So we had the crisis, and the collapse. We had the subprime losses. We had the general panic as everybody feared that the large highly-leveraged money-center banks' debt was no good because they held a lot of subprime and their subprime losses had eaten through their capital. And we had a bigger panic as people feared other things that might go wrong - the same financial establishment that had no clue what risks they were running in subprime probably had other points of vulnerability as well. All confidence that the highly-trained and highly-compensated risk management professionals on Wall Street knew what they were doing evaporated.
It was the standard story.
It was the story that we have seen over and over again since 1825.
As my old teacher Charlie Kindleberger liked to describe it: panic, revulsion and discredit. Nobody trusts anybody else’s paper. Everybody stops spending on currently-produced goods and services to build up their holdings of safe assets. But because one person's spending is another person's income, stopping spending stops income too - so there is no buildup of safe assets but rather a fall in demand, production, employment and incomes that further increases risk and further increases people's desire to cut back on spending in order to build up their safe asset stocks. The result is the deepest downturn in the post World War II era, and a painfully slow recovery since.
Now, this downturn is not nearly as bad as it could have been. Kevin O'Rourke and Barry Eichengreen point out that the 2008 shock to the world economy was bigger than the 1929 shock. In 1933 our unemployment rate kissed 23%, and our non-farm unemployment rate kissed 28%. This time the unemployment rate only kissed 10%. The non-farm unemployment rate didn’t get anywhere near the 28% of the great depression, it didn’t get anywhere near the 16% or 17% that Allan Blinder and Mark Zandi calculate would have been the peak unemployment rate had the government followed ineffective and counterproductive Herbert Hoover policies.
I think that if you could go to Tim Geithner and get him to tell you what he thinks, he would say that a 10% unemployment peak is not a good thing but it is not 17%, and it is definitely not 28%. He would say that he and his peers have done a lot better job at handling this than their predecessors 80 years ago did handling their problem.
And he would be right.
But now we have a stubbornly persistent slump in the economy. Now we have economic growth at about our normal long-run pace, with very little signs of closing the gap between the productive capacity of the American economy and its current level of production. We have a Washington, D.C., that is dysfunctional - out of ammunition to take any effective additional steps to boost the economy. There is now substantial fear of inflation - even though there are no signs of inflation gathering anywhere rather than energy and food prices, and we understand that those reflect China’s growing demand and not any domestic price spiral. There is now substantial fear of crowding out - that boosting U.S. government spending or cutting taxes to get more money into the hands of the consumers would discourage private investment even though there are no signs of crowding out even at our rapidly-growing level of the national debt. It is a fact that a bunch of us - including me - think that there really should be signs of crowding out right now, that financial markets should be scared of the fiscal future of America, but they are not. And there is the problem that Washington, D.C., has degenerated into pure Dingbat Kabuki theater on lots of levels.
It is a fact that if Congress simply goes home - doesn’t do anything for the next 10 years except keep the federal government on autopilot, or if it does do things if it pays for whatever increases in spending it enacts by raising taxes and pays for whatever tax cuts it enacts by cutting spending - that we do not have a long run deficit problem. If congress goes home for 10 years our program spending is matched to our tax revenues, which means a declining debt burden because the growth rate of the economy is larger than the interest rate on our debt.
Our belief that we have a long-run deficit problem is based upon the belief that congress will pass laws that increase spending and that cut taxes - that it will repeal the Independent Payment Authorization Board's authority to try to make Medicare more efficient, that it will repeal the Affordable Care Act's tax on high-cost health plans. Given that the fear is based on a belief that some future Congress will bust the budget, it is hard to see how we can address this fear through any possible piece of legislation today, for no congress can bind its successors.
This is a problem.
But the biggest problem generated by this right now is that Washington, D.C.,'s focus on the Dingbat Kabuki theater of the long-run fiscal stability of America is keeping it from taking any effective steps to use government to boost employment and output now. And things aren't helped by the fact that the way the rescue of the banking system was carried out convinced a lot of people that stimulus policies exist to enrich the top 1% of Americans at the expense of everybody else.
This means that our hopes for economic recovery right now rest not on any government boost to aggregate demand - whether through fiscal, monetary or banking policy - but rather on the natural equilibrium-restoring full-employment achieving market forces of the economy, especially in the labor market.
And so we are in trouble: right now there are no signs that the economy is crawling up back to anything like full employment on its own.
Back when I started in this business, back in the Spring of 1980, I had as teachers two of the smartest men I have ever known: Marty Feldstein and Olivier Blanchard. They taught that John Maynard Keynes had feared that if the economy got itself wedged into a situation of high unemployment that it would never recover by itself - that it would settle into an "underemployment equilibrium." It would need some large positive shock - either a wave of business exuberance, either rational or irrational, or activist stimulative monetary, banking, and/or fiscal policy on the part of government in order to knock unemployment down and employment back up to where it ought to be. Back in 1980 they said that we economists had learned that the market system worked better than that, and that there were substantial equilibrium-restoring forces in the world economy.
But look at the U.S. labor market over the past two years. Those forces are not there. There are no signs that the share of U.S. adults with jobs has been growing, or is about to start growing. Ben Bernanke and Barack Obama both like to talk about how the unemployment rate is falling. But all of the decline in the unemployment rate has come from the fact that people have been dropping out of the labor force. None of it has come from any increase in the share of the adult population with jobs.
That suggests, to me, that we have a very long slog. The economy will grow, but we won’t close the gap between actual and potential output. We will not for a long time to come get back to the 62% to 64% of the adult population having jobs that we thought was normal back in the decades of the 2000.
And that is the depressing overall macroeconomic picture.
I wish I could paint a better one.
But what is, is.
Now let me briefly turn to construction. We expected a construction slump after the mid-2000s boom. Take construction spending in the United States as it stood back in 2001 - when nobody thought we were overbuilding or overbuilt - and project it forward at the 3% growth rate of the U.S. economy. We should probably project the construction trend at a slightly higher rate than that, because as people grow richer they do want to spend a greater share of their larger incomes on housing in a way that they don't for, say, food.
We did have a large four-year housing boom. We all thought when that boom came to an end the country would be somewhat overbuilt. We did expect a post-boom construction slump.
But we didn’t expect this construction slump.
We didn’t expect construction to go back below trend and then stay below trend not for the amount of time and the depth that it had been above the trend before, but for a slump relative to the trend that now is, cumulatively, four times as large as the boom was. And a slump relative to trend that shows no sign of ending.
It is certainly true that a bunch of our boom houses were in the wrong place. We built a lot of single family houses in the swamp of Florida and in the deserts between Los Angeles and Albuquerque when we probably would rather have had more multifamily units in - say - close in Atlanta or in Venice Beach, California, where people could actually commute to jobs. We would rather not have so many houses in Las Vegas, where the major industries are entertainment, are distribution for Los Angeles, and are building more houses in Las Vegas.
But the fact that we build some of our boom houses in the wrong place should strengthen rather than weaken post-crash demand for housing.
The fact that we find it hard to envision a future in which gasoline prices go and stay as low as they had been from 1986 to 2005 also mens that a bunch of our houses are in the wrong place, that we rather have more infill and more ramping-of density, and that too should strengthen rather than weaken post-crash demand for housing.
And we also have the wild part of global warming. Over the next generation, we could have zero degrees of warming and we could have a two degree Fahrenheit warming. Bet on one degree Fahrenheit, but that bet has enormous variance - and every place in the world will be different as some places will get hotter, some will get colder, some will get rainier, some will get dryer, some will get floodier, some will get droughtier. I have no idea whether in 30 years the flow of water down the Colorado River will be greater and support more people in Phoenix than it supports now or less and support fewer instead. Maybe the winter storms that now feed the Colorado will drop their moisture on the Snake and the Columbia instead.
We just don’t know.
But things are going to change. Our current location distribution will turn out to be non-optimal. That too should boost demand for construction.
All these factors really should be pulling housing construction out of its depression right now. And I think they will pull us into a housing boom. But they will do so only when the employment-population ratio recovers, and only when people become confident that if they lose their jobs that they will be able to find a new one, and only when people get so profoundly sick of doubling up and living with their in-laws that they are willing to pay any price and take on any mortgage burden in order to escape.
I keep thinking that we are now so underbuilt relative to trend that the next housing boom should be coming any day now. But I thought that back in May of 2009. And I have thought that "any day now" every month since.
I wish I could say that we will have a rapid recovery to a normal employment-population ratio, and that there will be enormous pent-up demand for housing that will fuel a construction boom when that normal employment-population ratio is reattained. I can say that we built an extra $150 billion x four years times - because it is a triangle--1/2 = $300 billion extra of construction spending over 2003 to 2006 that left us overbuilt relative to trend. And I could say that there is now $1.2 trillion of construction spending below trend during the bust - of underbuilding - that’s going to be a $2 trillion gap of underbuilding before we get back to normal. When incomes and employment patterns return to normal and people get sick of living with their in-laws (and their in-laws get sick of living with them), Americans are going to want to buy those extra $2 trillion worth of houses.
Americans will want to buy them. Americans are an optimistic bunch. There will be this $2 trillion of pent-up demand. There will be population growth. There will be the effects of globalization.
A word about this last: I can’t look forward and see any future in which immigration falls. Move any Indian engineer with an M.S. degree from Bangalore to the San Francisco Bay and you double their productivity. Move anybody gutsy enough to crawl through a storm sewer into San Diego from Chiapas to the United States and you quadruple their productivity. With such enormous economic incentives to move here, people will find a way. Globalization means more people will see how big the rewards to getting to America are. And when they get here and attain an American standard of living they will want to buy houses.
That means that the long term picture for urban land prices and construction has to be bright.
And I haven't even mentioned that China and India’s demand for energy is rising so fast that I am fearing any week now that my next Prius fillup will cost $60, and $60 Prius fillups have powerful implications for boosting construction spending.
But that will not come until we get full recovery. And each month that passes with no further upward movement in the employment-population ratio makes me extend by two months, my forecast of when that full recovery will come.
And let me stop there.