We are on a Real Estate Monetary Standard

I’ve been thinking a lot about this over last few weeks when I have the chance to think. It seems like we are on a real estate monetary standard. Much like how we can use assets like gold to create a commodity money system, it seems like we operate our current monetary system as a real estate standard.

Banks create money against real estate assets. We use this money in our day-to-day transactions, without much thought about what stands behind this money, but most loans are for residential and commercial real estate.

If we did operate under a real estate standard, we would expect to see the larger economic business cycle greatly impacted by the real estate cycle, far more than the declines in real estate activity would predict.

As Cullen pointed out over at Pragmatic Capitalism, this is exactly what we see. We see housing as a huge controlling factor for our overall economic growth. Here is a key paragraph from the paper Cullen quoted from Ed Lerner:

“For long-run growth, residential investment is pretty inconsequential, but for the wiggles we call recessions and recoveries, residential investment is very very important. To make this visually clear, I have created a series of figures that illustrate what was happening to each of the contributions to growth before and during the recessions.

Here’s more:

“Eight of the ten recessions were preceded by sustained and substantial problems in housing, and there was a more minor problem in housing prior to the 2001 recession. The one clear exception was the 1953 recession, which commenced without problems from housing.”

The contribution to recessions is extremely clear – you can take a look at the paper and see just how huge of an impact housing has on our economy, despite its size.

The larger point I’ve been thinking about is that we’re close to running out of real estate to create money against, despite the urge for our economy to grow. Ed Lerner is talking about real estate creating conditions for a recession, I am also thinking about real estate coming up to create the conditions for a depression.

Real estate is valued 2 objective ways. One is against cash flows, the other is against replacement cost. We can’t leverage cash flows much more with the low rates we have, and even worse, we can  rebuild the structure for less then the housing price. So banks are naturally reluctant to lend much more value against real estate.

This is commonly thought of as a balance sheet recession, but it seems as though thinking about our system as a “real estate monetary standard” would help us give us more insight.

I’ll have more on this at some point, but wanted to throw this out there.

(Update: What are the odds?  Here is Mark Thoma on Robert Schiller: ‘Wealth Effects Revisited: 1975-2012’)




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57 Comments on "We are on a Real Estate Monetary Standard"

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4 years 7 months ago

Dean Baker explains all (rather plausibly, I think).
“The economy is acting exactly as those who warned of the bubble predicted. We saw a sharp falloff of residential construction as we went from a near record boom, with construction exceeding more than 6.0 percent of GDP at the 2005 peak, to a bust where it fell below 2.0 percent of GDP. This meant a loss in annual demand of more than $600 billion a year.

We also saw a large falloff in consumption due to the loss of $8 trillion in housing wealth. The housing wealth effect is one of the oldest and most widely accepted concepts in economics. It is generally estimated people spend between 5 and 7 cents each year per dollar of housing wealth. This means that the collapse of the bubble would be expected to cost the economy between $400 billion and $560 billion in annual demand.

There is no mechanism that would allow the economy to easily replace the combined loss of between $1 trillion and 1.2 trillion in demand that would be predicted from the collapse of the housing bubble.”

Note that Baker is talking $1T to $1.2T a year, which makes Obama’s $800B in stimulus spending over 2 years less than even half-assed, on an annualized basis.

4 years 7 months ago

There is a lot of truth to this, but as far as building for less do you mean less than owed as much is underwater or less than is being sold for which is not true of markets I am familiar with? One could also compare payments to incomes but even with the drop in incomes payments have fallen further making housing more affordable, though how much one should use current rates as proxy for the long term is a concern.