Skyscrapers And Business Cycles

A recent Forbes article listed the ten “tallest cities”, those with the most buildings over 700 feet tall. The current record holder for tallest building is the Burj Dubai in the Arab Emirates, at 2684 feet, scheduled to open this fall. It is more than 1000 feet taller than the previous record holder, the Taipei 101 in Taiwan. There are plans to build a couple of skyscrapers over 3000 feet tall.

The article brings to mind a concept introduced in 1999 by Andrew Lawrence, called the “Skyscraper Index”. The index highlights a fairly strong correlation between new world record buildings and the onset of recession. While correlation isn’t causation, and tall buildings certainly don’t cause economic downturns, it is quite interesting and can help to shed some light on the workings of business cycles.

Business cycles can be more aptly described as banking or monetary cycles. They arise in conjunction with inflationary credit bubbles, the responsibility for which lies with the central banks and the fractional reserve banking system. The relative regularity of the bubbles is linked to the fact that the actions taken to mitigate the deflationary effects of an economic downturn, when the bubble bursts, actually plant the seeds for the next bubble.

The root of the matter is that central bankers use incentives to spur rapid economic growth. The interest rate is artificially reduced to below the market rates and the market is flooded with money. Fractional reserve banks greatly leverage the money supply, and it expands like an accordion. The banks use deposited money to make loans, and the leverage of fractional reserves transforms a billion dollars of new reserves into ten billion dollars of new money, created out of thin air.

When interest rates are artificially lowered, business ventures that might not make sense under normal conditions suddenly look profitable. The beginning of the bubble is actually the end of the previous bubble, so costs look favorable. The prior shakeout means that there are lots of resources available at cheap prices. Business really does look good, and entrepreneurs make rational decisions to start projects which look profitable. The money entering the system makes it appear that business is booming for everyone. High spirits and lots of cash stoke the fires for bigger and bigger projects. At times like this, record breaking skyscrapers start to materialize. The thesis of the Skyscraper Index is that when world record building projects get rolling, it is likely that the end of the bubble is near.

The problem is that real resources are limited in the short term. More money pouring into the system does not make any more steel, concrete or lumber available. It does not make more people available to do the work. As the market heats up, the limitation on real resources becomes apparent and costs of production are bid up far beyond expectations. It turns out that entrepreneurs have been fooled. Projects that once looked like big winners now become losers.

The downhill side of the bubble occurs when businesses and individuals can’t pay and the loans go bad. The accordion of fractional reserve banking starts to contract as the leverage is reversed. A billion dollars in bad loans will cause a contraction of 10 billion dollars, as money made from nothing disappears into the ether from whence it came.

As the bust progresses, the real productive resources are still there. Skyscraper owners may go bankrupt but deflation should make prices come down. Productive assets, or overpriced homes in the present case, should become more affordable and realistically priced. If that was allowed to happen, the efficient entrepreneurs would take over productive assets and prospective homeowners would finally be able to afford the homes that they were responsible enough to avoid when they were overpriced.

The reaction among politicians today is to flood the market with “stimulus” to prevent prices from falling and to prop up failed banks and businesses. Aside from the glaring moral hazard of supporting failing businesses and irresponsible homeowners at the expense of those who were responsible, the actions prevent the adjustment that is needed for the economy to become productive again. Skyscraper owners are bailed out, while Average Joe drowns.

Eventually, we may wake up to the reality that the present banking system is the problem. Real banking reform may make the bailout mentality obsolete. It is probably not a good idea to hold your breath waiting, though. Big banks and skyscraper owners with political clout have become addicted to bailouts.

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