The Cost of CARS: Can Cash-for-Clunkers Build a Bubble?
By all indications the government's "Cash-for-Clunkers" program is a huge success. It has effectively achieved multiple goals. First, it has gotten gas-guzzlers off the road. Those cars are destroyed utterly to ensure they will never pollute again. Second, its getting cash into the hands of auto-dealers (which filters back to suppliers and auto makers reminiscent of "trickle-down economics") and creating cash flows through financing programs. While the government's offering between $3,500 and $4,500 is substantial the average price for a new car is $28,400. That means that at best consumers will have to pay about $24,000. Not a small sum, so most consumers will enlist in a financing plan which will create a cash flow for the financiers.
While this program is being heralded as a "bail out that works" if you start really examining the program it looks like so many other booms that have led to tremendous busts.
Once you start scratching you quickly find that this program is not made of gold but instead simply gold coated lead (something the ancients referred to as counterfeiting). The program literally destroys productive assets, creates additional debt, broadcasts artificial signals to the markets, raises used-car prices, and threatens to blow up yet another bubble. Whether its big enough to accomplish inflating our economy again remains to be seen but it certainly demonstrates how such a bubble is manufactured.
The first issue is that this program destroys productive assets. Say what you will about their environmental impact, many of these cars get people from point-A to point-B. "Clunkers" are traditionally the cars of teenagers and lower income people. Many of the working poor need clunkers to get to work and do what they can to get out of poverty so maybe one day they can afford something other than a clunker. Whereas normally many of the clunkers being turned in would be sold to these needy people they are now simply destroyed. This effectively removes them from the marketplace and raises prices on those used cars that remain, thus making it even harder for someone choosing between months of groceries and a means of transportation.
The second issue is that this program adds to our ever growing mountain of national debt. While its a relative drop in the bucket its these small drops that have turned into the flood. The true costs are unknown at this juncture. Besides the money being shelled out for each trade-in taxpayers are on the hook for the destruction and disposal of these clunkers. All of this is financed by borrowed money which must be repaid at interest. Ultimately, whatever savings are generated by increased fuel efficiency may be lost or even dwarfed in interest payments.
One of the most major issues with the program is how exactly the beneficiaries will handle it. If they are wise they will collectively recognize that this is a one-time boost not fueled by any permanent economic improvement but by a one time government subsidy. If they do recognize this they will not dramatically increase production or orders for the new model years. It appears, however, that the Big 3 may be preparing to up production in order to address their wanning inventories. Under normal circumstances this would be prudent. This is most certainly not a normal circumstance, however, and doing so could be disastrous.
This is a classic bubble scenario. The artificial demand for new cars will drain inventories, indicating to auto makers that they must increase production. This will up their orders for the materials and labor necessary to meet the new demand. This increases sales for steel makers among others and this reverberates throughout other associated markets. It also attracts capital to these markets as investors note the increases and decide there is money to be made. However, all this excess is false. The overall demand for new cars has not increased because the economy is doing better and people have more money to spend on something like a new car. Eventually, the government money will stop flowing and then the demand will fall even as new cars are in transit to dealerships with more on the production line.
As this happens dealerships will face massive inventory problems. They will be forced to slash prices in order to move product, even taking losses just to clear room. They will ratchet back their orders for more cars from the auto makers but will be contractually obligated to take those already ordered. The producers will likewise cut back on their demands for associated products and simultaneously reduce their workforce. When this happens all that additional capital that flowed into these markets will evaporate as investors experience massive losses. These losses then affect their ability to invest elsewhere which effects credit markets.
This is essentially what happened with the housing bubble and we could end up in a worse situation once this all shakes out. Even worse, car makers shouldn't expect demand for new cars to pick up anytime soon. After all thousands of people are now driving 2009 or 2010 models so why would they buy 2011 or 2012 models?
Perhaps most galling, even if the bubble created isn't big enough to drive us further into recession, is that this program encourages further indebtedness. As stated, most people driving clunkers aren't exactly swimming in cash. This means for them to get those $28,000 or so cars they will have to get loans. For a period of years they will be paying these cars off (making them less likely to increase their debt load by buying another new car in a few years). This means that for that term period somewhere in the range of $28,000+ of their disposable income will be eaten up paying for their car. That's money that could go to education, food, energy, housing, leisure, investments, or whatever.
Ironically, should those same people default and have their cars repossessed they will find used cars more expensive because of the program. Even if they do manage to get out from under their loan (with their credit destroyed) and get a used car, they will still be paying for the program through taxes. This, of course, is made even worse if they lose their job due to the bursting of the latest bubble. The program actually has the potential to make the poor poorer.
Whether or not CARS can successfully manufacture another bubble remains to be seen. Hopefully, those left in the industry are smart enough to detect what's going on. If not it certainly threatens to dig this hole even deeper. We'll get out of this recession eventually but not until fundamentals change and fundamentally nothing has changed here.
While this program is being heralded as a "bail out that works" if you start really examining the program it looks like so many other booms that have led to tremendous busts.
Once you start scratching you quickly find that this program is not made of gold but instead simply gold coated lead (something the ancients referred to as counterfeiting). The program literally destroys productive assets, creates additional debt, broadcasts artificial signals to the markets, raises used-car prices, and threatens to blow up yet another bubble. Whether its big enough to accomplish inflating our economy again remains to be seen but it certainly demonstrates how such a bubble is manufactured.
The first issue is that this program destroys productive assets. Say what you will about their environmental impact, many of these cars get people from point-A to point-B. "Clunkers" are traditionally the cars of teenagers and lower income people. Many of the working poor need clunkers to get to work and do what they can to get out of poverty so maybe one day they can afford something other than a clunker. Whereas normally many of the clunkers being turned in would be sold to these needy people they are now simply destroyed. This effectively removes them from the marketplace and raises prices on those used cars that remain, thus making it even harder for someone choosing between months of groceries and a means of transportation.
The second issue is that this program adds to our ever growing mountain of national debt. While its a relative drop in the bucket its these small drops that have turned into the flood. The true costs are unknown at this juncture. Besides the money being shelled out for each trade-in taxpayers are on the hook for the destruction and disposal of these clunkers. All of this is financed by borrowed money which must be repaid at interest. Ultimately, whatever savings are generated by increased fuel efficiency may be lost or even dwarfed in interest payments.
One of the most major issues with the program is how exactly the beneficiaries will handle it. If they are wise they will collectively recognize that this is a one-time boost not fueled by any permanent economic improvement but by a one time government subsidy. If they do recognize this they will not dramatically increase production or orders for the new model years. It appears, however, that the Big 3 may be preparing to up production in order to address their wanning inventories. Under normal circumstances this would be prudent. This is most certainly not a normal circumstance, however, and doing so could be disastrous.
This is a classic bubble scenario. The artificial demand for new cars will drain inventories, indicating to auto makers that they must increase production. This will up their orders for the materials and labor necessary to meet the new demand. This increases sales for steel makers among others and this reverberates throughout other associated markets. It also attracts capital to these markets as investors note the increases and decide there is money to be made. However, all this excess is false. The overall demand for new cars has not increased because the economy is doing better and people have more money to spend on something like a new car. Eventually, the government money will stop flowing and then the demand will fall even as new cars are in transit to dealerships with more on the production line.
As this happens dealerships will face massive inventory problems. They will be forced to slash prices in order to move product, even taking losses just to clear room. They will ratchet back their orders for more cars from the auto makers but will be contractually obligated to take those already ordered. The producers will likewise cut back on their demands for associated products and simultaneously reduce their workforce. When this happens all that additional capital that flowed into these markets will evaporate as investors experience massive losses. These losses then affect their ability to invest elsewhere which effects credit markets.
This is essentially what happened with the housing bubble and we could end up in a worse situation once this all shakes out. Even worse, car makers shouldn't expect demand for new cars to pick up anytime soon. After all thousands of people are now driving 2009 or 2010 models so why would they buy 2011 or 2012 models?
Perhaps most galling, even if the bubble created isn't big enough to drive us further into recession, is that this program encourages further indebtedness. As stated, most people driving clunkers aren't exactly swimming in cash. This means for them to get those $28,000 or so cars they will have to get loans. For a period of years they will be paying these cars off (making them less likely to increase their debt load by buying another new car in a few years). This means that for that term period somewhere in the range of $28,000+ of their disposable income will be eaten up paying for their car. That's money that could go to education, food, energy, housing, leisure, investments, or whatever.
Ironically, should those same people default and have their cars repossessed they will find used cars more expensive because of the program. Even if they do manage to get out from under their loan (with their credit destroyed) and get a used car, they will still be paying for the program through taxes. This, of course, is made even worse if they lose their job due to the bursting of the latest bubble. The program actually has the potential to make the poor poorer.
Whether or not CARS can successfully manufacture another bubble remains to be seen. Hopefully, those left in the industry are smart enough to detect what's going on. If not it certainly threatens to dig this hole even deeper. We'll get out of this recession eventually but not until fundamentals change and fundamentally nothing has changed here.