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.
“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’)