those deposits at huge interest rate spreads. Nice for the banks.

So the public economy looks good. In fact, BusinessWeek just ran a front page article on how much Wall Street loves this current recovery. They also loved the economy that was created from 2002 to 2007 because it too was fueled by incredibly cheap debt. Be careful about putting too much faith in what Wall Street thinks about the economy; we did that before. The Street simply follows the path of least resistance to profits. And right now it's another cheap, debt-fueled bonanza, and our public policies are encouraging it.

Private Economy. But what about this private economy? Well, that consists of non-publicly traded companies and most state and local government entities. These two groups in general don't have the same kind of access to public money.

• Most people work for privately held businesses, and these businesses cannot borrow from the public through the bond markets. They are stuck essentially with bank financing. And it's not easy to get a loan from a bank these days as a private business. Thus, most private businesses are not expanding or taking on new business risks.
• We can't measure the value of private businesses as we can the S&P 500, but I expect if we could we'd see steep declines in the value of these businesses.
• If you netted the decline in private business valuations against some recent stock market increases, I expect we would have a different picture of the economic recovery.
• Since small businesses drive most employment growth, it's no wonder we're still seeing an anemic employment market. Remember, not everyone can work for a Fortune 500 company or the federal government.

State and local governments are also in a world of hurt. They can't run huge operating deficits and finance the deficits with bond sales to the public. They need to balance their budgets, and these days it's pretty tough. Even though the federal government has helped with the Build America Bonds program and other support, it isn't enough to offset falling sales and income tax receipts. Those tax numbers give you a better read on the total economy than profits of the S&P 500.

Now, I'm not saying we didn't need these federal initiatives given the mess in the financial and housing markets. All I'm saying is that the recovery has impacted these markets in vastly different ways. The policies have primarily favored those with access to public funds and punished those who must rely on private financing.

Bottom line. Until we get regulatory and tax policies that favor both economies, I would remain cautious and skeptical about the sustainability of any short-term improvements.

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