From the proverbial 100,000 feet, it is not difficult to see that the “Great Moderation” was a chimera or sham, a period of sustained disinflation that masked the quest by the former American middle class to hold on to its status by going deeper and deeper into debt, financed at lower and lower interest rates.
When the last, biggest attempt at refinancing via the housing bubble that turned residences into temporary ATM’s finally burst, a prolonged period of households paying down debt, increasing savings, and minimising carrying charges by conservative refinancing at once in a lifetime interest rates, became inevitable.
It is almost certain that at some point in the first half of next year, we will learn that households have deleveraged to the point where their debt as a percentage of disposable income is the lowest since records began to be kept over 30 years ago.
Aside from the necessity of deleveraging, one can almost completely explain the subpar recovery of the last two plus years based on two factors: (1)the Oil choke collar that chokes off growth as soon as it accelerates with prices in excess of ~$3 a gallon or $90 a barrel; and (2) the continuation of the housing bust.
I raise this because in the last week there have been several articles propounding the view that it isn’t consumer demand holding back the economy, it is the lack of investment spending, as shown in this graph:
The implication is that if we just make things even easier on the “job creators,” then increased investment will appear and lift us up. The problem with this view is its bait-and-switch nature, for as Karl Smith of the blog modelled behaviour explains, Construction generally and residential construction specifically are components of investment. The entire post is well worth a read, going into great detail with many helpful graphs.
In fact, residential investment is the biggest single component of gross domestic investment:
In the graph above, total investment (blue) is compared with total investment minus housing (red). It’s pretty easy to see that the decline in private residential investment was a very large component of the total decline in investment from peak to trough. Even more telling, once one leaves out private residential investment, remaining investment has almost completely recovered to its pre-recession peak.
Given that Karl Smith had just shown that construction investment was almost the entire shortfall in the recovery, it is strange at very least that just a couple of days later, responding to Dean Baker, he suggested that there was never a construction bubble!
It is easy to show that the main factors keeping demand depressed are the sharp falloff in construction due to the overbuilding from the bubbles in residential and non-residential construction and the large trade deficit. The trade deficit was offset in the bubble years by bubble-driven consumption and construction, but it is ridiculous to envision the U.S. economy returning to this growth path.
In response, in a post called Why can’t the CEPR hire economists who know how to look up data?, Smith ran the following:
[H]here is the total construction series from FRED.
Here are growth rates
I can see a burst alright but that doesn’t look like much of a bubble.
Excuse me??? There wasn’t a construction bubble?!?! I beg to differ. The problem arises from the fact that non-residential construction trails residential construction by 1 to 2 years. Here’s a graph showing residential (red) and nonresidential (blue):
To make the point even clearer, let’s isolate the bubbles and norm the beginning of each to 100:
As you can see, both residential and nonresidential construction went up over 60% in just three years, for a nearly 20% annual rate! Had the growth continued, construction in each would have doubled in just 4 years – and residential building had already been rising at about 8% a year since the early 1990s without interruption before it entered that blowoff period. But the residential construction bubble was from 2003-2005, while the smaller nonresidential construction bubble was from 2005-2007, thus masking the effect.
These Hard Times will end when and only when (1) households have satisfactorily deleveraged, (2) efficiency and new sources of energy supply break the Oil choke collar, and (3) we work through the housing bust. Even so, as has been the case since the onset of the “great recession,” average Americans’ lot will improve only as much as their real income improves for a long time to come. And until such time as “too big to fail” financial institutions are brought to heel, we remain totally vulnerable to repeat financial crises.
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