Thanks for joining me again. If you missed last week’s blog you will want to read it before you read this one.

The Goods and Services Market

When Economists talk about “the Economy” this is the part they are generally talking about. This is (most of) GDP, products going to customers, and services being used. However this process is not instant, perfect, all knowing, or omnipresent. Even in the world of modern e-commerce where hundreds of intermediate sellers are presenting the same item, the results at check outs can vary and the item still has to be shipped. In cases where products are similar but not identical more research is need and sources may be good for popular items but will most likely be limited for more specialized items.

Different products and services can take on different market structures. As we move from identical or nearly identical products into items which are more complex, specialized or unique, the rules shift. The issues of understanding quality, getting clear pricing, and delivery/transaction costs can increase in complexity and increase dramatically. In these cases it is also common for market structures to shift from near prefect competition into more oligopoly like conditions.

The key thing to remember here is the effect of these frictions. There is no factory, retail outlet, or service provider that is going to be as fluid as the financial markets. Prices will not change by the second, items are not delivered instantly, and disclosure rules are minimal (if at all) thus information is normally wrapped in marketing or opinions on review sites.

The market for goods and services (GnS) will adapt but it takes time and energy to produce products, liquidate excess inventory, restock, and for management to manually adjust prices. Most companies are doing all four of these tasks at all times to some extent or another. While different financial markets tend to be highly interconnect, goods and service can be surprisingly independent from each other at times. There have been many, many times where people say “the economy” is doing badly but a large number of sectors are very stable and growing year to year as if nothing has changed.

It is a well understood economic phenomena for some companies to be cyclical while a few are counter-cyclical, i.e. for some companies to perform well in tandem with “the economy” while others actually improve when the economy is down and struggle when the economy is doing well.

Yes, we live in an age where things have become more and more connected than ever before; however, we must be careful not to jump to grand conclusions and image connectivity where it simply is not, or where they may be an effect but it is minor at most. My challenge for anyone on this issues is simple. Before you think something is connected try to quantify how interconnected it is. Try to calculate that number. If the best you can muster is notions about how it is connected to “the economy” as a whole then they probably are not as connected as you think.

A shift in other sectors might change a company’s revenue from 52 million to 51 million. A million dollars is a lot of money, but note that 98% of the firm’s revenue has not changed. When was the last time 98% of your life was exactly the same from year to year?

The news media, politicians, and even we lowly economists like to talk about “the economy” as if it is a race horse bounding down the track. It makes for great TV and catchy news titles online but is commonly over stated. In reality it a jumbled mess lurching in all direction with the aggregate effect being a slight movement in one direction or the other. For most companies the actions of your competitors and middle managers are more important to your bottom line than the larger economic picture. I am not saying the effect isn’t there. I just want to place that effect in a more reasonable, empirically accurate context.

Not all Markets are Highly Competitive Open Markets

When people talk about economics they tend to assume an underlining structure of an open competitive market place with near perfect information, lots of sellers, and lots of buyers. However if you take a hard look at most market places the reality can be much less Marshallian than we imagine. Marketers work very hard to create price discrimination via ad campaigns and product differentiation. Branding has become a proxy for quality. Stores are stocked to provide options… but those are often limited to good-better-best sales pitches. Sales, coupons, and various point schemes cloud the true costs/savings of different bundles of goods.

For many industries, selection can be a real issue. It common to see a pair of heavy weight businesses going head to head with a more niche 3^rd tier competitor far behind. This has improved dramatically in recent times with e-commerce outlets bringing a range of smaller sellers to market places well beyond their normal geographical reach.

The connection between Financial Market and the Goods and Services Market

Before I dive too far into this connection I want everyone to take a second and just think through a question: If the NYSE drops 2% on Thursday does a car manufacturer in Alabama drop its production goal for Friday?

No… of course not.

The talking heads on the news love horse races and thus financial markets. They are always in flux thus have content to cover, regardless of if that content actually means anything. So the question quickly becomes how does the financial market effect firms? The answer to that question largely depends on the firm, but we will cover large archetypes here.

The first is a mix of long term and short term loans. Long term for when they can’t, or shouldn’t, self-fund expansions and retooling. The second is short term loans for covering various cash flow issues like seasonal variants in revenue or one time production costs both of which are common issues in business.

Note that these are fairly simple bank operations, not complex financial arrangement. Financial markets can lower the costs of these transaction or simply provide a skilled CFO a range of options beyond traditional banking, like issuing stock or corporate bonds. The results of lower costs will increase the rate at which companies retool or the easy with which they can address cash flow issues. Although these costs are lowered they still exist and of course not needing to pay any cost will always beat paying a low cost.

Improvements in the financial markets, lowing financing options, and providing flexibility to CFO’s who are facing complex financial challenge can all help to increase production in the GnS markets… but only among the firms facing those kinds of financial problems and then only for a fraction of those firms’ total production. These are marginal gains, not grand economics revolutions.

The important thing to remember about financial markets is that it is at the edges, not the core, of business finance. Although we saw major financing issues starting in 2009, specifically in housing and cars, most elements in the economy were unaffected. Groceries were still bought, doctors still cared for patients, and electronics were still developed/produced/sold. Firms that had financial issues before the financial crisis were the ones that suffered heavily during the credit crunch. The credit crunch was irrelevant to businesses that did not need credit.

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Next week I will be concluding this series with a discussion of the labor market and how it differs from and interacts with both the GnS and Financial Markets.