Can the US housing market drive the recovery forward?

I have been seeing more and more analysis that “believes” that this could well be the case. 

I would however be very careful of the impact of asset focussed money supply growth on economic activity, in that it may well draw nearer the time for interest rates to rise: the combination of asset focussed money supply growth and rising interest rates was precisely what precipitated the current crisis.  

The risks are also that QE initiated asset price rises might overly focus economic activity on certain areas (i.e housing and debt related to housing) without allowing underlying economic fundamentals to provide the necessary economic infrastructure for that demand and that debt.  This was another issue behind the crisis: structural economic imbalances that had been allowed to accumulate and that accentuated the length and depth of the crisis and which still pervade the current weakness.

New home sales typically drive the residential construction component of GDP and activity has clearly found some traction (which has also been mirrored by new housing permits), although December data shows recent weakness:



Residential real estate investment in Q3 2012 was some 49% of its Q1 2006 contribution, even without adjusting upwards for inflation.  So if you were to argue that the current recession/depression has all been a bit overdone/over baked, then you might also believe that there is substantial potential for contribution to GDP growth from housing investment going forward.

Historically, this has not been a massive  contribution, apart from the 1950s, although residential infrastructure investment has gone hand in hand with strength in other areas: image

But while home ownership rates are well down from their peaks, they are still healthy compared to pre boom time periods:


Given weak earnings growth to date, slow economic growth and uncertainty over growth, and an unlikely return to the mortgage lending practises of the early noughties, there may be little pressure to increase home ownership rates. 

That leaves a greater reliance on demand for new housing from the rental side and this depends on new household formation (young adults leaving home).   This is plausible but it is also one dependent on rising incomes and employment for magnitude, an outcome which must also be balanced against high unemployment in this demographic and other issues such as student loans and fertility rates.

As far as rentals are concerned, it is worthwhile noting that while vacancy rates have fallen, they do not appear low by pre boom standards.


Housing inventory has also come down, but there is much disagreement over the potential size and role of shadow inventory in the housing demand and supply equation.

I do not believe that the economy can rely on home building to carry it, and if it does, I would be concerned:  private sector debt is also still historically high and much of the decline in mortgage debt has come from defaults; a large surge in residential construction from new homeowners would imply a significant rise in consumer debt, exposing the economy yet again to both higher debt and rising interest rates. 

A rise in demand from renters may be less dangerous (although this depends on the gearing and its dependence on rental income) but would also risk skewing capital investment towards the home building sector.  If homebuilding is to be used as a temporary engine of growth, the risk needs to be hedged, for the fall out of such could be significant.  The consumer remains too important a component of GDP in the US.  

I also believe that the combination of large consumer and government debt, and low wage growth, places too big a drag on growth to expect to see a boom in residential construction drawn from fundamental factors.   This is especially so in the context of global economic risks. 

Nevertheless, an asset focussed, QE supported, surge in monetary growth could just do something like this.   If this happens expect a number of things in the order noted: higher asset prices, higher asset based expenditure, higher inflation, higher capital investment per se, and ultimately higher interest rates.   The trouble here is that it would be asset focussed, it would be driven by broad money supply growth, it would be dependent on structural imbalances and it will lead to a rise in interest rates.  But this all assumes the gambit gains the necessary traction against a background of numerous significant risks.

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