Thursday, June 15, 2006

Boom Bust cycles and the Neoclassical myth

Some of this post is based on the section found at Wealth and Want on Boom and Bust cycles.

Henry George held that the failure to tax the rent of Land leads to speculation in land, which causes the boom/bust cycle. This was predicted 50 years before Keynes was writing. The slack wealth, looking for a tax shelter, will harbor itself in land. As land becomes scarcer and more land is taken out of production due to speculation, this process increases.

In this Irish famine which provoked the land agitation, there is nothing that is peculiar. Such famines on a smaller or a larger scale are constantly occurring. Nay, more! the fact is, that famine, just such famine as this Irish famine, constantly exists in the richest and most highly civilized lands. It persists
even in "good times" 'when trade is "booming;" it spreads and rages whenever from any cause industrial depression comes. It is kept under, or at least kept from showing its worst phases, by poor-rates and almshouses, by private benevolence and by vast organized charities, but it still exists, gnawing in secret when it does not openly rage. – Henry George: The Irish Land

Or if you prefer econ speak:

Economic cycles are accepted as a given in both government and business
circles. But there is compelling evidence that such cycles have their roots in the tendency for elements of the financial community to speculate in real estate, fostering bubbles in their market prices that ultimately must be reconciled with the real demand.5 Because the market price of Land is in good part a function of the settling of rent, the recapture of that rent in the form of taxation can both stabilize those markets and remove the cause of those periodic cycles. – Bill Batt: The Fallacy of the
"Three-Legged Stool" Metaphor

The working poor always notice the effects of an economical downturn more severely and for longer

The amazing thing about George’s theory was not that he was able to predict boom/bust cycles, but rather how they happen. An exhaustive study was done back in 1933 by Homer Hoyt called the One Hundred Years of Land Values in Chicago.

What was so outstanding about Hoyt's book was its compelling confirmation of George's analysis, some thirty-five years after George's death in 1897! What is even more significant is Hoyt's handling of his data in chapters six and seven, the balance of the study. In these two chapters, he selects some sixteen events which not only are present in each cycle, but which occur in the same order in
each cycle. - Weld Carter: A Clarion Call to
Sanity, to Honesty, to Justice

The following table is sourced from the above as well, with my analysis interjected.

A Case History of Five Major Booms and Busts 1830-1933
1. Machine techniques, production methods improved

Internet boom

2. Population begins to spurt up

“Between 1990-1997 California gained 3.2 million residents (10.7 percent increase, despite the out-migration of an estimated 1.2 million residents in the early 1990s. The highest growth rate was in the Central Valley (16 percent).”
3. Shortage of housing, office & commercial space first felt

“Residential overcrowding, which doubled in the State between 1980 and 1990, continued to increase significantly in selected metropolitan areas, including Los Angeles, Orange, and Santa Clara counties.”

4. Rents begin to rise.

“Sharp increases in rents have occurred in selected metropolitan markets of the State. Between 1995-1997, the asking rents in San Francisco, Santa Clara, and San Mateo counties increased by 20 percent to 35 percent.”

5. Selling prices of old buildings begin to advance
“WASHINGTON -- (BUSINESS WIRE) The market for existing single-family home sales rose in November and set the stage for a possible record year, according to the National Association of Realtors®.”

6. Vacant lot purchases begin to rise

7. Rate of new construction begins to rise sharply

“A temporary sag in interest rates and the nation’s warmest January on record pushed up new home construction for the month by 14.5%, the U.S. Commerce Department reported last Thursday.”

8. Credit eases to stimulate volume of new building

Scroll down to long term trends.

9. Rapid growth of population projected far into the future

10. Prices of tracts near settled areas advance rapidly to peak.

“But in the last decade, with development pressures rippling up from Westchester County, that has begun to change. Big-box stores have arrived, along with a spate of McMansions and the occasional town house community. As a countermeasure, the County Legislature recently voted unanimously to place a bond referendum on the ballot in the fall that would allocate $20 million to preserve open space.”

Me- Even though this is the community buying land for public use, it is still illistrative of the rising costs of land near the urban center

11. Large tracts subdivided beyond needs of immediate development

and , and of course The Mega-suburb here

12. Lavish public expenditures

Do I really need to list examples?

13. Rate of population growth falls off 14. Vacancies reappear

and then go here

15. Rise in rents slackens

I personally think this is where we are at now. The statistics above are for the last quarter.
16. Volume of building construction at peak.

17. Asking prices of land advance in face of fewer land sales
18. Financial institutions continue loans on peak values in face of lessened construction
19. Holders of 2nd mortgages begin to foreclose with faith in 1st mortgages
20. Stock market crash
21. Unemployment mounts to peak; wages down
22. Increased movement of population to small city or farm; doubling up in city
23. Vacancies mount to peak in houses, apartments, offices, stores; industrial rents down
24. Interest charges high in proportion to net rents
25. Taxes high in proportion to net rents
26. Second mortgage holders wiped out in flood of first mortgage foreclosures
27. Bank failures mount; loaded with real-estate "frozen assets."
28. Volume of new building at bottom
29. Subdividing stopped; most vacant land not salable at any price
30. Construction costs at lowest point

Where am I going with this? We are not very far away from entering another major recession. The one we experienced around the year 2000 was nothing compared to the one that will be coming soon. Not a day goes by when we don’t hear about the AIMs conundrum. We are already seeing #18 and so we are really only one or two small tiping points, according to this analysis, away from another bust cycle.

The neoclassical myth is that Boom/bust cycles are a natural part of the economy and we can not prevent them. The best we can do is minimize them. However, this is not true. If we wish to get rid of the boom/bust cycle we would need to implement the LVT as envisioned by Henry George in Progress and Poverty and his other writings.