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Monday, April 19, 2021

Video Clip About North American Lumber Situation

The linked post (from Twitter) is a short discussion of the supply squeeze in lumber in Canada and the United States by Stinson Dean, the CEO of Deacon Lumber. I have not dug too deeply into this story (other than knowing about this courtesy of having a home renovation project done recently).

His story is that the issue is that there are supply disruptions. Canadian governments have cut back on logging approvals since the pace of cutting was unsustainable. He notes that Canadian lumber is key for structural members. Also, tariff policy resulting in mills closing in the United States. That is, the supply disruptions predated the pandemic. 

This limitation of supply collided into a surge in house construction in Canada and the United States. (My neighbourhood has been the scene of continuous teardowns of sensibly-sized 1960s bungalows to be replaced by McMansions.) Unlike some European countries, detached house construction is generally wood framed, although I saw a metal frame replacing structural members in one site.

The collision of rising demand and falling supply has caused inevitable problems. Construction firms had entered into delivery contracts, and now they either have to buy expensive lumber of break the agreements. 

From one angle, this situation supports neoclassical theory. Low interest rates helps the housing market, and so the demand has created a spike in prices. 

The question is whether there are any implications outside the industries industries directly involved.

On the construction side, if lumber is not available, construction has no choice but to slow. This puts a damper on the need to hire workers, as well as the demand for all of the other materials. In other words, the real economy stimulus from housing is capped out -- even if existing home prices will rise. The only way that the lumber price shortage feeds through to greater real activity is if there is a surge in investment in lumber mills. (Increasing the supply of trees is a slow process.) The aggregate effects of such investment are unlikely to be significant relative to the size of the economy.

From the inflation side, this is mainly a relative price shock. Renovations are more expensive, but if we look at new homes, it is entirely possible that the lumber price increase will be absorbed by the components of the house (most notably, land), if we assume that buyers' total budget is fixed by lending standards. That is, house prices are asset prices, and since the asset price is greater than the cost of construction, asset price trends dominate.

In summary, it would be a concern if we continuously write off price rises as isolated events. However, in this case, since the effect of lumber shortages is to put real limits on construction speed, the spillover effects seem less dangerous from the perspective of price stability. 

(One of the common reactions to articles similar to this: what should policymakers do about this? Once again, the most sensible policy is to tighten credit policy with regards to residential housing to directly address the part of the economy that is arguably overheating. Rate hikes would probably do the job, but the financial markets would likely freak out, and the Fed would have thrown away whatever credibility they have with respect to their new policy framework.)

(c) Brian Romanchuk 2021

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