FT Alphaville " More on auto-driven growth Karl Smith is mildly annoyed at us for not mentioning in yesterday's auto sales post that the trend fits into the broader Smithian/Neo-Wicksellian/Kindasorta-Woodfordian view of the US economy. He's kidding, we think. But he's also right, and he did call the motor vehicle trend early, just as he explained early how the combination of reversing household formation trends and under-construction since the crisis could lead to a residential construction kick and a self-perpetuating economic upswing. More recently we discussed Karl's point that too many people are under the impression that there was rampant over-construction prior to the crisis. There wasn't: it was a house price and mortgage credit boom, not a construction boom, and we too think it likely that multi-family construction will keep growing robustly. All of this is tied together, which is the simple point of this follow-up. If we had more jobs, we'd also have more young people leaving their parents" homes, and more foreclosed-upon people leaving their relatives" homes, to move into new places. Which means we'd have more construction -> which would lead to still more jobs -> and all of which would mean not only that more people could afford to replace their ageing cars, but also that more people who have gone carless these last few years would need new cars to get around. We're a more timid blogger than Karl is and a bit more loathe to make predictions, but we've long found his reasoning persuasive. Our own hesitation with calling the kick - aside from the usual "prediction is hard especially about the future" epistemology stuff and worries about Europe - is simply that we just don't have a good sense of 1) whether more jobs growth is needed first, and if so how much more, or if perhaps 2) the kick will be led by a resurgence in activity and jobs in those very sectors that were most impaired by the crisis: construction, manufacturing, government, etc.. Obviously there are other factors, not least about fiscal and monetary policy, but those are the uncertainties that have loomed in our mind the longest. When it comes to homes and durables especially, things are leaner and more poised for growth than many have realised - this blogger just isn't sure exactly what's needed to "trigger" it or when. Now, we've written previously about the trend in auto sales in the context of pent-up demand, an admittedly vague phrase. But all we meant was that given the amount of time that purchases were below the replacement rate in recent years, it means inevitably that many cars are getting old and well past the point where traditionally they'd have been junked or replaced. Smithianism, though arriving at a similar conclusion in the case of cars and houses (for now), looks at the issue through a somewhat different lens: Consumer durables are capital. They are just non-market capital. You use your car to do things. You use your washing machine to do things, etc. In some sense it's household production all the way down... So, you are thinking about borrowing or saving some money. This is really a question of portfolio management. You can "save," which is to say invest in the economy wide capital or you can "borrow," which is to say invest in durables. So, we then return to how investing in durables goes up when "your car breaks down," "You have a new baby," etc.. you will tend to want to shift your portfolio towards durables and so the natural rate of interest rises. What we saw in the Great Recession was a massive collateral crunch that kept folks from investing in durables at the rate they would want. As a result the marginal return to durables skyrocketed. As that collateral crunch eases, folks will rush into buying durables because the return is enormous. They will do this even if they are heavily indebted already, just so long as the collateral crunch allows them to do it. The reason a balance sheet recession can potentially go on for so long is that the collateral crunch is so severe that even though the return to durables is racing into the double digits, it's hard to get funds. Typos from the original fixed - if we diverge severely from Smithianism on one issue, it is on the returns to copy editing. We rather like this way of thinking for a few reasons, including some quirky ones. One is that it reinforces the idea that the collateral crunch isn't purely a finance-sector phenomenon. Another is because this strikes us as a way to transcend the balance sheet and negative wealth effect theories of what's been holding back consumption in the recovery. Finally it makes the necessary and oft-ignored point about financing - and hey look over there, subprime auto ABS is making a comeback. Anyways, here is Karl with a big long-term prediction about cars per person, here on auto assemblies going parabolic, here on domestic auto producers revving up production. And he predicted in the comments to our post yesterday that "auto contribution to GDP growth over the last year or so will be revised up in next release." So Karl, tack us back on to the Smithianism booster list (and don't be so quick to scratch us off next time!). And everyone go catch Karl and Adam Ozimek over at their new jams - it's about time these dudes got proper sponsorship. This entry was posted by Cardiff Garcia on Friday, May 25th, 2012 at 19:21 and is filed under Capital markets. Tagged with auto, cars, Karl Smith.