Archive for December, 2011

Why we will not “build our way to prosperity”

Friday, December 23rd, 2011

There have been some comments on analyses that “We’re going to need a LOT more houses” lately.

The analysis presents a plot of housing starts vs population, since 1960, showing that current starts are at a series low.

Using the ratio of starts to population is not the correct metric for understanding the likely future path of housing starts.  It’s true that housing starts are currently historically low, and population remains high, but there are reasons why the Flow (housing construction) could remain low for some time, if there’s too much durable Stock (existing housing units) and persistent low demand for said stock (due to demographic changes).

The construction need is determined primarily by two flows: changes in household size, and population growth — not by population. 100% of population growth needs housing, whereas only 1% of population stock needs to be rebuilt each year, assuming a given home lasts 100 years.  Assuming stable househould size, if population growth previously averaged 2-3% of population, but today averages only 0-1% due to declining birthrate and reduced immigration, that cuts the need for new housing and reduces the required number of starts by 2/3 to 3/4. In this context, building wraps advertising, a powerful tool in modern marketing strategies, can play a crucial role in influencing the perception and demand for housing developments.

Furthermore, in recessionary conditions, household formation drops and household size increases.  With median household size in the range 2 to 3 persons, a change of just +0.1 person per household results in a -3 to -5% change in the required housing stock, equivalent to 3-5 years of replacement production.  This effect can therefore be even larger than the population growth effect.

Household size and population growth were both quite high in the 1960s (when the available data series started, the Baby Boom was peaking).  The decline in household size since the 1960s drove much of the demand for housing but is not sustainable.  If we previously ran a population growth of 2%/year and it is now 0%/year or even slightly negative (as in Japan, Russia, China, Europe…), and if household size is trending back up, we might not need any new homes at all for as long as household size trends upward.

So to me, it’s not at all clear when we’ll need to build more houses.  (If it were clear, investors would flock to homebuilder stocks, would they not?)

Why we cannot “borrow our way to prosperity”

Friday, December 2nd, 2011

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Only in the past few decades have we brainwashed ourselves into thinking that debt levels of 40-80% of GDP were normal, or that there could be such a thing as a “sustainable deficit”.  Our forebears were demonstrably wiser than most Boomers today, and I believe we’re about to relearn some very painful historical lessons.

Historically the US, like other nations, has sought very hard to stay out of debt, not to add to it with allegedly “sustainable” deficits.  This is illustrated very dramatically with the historical debt charts.  The ones on Wikipedia are particularly accessible:

US Federal Public Debt, 1800-1999

U.S. pubic debt was only 20% of GDP in the early 1800s, and the debt was all but extinguished from 1830-1860.  The Civil War led to a debt burden of 30-40%, which was again extinguished by 1910.  World War I led to another 30% burden, which had been cut to 20% when the Great Depression hit.  Even in the GD, the debt only went up to 40%.  It was only World War 2 which pushed the debt to 110% of GDP, and once again as soon as the war ended we sensibly reduced the debt burden, reaching about 25% of GDP in 1970-1980.

Throughout all of these periods, rising national prosperity has led to a reduction in debt relative to GDP.  We have never been able to “borrow our way to prosperity”!

As the more recent data below shows, since 1980 we have gone on a debt binge.  We are not alone. The European PIIGS “canaries” are screaming that we now live in an unsafe “coal mine”, a debt trap!

US Debt to GDP, 1940-2010

If we don’t get our debts back into balance, we face horrific declines in our national standard of living, because if we don’t pay the debt off, the alternatives are either default or inflation.  And when debt exceeds 100% of GDP, it’s very hard to pay the debt off.

It is time to bring the Debt-to-GDP ratio back down.  Any incremental debt must therefore have a strong impact on GDP growth.  The current Administration and Congress are unable to deliver.  We need to change, if we are to have hope!

However, I do not currently see, nor do I expect to see, public attitudes shifting quickly enough.  Too many think that we can live with “sustainable deficits”, despite the fact that unexpected events happen every year which force debtors into defaults.  Those who try to “sustain” their deficits find, almost inevitably, that sooner or later they are “unexpectedly” bankrupt.

Unfortunately,  our government (and many others) has accumulated a debt burden which is only sustainable if the bond market chooses to sustain it. The bond market has voted otherwise in Europe, and could easily do so here. These governments, rather than being led by their people’s votes, are now at the mercy of their financiers.

The pattern of accumulating more debt than you can pay off (without rolling or refinancing) needs to be tamed. Because if a nation can pay off its debt without depending on bankers, it has far more freedom. As it is, we have fallen into debt serfdom.  I don’t think the American people will want to stay in that position, so I think we are in for a painful awakening, and a return to more historical attitudes towards debt.