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Sunday, August 9, 2009

Cash for Clunkers Driving Up Prices

The much ballyhooed Cash for Clunkers program has had the unintended consequences of driving up the cost of new and used vehicles and used auto parts, according to independent studies of the auto markets. The Cash for Clunkers program demonstrates the danger of government trying to micro-manage supply and demand, and is a warning as to the dangers of Democratic plans for health care restructuring and a cap-and-trade system.

In a press release issued on Friday, August 7, 2009, Edmunds.com released the data on the effect of the program on new car prices. Edmunds found that the government-funded incentives had caused car dealers to reduce the discounts off manufacturers suggested retail:
"Since the program launched, we've seen that shoppers are getting less of a discount off sticker price for new cars," notes Senior Analyst Michelle Krebs in her report on Edmunds' AutoObserver.com. "In some cases, they are choosing less expensive trim levels and option packages than had been typical in recent months, but paying more for them."
Edmunds also found that the incentive program came at the worst possible time:
"In truth, this program launched at the worst possible time of the year," opined Edmunds.com CEO Jeremy Anwyl. "The annual summer sell-down typically creates a rush of activity for the industry, and this year that rush came right after automakers cut production in response to the floundering economy. It's a simple case of supply and demand, bolstered by a reduced level of negotiation on the part of excited clunker traders. Add to this the automakers' unseasonable reduction in incentives and the message is clear: if you buy a car this summer, you should expect to pay higher prices."
As if price increases for new cars were not bad enough, the Cash for Clunkers program also appears to be driving up prices on used cars, creating a bubble in prices and the danger of a collapse in car demand. According to the Kelley Blue Book August Report:
With a total of 750,000 vehicles being removed from the marketplace, dealers are stocking up on used inventory in anticipation of low supply and high demand. This scenario is driving used-car prices up significantly in the short term, causing a bubble in values that will seriously impact used-vehicle values when the Cash for Clunkers program ends.

"Dealerships have reported increased foot traffic, creating a false sense of automotive market recovery," said Alec Gutierrez, senior analyst of vehicle valuation for Kelley Blue Book. "As a result, dealers are going to auction to restock inventory, driving up used-car values. However, the effect of a supply reduction of this magnitude could have an immense impact on these values in the short-term, exacerbating the already-limited supply at auction. If this bubble comes to pass, dealerships will end up with excess inventory of both new and used vehicles and be forced to offer deep discounts to remove surplus inventory, driving values down. Ultimately, there will be the possibility of a severe contraction in auto sales as soon as the Cash for Clunkers program runs out of funding."
But there's more. The Cash for Clunkers programs is likely to drive up used car parts prices according to dealers who were interviewed for a Dayton Daily News article. While I haven't seen any independent evaluation similar to the new and used car reports linked above, it makes sense that destroying working used cars would take the parts from those cars off the market, thereby decreasing the supply of used parts.

While Cash for Clunkers is being portrayed as a success, in reality it is driving up prices for consumers of all vehicles and used parts, but hits used car buyers and those who cannot afford a new car the hardest because the government rebates only apply to new vehicles. More important, this government program is likely to create a substantial distortion of market forces and a collapse of demand once the program ends.

Only in Washington could a program which uses borrowed money to drive up consumer prices, including a bubble in used car prices, be considered a success. I can't wait for health care restructuring and cap-and-trade.

Related Posts:
Loss of Hope Is Good News?
Obama Hits The Wall
Stimulus -- Just $99.99 While Supplies Last

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  1. I’ve been thinking about what this program actually accomplishes, given that it is being touted as this “big score” for the economy.

    So I decided to get into the details and run some numbers. Here is what I have found:

    The Washington Post ran an article on August 4th saying that the average mpg of cars that people are turning in is 15.8 mpg and the average of the new cars are 25.4 mpg. We’ll round that to an even 10 mpg increase.

    So with the increase in mpg, the owner will use less gas over the lifetime of the car. If we use 1 00,000 miles as the lifetime of the car, the owner would save about 2,650 gallons of gas. At $2.50/gallon gas, this is a good deal for the owner but has significant hidden consequences.

    The federal government levies a $0.184 tax per gallon and states levy additional taxes (I’ll use IL @ $0.338/gallon) and sales tax (IL @6.25%). If we use the same $2.50/gallon gas price, the loss of tax revenue for that new vehicle equates to around $1,800.

    That doesn’t seem so bad until you factor in the scale of this program and the means to finance it. The initial $1 billion sets aside the $4,500 allotment for 222,222 cars. If you multiply the 222,222 vehicles with a loss of $1,800 per vehicle, you end up with a tax shortfall of $400 million.

    On the financing end, it is the issuance of long dated treasury bonds that is covering this program. At Friday’s 30yr T-Bill rate, the cost to finance $1 billion of debt is $850 million.

    So in the end, for every $1 billion issued for the Cash for Clunkers program, it costs $850 million to finance the program and it creates a $400 million tax revenue shortfall.

    That is total fiscal incompetence.

  2. I bought a new Lexus IS 250 this past Friday, the prices seem not too different thus far. Of course, I wasn't eligible to C4C, since I only buy economical cars and our government is hell bent of taking my money and give it irresponsible people (I also pay my mortgage).

  3. Similarly the Student loan program drives up the price of college.

    More money chasing goods = inflation.

  4. It's even worse, because under Cash for Clunkers it is more money chasing fewer goods because the program requires the destruction of the used vehicle.