Perhaps no manufactured good is less technologically sophisticated than a 2×4, while none is more complex than the latest microprocessors. Yet the U.S. economy is currently suffering from shortages of both lumber and chips—and for similar reasons.
In both cases, today’s shortages are the legacy of past busts, which then led to years of underinvestment that has left producers unable to respond to sudden surges in demand. Start with lumber, which is an essential material input for home building. Sawmills and other wood product manufacturers cut their production capacity by about a quarter after the housing bust. While investment has since recovered, productive capacity in March was still about 11% below the 2006 peak.
Until recently, that seemed like a sound business decision. Most lumber and other wood products are used for construction and furniture manufacturing—two industries that looked to be permanently smaller after the mortgage debt bubble popped. The number of single-family housing starts from 2017 to 2019 was about half what it was from 2003 to 2005. Despite the capacity cuts, the Federal Reserve estimates that sawmills and other wood product manufacturers were operating at about 78% of capacity in the years immediately preceding the pandemic, compared with 79% during the peak of the housing bubble.
The problem—for both home builders and home buyers—is that the construction industry’s lost decade- plus ended so suddenly. Since July, Americans have bought about 79,000 new single-family homes each month, up roughly 50% from the recent pre-pandemic average—and the pace of purchases seems to be accelerating.
Even during the best of circumstances, builders would have struggled to meet that surge in demand, because construction takes time. That’s why the number of completed new homes available for sale has plunged to its lowest level ever. Builders have only been able to prevent overall inventory from collapsing by selling homes where construction hasn’t yet started.
The current situation is being exacerbated by the atrophied lumber supply chain. Just as it takes time to build a house, it takes time for sawmills to boost their capacity. Until then, markets ration scarce quantities through higher prices. The producer-price index—businesses’ version of the consumer-price index—shows that the cost of goods sold by sawmills are up more than 70% since the pandemic began, while the price index for all materials used in construction is up more than 13%.
Despite the strength in demand, soaring costs are causing home builders to begin cutting back on construction starts for new single-family homes.
The situation with chips may seem different, but it’s actually the same. The first key piece of context is the boom-bust cycle that hit America’s semiconductor industry in the 1990s and 2000s. Sales of American-made semiconductors and related devices fell from $94 billion at the peak in 2000 to less than $66 billion the following year. As of 2019, sales were worth less than $65 billion. Similarly, revenues from printed circuit assembly fell from a peak of $37 billion in 2000 to $24 billion by 2002, and were also $24 billion in 2019.
Unsurprisingly, businesses responded to the lack of sales by keeping a tight lid on their investment in property, plant, and equipment. After hitting at a little more than $33 billion in 2000, capital spending on physical manufacturing capacity by the total computer and electronics manufacturing sector was just $25 billion 2019.
Producers in the rest of the world made up the difference as demand from the U.S. and elsewhere continued to rise over the past two decades. But like American sawmills, those foreign producers were similarly unprepared to handle the surge in demand for chips during the pandemic.
Being stuck at home and flush with cash from economic impact payments and enhanced unemployment benefits led to a huge spike in spending on consumer goods that require microprocessors, including phones, TVs, laptops, tablets, exercise equipment, and cars and trucks.
At the same time, businesses felt compelled to spend more on computers, phones, and specialist medical devices either to support their remote workforces or to respond to the pandemic itself.
The combined effect has been similar to the impact of the demand for new homes on the lumber market. But instead of home builders cutting back on construction starts, we have auto makers restraining their production in a hot market even as they get stuck with inventories of parts for unfinished vehicles.
Ultimately, both the lumber shortage and the chip shortage will be resolved with some combination of lower demand and higher supply. The question is how long will it take. Investment takes time, and businesses reasonably want to be confident they won’t get burned with an overhang of excess capacity if the current demand spikes prove short-lived.
This means that the fastest way to fix the current shortages and bring prices back to normal—at least, the fastest way that doesn’t involve tanking the economy—is to keep the boom going. And that seems like the plan of both the Federal Reserve and elected officials.
Write to Matthew C. Klein at matthew.klein@barrons.com
