What contributors to the U.S. economy will give us a broader recovery and what is the outlook on inflation? These are just a few of the topics discussed by Dr. Sam Chandan, president and chief economist of Chandan Economics and associated faculty of real estate, The Wharton School, during a presentation to the NAIOP Corporate Board of Directors at the NAIOP National Forums Symposium held in Chicago, IL.
Consumers, he said, will play a larger role in the recovery in 2013 than they did in 2012. Despite job, wage and salary numbers that are not good, sentiment is strong because of the wealth effect. “Most folks surveyed own their home and between 2007 and 2010 they were miserable” he noted as they watched their homes decline in value, dragging down their net worth. As consumers saw this, they stopped spending and ratcheted up savings. Today, the wealth effect is reversing and turning positive as consumers see improvements in home values as well as their ability to draw on home equity lines of credit. When people find themselves with a discretionary dollar and see that their housing is working for them as an investment, they are more likely to spend that extra dollar.
Housing Construction, Chandan said is not large in and of itself but the spillover and multiplier effects are significant. Once this gets going, jobs in areas such as architecture, engineering, construction, design, and sales are added as are transportation jobs, which move the numerous goods and supplies, necessary to build a home. There is also stimulation through consumer channels as individuals purchase items such as furniture and appliances. Once this process gets going, the economic effects are considerable.
The business picture is mixed, he noted. Large companies are generally in a holding pattern while small entrepreneurs are showing signs of life. Citing Apple as an example, he said the company is sitting on close to $2 billion. The technology giant indicated it was saving in order to purchase new companies through strategic acquisitions, but they have not yet moved. Why? Because at this point there is still a lack of clarity about what makes a good investment. Uncertainties in the regulatory environment are driving this lack of movement.
Chandon observed that small businesses are different. He stated “Those are not folks that are going to the Small Business Administration to get small business loans, by and large, successful entrepreneurs are funding their ideas, figuring out how to monetize them and live that American dream, because they have access to home equity lines of credit.” So when looking at how most new businesses have been funded, overwhelmingly most were funded by the owner’s or principal’s own equity, often through home equity lines of credit. So the absence of access to a home equity line of credit has constrained the growth of small businesses in the U.S., but with housing values recovering, this will change in the coming years.
Monetary policy is a problem. He noted that among the voting members of the Federal Open Market Committee (FOMC), real conversation is beginning to occur about the right time to begin winding down some of the extraordinary accommodation (i.e., extraordinarily low interest rates). “There is nothing happening in monetary policy today that is by the book. Everything we see is innovative and experimental.”
He noted that very high inflation is the most troublesome potential scenario. “We expanded the money supply tremendously, practically running printing presses all night. Why then do we not have inflation when everything we know about the way that central banking works tells us that inflation should be through the roof?” It turns out that although we are putting money out there, “… people aren’t using it! The money is out there but the velocity is low. People are not confident about what to do with it, so the velocity of money has fallen.” There is lots of money out there but it is not moving around in a way that can generate inflationary pressures.
Chandan stated that this is important because it has implications for how and when we might observe inflation in our economy. “If the low inflation environment depends on the low velocity of money and we know that the velocity of money can change on a dime, we can observe an inflection here that is much more abrupt than anything that happens in the real economy. We can go from an environment of low inflation to one of very high inflation very quickly.”
This means that when developers and investors are thinking of downside risks or lenders are contemplating ways to mitigate against stress scenarios, they need to consider two distinct possibilities. On the one hand, inflationary pressures can begin to be felt in two or three years; on the other hand, there is a possibility of rampant inflation in 12 to 14 months. Chandan warned that the latter could “… come back to bite us in a way that is as unprecedented as the interventions that we have undertaken.” That is a real risk so we have to be careful because it could happen quickly.
Chandan noted that the hedging mechanism of commercial real estate owners is the ability to pass cost increases on to the tenant. “If as a landlord you do not have pricing power, then you do not have a hedging mechanism.”
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