Forecasting Errors

Homebuilders in the US are seeing record number of cancelations, and this is happening while there's a record number of new units being built. Clearly, a lot of homebuilders got their forecasting wrong.

This is at first glance odd because it was easy to see that demand for houses would go down as a consequence of what policy makers have thrown at us lately. The decision to turn off the economy, and the prospect of surplus deaths extending for years into the future are but two red flags. So, what triggered the homebuilders to continue full steam ahead despite such icebergs floating around everywhere?

The answer to this is central bank intervention. When the politicians turned off the economy in order to save granny, central banks came in with cheap credit to make sure people kept investing as if nothing had happened. There were also stimulus checks sent out to households for people to spend and invest during the lockdowns.

This worked. People went on an investment binge, and houses were high on people's wish list. Instead of a drop in demand due to the lockdowns, there was an increase in demand due to cheap credit. Homebuilders who were initially scaling down their activities due to real world forecasts responded to the cheap credit issued by central banks by increasing their activities instead.

The central bankers saw this as proof that they had saved the economy, and policy makers saw this as proof that they can do all sorts of things without consequence because central banks can always back them up with cheap credit. They concluded that the system works as intended. Any hardship hoisted onto the public can be mitigated by central bank interventions.

Having saved the economy, central bankers could return to their regular tasks, and focus on such things as price inflation and employment. With high activity in the economy, their only issue was with price inflation which had started to take off due to an abundance of cheap credit. The solution to this minor problem would be to raise interest rates, which was exactly what they did.

But by raising interest rates, houses quickly went from affordable to unaffordable, and people started to cancel the contracts they had signed during the years of central bank induced low interest rates.

It turns out that nothing was saved. The mess that was averted by cheap credit during the virus scare is back with a vengeance. Things are far worse than they were back at the start of the virus scare because investments were made that now have to be unwound. There are malinvestments everywhere, and they all have to be flushed out in order to get the economy back on track.

But few people will understand why this is so. The homebuilders will instead be blamed for the mess in the housing industry, and the same will happen to entrepreneurs in other businesses where this same mechanism played out. Hardly anyone will point their fingers at central bankers. The mechanism employed by them is simply too complex for most people to follow.

One argument used to demonizing entrepreneurs when central bank induced malinvestment bubbles bust is that entrepreneurs should have had the good sense to steer clear of the bubble. Entrepreneurs are professionals. Their job is to look into the future and make investments based on what they see. Why then did they miss something as obvious as a massive housing bubble?

This argument makes superficial sense. It should've been clear to homebuilders that the increased demand for houses wasn't going to last. In fact, they saw this danger early on. They were scaling down their activities. Why then did they change their minds? Were they blinded by greed?

It can be further argued that any homebuilder who ignored the lockdown bubble and scaled down their activities regardless would now be in a position of advantage. These sensible homebuilders would now be awarded by their patience and good sense at a relatively low cost of two years of missed profits.

But if every homebuilder but one did the sensible thing and scaled down their activities in light of real world constraints, the one homebuilder expanding its business would have made enormous profits during the two years of lockdown mania. Central banks would have seen that the economy still had room to grow, and the low interest policy would have been continued. What lasted only two years may have lasted a decade. That's far longer than any business can stay partly dismantled before it goes out of business.

The point is that central banks lowered their interest rates for the express purpose of stimulating activity. The policy would have continued however long it would have been required in order to meet their goals. Instead of homebuilders making decisions based on real world constraints, central bankers decided to overrule their foresight by creating artificial demand.

Once the demand for houses came in at whatever level the central bankers found correct, they changed their focus, and reality came back into the market. Artificial demand vanished, and homebuilders are now stuck with inventory and projects that no-one is interested in.

Had central banks done nothing, homebuilders would've scaled down their activities during the lockdowns, which would've made it obvious to everyone that the economy had been hit hard by political meddling. However, now that central bankers have injected a few years of delay into the equation, we see the economy tank at a time when things are supposedly back to normal. The link between cause and effect has been obscured. Policy makers can therefore say that they saved us all with their lockdowns, and central bankers can say that they saved the economy. They can then turn around and point at the entrepreneurs as the culprits for the current mess.

Unfortunately for us, central banking is too complex for most people to understand, and it's therefore unlikely to be among the first institutions to be dismantled as we move out of the progressive era. We'll see a lot more damage going forward before it's clear to everyone that central banking is a scourge that has to be dismantled. In the meantime, we are best advised to keep as far away from anything related to their debt and currency creation.

Reflection in a soap bubble

By Brocken Inaglory. The image was edited by user:Alvesgaspar - Own work, CC BY-SA 3.0, Link