The Cantillon effect: tall buildings and what they indicate.
"Look on my works, ye Mighty, and Despair."
Shelley, in Ozymandias
"Not everything longer than it is wide is a phallic symbol."
Sigmund Freud, when questioned about his cigar.
Sometime in the very early 1800s, a Manhattan carpenter named Lozier came to the somewhat startling conclusion that the city in which he lived was dangerously lopsided and had too many buildings on its lower end. If any more structures went up, he proclaimed, the island would sink into the Hudson River. To head off this expected calamity, Lozier suggested to the city's mayor that a chunk of Manhattan's northern end be hacked off, towed down the Hudson, and then attached to the southern tip. This, Lozier explained, would redistribute the island's weight and ensure no further sinking. Impressed with the scheme and with Lozier's ingenuity, the mayor suggested Lozier commence at once, handing over to him from the City Treasury wads of cash to do so.
As real estate historian and writer Dana L Thomas tells it (Lords of The land, page 37) "Lozier advertised for an army of labourers to help him execute his plastic surgery. Five hundred men showed up one wintry morning. For several hours they stood in the cold, stamping their feet and blowing on their hands, waiting for the boss to show up." As the reader might already have guessed however, our carpenter Lozier was long gone, taking with him the city's money intended to finance the project.
Over the years, New York city has had its fair share of real estate swindles. Another was thought to be in progress when a 50 metre high 'superstructure' was started on a six and a half metre plot of Broadway land in the spring of 1887. The owner, a Manhattan realtor named John L. Stearns, actually owned the neighbouring plot as well, off lower Broadway in New Street. The front plot however, facing Broadway, had become so hemmed in that Stearns found it practically unsaleable except at a give-away price.
Frustrated, Stearns approached Bradford Lee Gilbert, a nearby architect for a possible way out. The solution, Bradford recalled in his reminiscences, was to build an iron bridge truss, but stand it on its end; a solution that took him a full six months to conceive and design he said later. In this way, the real structure of the building would start several stories above the curb and help produce the best design to maximize occupancy and rentals.
Satisfied as to the design's safety, and once negotiations with the New York building department had been completed (the structure was so different, no law was present on the books under which the department could approve its commencement), Gilbert began building. New York's newspapers ridiculed the idea, calling it 'idiotic'. Fellow architects pronounced the building unsafe. Building experts said it would blow over in the wind, if the building ever got off the ground that is. New Yorkers themselves were aghast with the notion that a building in the city would tower above their side-walk to a height of 160 feet. A fellow engineer and friend begged Gilbert to abandon such a stupid idea, pointing out that if the building really did fall over, his legal bill would ruin him. Lawyers confirmed the likelihood.
Stearns himself began having second thoughts, but Gilbert knew better, pointing out that the way the building was structured, with wind bracings from top to bottom, the harder the wind blew, the safer the building would actually become. This was a scientific certainty Stearns heard Gilbert suggest, and to put the matter to rest Gilbert requested the top two floors of the new building for his offices.
Building began shortly thereafter, attracting crowds of on-lookers as the building grew taller. On one particular Sunday, the wind was really howling. Gilbert went down to inspect his project, where a huge crowd had gathered in anticipation of the inevitable collapse. Gilbert asked the foreman on the job for a plumb line and began ascending one of the ladders to the top of the construction. Dana L Thomas takes up the tale: "When Gilbert reached the thirteenth story, the wind was blowing so fiercely he was unable to stand upright. He got on his knees and began to crawl along the scaffolding. He dropped the plumb line, lowering it to the ground. There wasn't the slightest vibration; the building stood steady as a rock. Exhilarated, Gilbert straightened up, waving exultantly to the crowd." Suddenly, one of those prevailing wind gusts caught him and carried him right out towards the end of the scaffolding. "It is in emergencies like this that a man prays, if he ever prays," Gilbert recalled afterwards. As he hurtled toward the end of the platform, a rope swinging in the wind from an upright beam of the tower swept within his reach. Gilbert grabbed onto it firmly, went down on his knees and crawled slowly back to the ladder...
The world's first skyscraper, as the invention was later called, built of skeletal steel, was born. So ingenious was the invention, utilizing the land space as never before, that the design enabled its owner to reap $90,000 a year more in rentals than would otherwise have been possible. A mania for tall buildings quickly developed, a phenomenon that continues to this day.
EIS has called the phenomenon the Cantillon effect: so named after Richard Cantillon (1680 - 1734), an Irish banker of the early 1700's, generally credited today as the first economist to suggest that a change in the supply of money and credit will affect the economy by changing prices. Cantillon recognised that an increase in the availability of credit would result in economic expansion but that ultimately this would be overdone as prices rose and imports increased. His work pre-dates Adam Smith and was just as important.
The elegance of the skyscraper structure soon became obvious to all architects and engineers; the further the steel skeleton is buried in the foundations, the stronger the structure becomes. A rivalry developed to build the biggest, the tallest, the most prestigious: a trend that has continued to the present day. It is being witnessed currently in Melbourne as Grollo builders add a 50 metre communications mast to their Eureka building, in competition with the Sunland Group in Queensland for title to the world's tallest residential tower. (Herald Sun, Jan 12, 2005) Something similar occurred in 1929 when Craig Severance, architect of 40 Wall Street competed aggressively against architect (and former partner) William Van Alen who was in charge of the Chrysler building, where, at the very last second Van Alen added a previously secret 50 metre spire to the project to make it the tallest. (Grant.)
As it happens, the world's tallest buildings have had a habit of being completed right at the top of the real estate cycle, (since Gilbert's first tower, there has not been an exception to this occurrence at each real estate peak), producing for us - at least so far - the most reliable indicator of a real estate cycle top.
Completion in the past of the world's tallest:
year completed building
1830's Astor House, New York
1850's Produce Exchange, Studio building, New York
Early 1870's Haight House, Stuyvesant Apartments, New York.
Drexel building, Block Apartments, New York.
Early 1890's Masonic Temple, Chicago
Manhattan building, Marquette, Chicago
Old Waldorf, Cable building, Downing building, New York.
1907/8 Singer building
1909 Metropolitan life
1910 Hearst building, Chicago.
1913 (April 24) Woolworth building
1929 40 Wall Street (Bank of Manhattan building)
New Waldorf Astoria.
1930 (May 28) Chrysler building
1931 (May) Empire State
1972/3 World Trade Centre
1974 Sears Tower, Chicago
(1991 Zarro's arrow 445 metre tower planned by Gold Coast (Australia)
developer Pat Zarro, unveiled in the late 1980's but never built)
1997 Petronas Tower, Malaysia
Ironically, tourists to the Empire State building (dubbed the Empty State building for years after the depression because no one was occupying any part of the building above the 60th floor) most oft asked question was whether the weight of the building, over 360,000 tons, was forcing Manhattan to sink lower into the water. (Thomas, page 253.) Another oft asked question was whether it could ever blow over ! The Empire State sways little more than an inch at the top in gale force winds. The building also survived an (accidental)army B-25 plane crashing into the 78th and 79th floors, killing 13 and injuring 26.
As a general rule, skyscrapers are a speculative project, built mostly by developers with other people's money. Such buildings are going to be built only when credit conditions are easing or at their easiest, and when developers are most flush with funds. But to best apply the tall building syndrome – the EIS Cantillon effect – for maximum forecasting ability, do so only towards the end of the 18 year real estate cycle, which is when the Cantillon effect will be at its most functional with easy credit conditions on display. (And when competition for the world's tallest is sure to be at its height, pardon the pun.) The taller the building on the drawing boards, the more available and easier to procure is the bank created credit.
For maximum understanding, the Cantillon effect should be interpreted in conjunction with the real estate cycle. For example, the construction of the Singer building in 1907 did not mark the height of that year's panic because the normal 18 year real estate cycle had not yet run its full course from the previous real estate led downturn of 1893. Something similar can also be said for the downturns of 1920/21 (war related), 1937/38 and 1981/82, recessions that were not real estate induced. The opening of the Woolworth building, in 1913, was right on cue, just over 18 years from the previous real estate led downturn. However, as is explained in the relevant US chapter, world war intervened to either stave off the collapse, or to lengthen that cycle, (depending upon how one reads it), the only event so far that has been able to exert any pressure on the 18 year cycle to change it. Perhaps significantly, if not ironically, the Woolworth building, the world's tallest at the time, was built by its owner entirely out of cash: no bank credit was involved.
The most recent real estate led downturn of 1991, plus 18 or so years, takes us to 2009. It is interesting to observe just how many 'world's tallest' buildings and the competition, arguments and owner's ego involved to do so, are due for completion at this time, most notably Freedom Tower, New York. (Don't be surprised to see this tower open around March of 2009, 90 months from 9/11.)
Tall buildings are a visible reminder of easy credit conditions. Although the skyscraper is considered an art form, its construction, as Thornton pointed out (page 61) is essentially a business. In other words, the builder of the skyscraper will be constrained by the economics of the time and how much profit can be generated. Most books about skyscrapers do in fact point this out. "Architecture simply doesn't count...With pitifully few exceptions in the past, New York skyscrapers have never reached for anything but money." (Huxtable) Such architectural writers also point out far more frequently than do economists that it is easy financing that underlies all building booms. Willis (page 146) shows quite clearly that "all skyscrapers – even corporate showcases – can be viewed as real estate ventures, either as income-generating properties or as long term investments in high-value urban land."
Which is why the EIS Cantillon effect will continue to work. "The history of speculative bubbles in construction is paralleled by a history of big increases in debt financing whether it is generated by endogenous factors, gold flows, central banks... or bank regulators." (Thornton, 2005) Skyscrapers are real estate ventures ultimately. Land price goes higher the longer we proceed into the real estate cycle and the more available credit becomes. As the land price goes higher, taller buildings are required to offset the cost of building a square meter of lettable space. Willis repeats something similar (page 166): "Because escalating land prices drive up the number of stories needed to spread the cost of a lot, the tallest buildings generally appear at the end of a boom cycle." Canning Fok, CEO at Hutchisons, one of Hong Kong's richest companies said much the same to Fortune Magazine, Jan 8, 2001, when, as he was seeking to apply his previous real estate knowledge to Hutchison's spectrum bidding around the world, noted: "The more the plot of land costs, the taller the building must be to get your money back."
Given the nature of human speculative behaviour, readily encouraged where government granted licenses are permitted to capitalize into a tradeable commodity, the completion of the current crop of 'world's tallest' buildings are highly likely to mark the peak and subsequent turn of the next real estate led downturn.
So there it is, the 'mine's bigger than yours' syndrome: the Cantillon Effect. Just one caveat however. As with all the indicators, they should not be taken in isolation from what the other indicators are suggesting. So the Cantillon effect should be linked to what the yield curve and the land price index are also telling us. Toward the end of this decade, if, as the world's tallest buildings open for business, the yield curve is close to or goes negative and the land price index is way out of proportion, we have a very high probability of a peak in the real estate cycle and real estate led downturn to follow.
To put this into a bit of stock market parlance: as builders begin work on the roof of the world's tallest, we could look for a double top; the top of the tower and that of the real estate market.
Dewey, Edward R., and Edwin F. Dakin, Cycles: The Science of Prediction, Henry Holt and Company, 1947.
Grant, James. The Trouble with Prosperity: A Contrarian's Tale of Boom, Bust and Speculation. Random House, 1996.
Huxtable, Ada Louise. The Tall Building Artistically Reconsidered: the Search for a Skyscraper Style, Berkeley University of California Press, 1992.
Thomas, Dana L. Lords of the Land: The Triumph and Scandals of America's Real Estate Barons from Early Times to the Present. G. P. Putnam Son's, New York, 1977.
Thornton, Mark. Skyscrapers and Business Cycles, Quarterly journal of Austrian economics 8 (1) pages 51 – 74, Spring, 2005.
Willis, Carol, Form Follows Finance: Skyscrapers and Skylines in New York and Chicago, Princeton Architectural Press
Leithner Letter, available at leithner.com.au/newsletter/issue34.htm
Developers Bicker over Tall Storeys, Herald Sun, January 12, 2005, page 34.
Hutchison Sells Out for Now, Fortune, January 8, 2001.
Below, a few charts and images to highlight the effectiveness of tall buildings as a forecaster of land price peaks. From Cycles, page 123, Fig. 7, New York skyscrapers, and Fig. 8, Chicago skyscrapers. The dark line is the Composite – Riggleman, Wenzlick and 120-City-Index of building activity 1830 to 1936, after Warren and Pearson.