Latest economic data, dip in the prime rate look good for economy
The latest business news is that the economy has indeed slowed down. But it would be wrong to say it was doing more than slowing in its rate of growth. The banks began to lower their prime lending rate, reflecting some slowness in business loan demand. And the leading economic indicators for August, while on the upside, were not robust.
The leading indicators are not always an accurate barometer, but they are one important benchmark in looking at the direction of the economy six months out.
In June and July the indicators fell; had they fallen for a third straight month, some economists would have been more concerned about the approach of recession, and some politicians would undoubtedly have made capital of the number. As it was, the 0.5 percentage point rise was not great, although at the same time the July number was revised downward from a minus 0.8 percent to minus 1.8 percent.
At the time these indicators are released every month, only 10 of their 12 components are available. So revisions are frequent. In the present month, only 4 of the 10 that were available were positive, but they were strong enough to tip the index upward. These four were stock prices, new business formations, the inverted number for new jobless claims, and new orders for consumer goods.
It isn't smart to take any one indicator - even a composite such as the leading indicators - and rest one's case only on that. But the August figure does coincide with other data indicating that the economy is less robust but still able to chug along, perhaps indefinitely. In any case, they make it less likely that the current state of the economy can be exploited as a political issue in the remaining five weeks before election day. (One number with potential political significance is still to come, however: the September unemployment rate, due to be released Friday.)
A word of explanation about the prime rate might be helpful. Some banks lowered this rate a quarter of a point last week, to 123/4 percent; others went all the way to 121/2 percent. But it appears that the rate isn't as prime as it used to be. Years ago the prime rate was described as the banks' lowest rate, offered to their best business customers. Other rates got scaled upward.
They still do; many smaller businesses, or individuals who borrow on the strength of their own financial statement, pay one or two percentage points above the prime. This depends on many factors that legitimately influence the banks - the borrower's liquidity, how frequently he borrows, his ability to raise funds from normal operations to pay off the loan, and, of course, the size of the borrowing. One reason a large borrower pays less is that it costs no more to put a large loan on the books than a small one. So the small borrowers get socked for more of the overhead costs the bank incurs in servicing many smaller loans.
In recent years, however, big corporations that used to borrow at prime have found a way to pay banks somewhat less. This is because they can also go into the commercial paper market and sell their own paper, or IOUs, at rates lower than prime. The banks, for their part, can get incremental funds to make up their required reserves by borrowing from other banks in what is called the federal funds market, or by issuing large certificates of deposit.
As long as a bank can cover its incremental cost of funds, it may find it advantageous to put on new loans at some small margin over that cost. Conversely , if it has extra funds, a bank might find it attractive to lend them at a rate just above the fed funds rate. So someone paying 1 percent over prime may actually be paying a couple of percentage points more than the big business borrower.