No doubt the big automakers have some elaborate market models. But a simple approach can tell us a lot too.
Demand has slumped some 30 – 40% in the last couple of months. Those missing buyers aren’t giving up on owning an auto – they are postponing purchase of a new one. A few may be deciding to switch to second hand autos (we’ll come back to that later).
For the moment, let’s take it that around one-third of new auto buyers have postponed their next auto purchase. Many may not be too sure how long they’ve postponed for. But caution will reign: with the shocks and turmoil on financial markets, asset price losses, weaker economic prospects and spending packages from government taking a while to kick in. So, most auto buyers will probably not be expecting to reconsider short of six months or a year unless something else shifts them.
The odd couple of grand encouragement from government is not likely to have much impact, unless you were just about to purchase and thought you might lose the bonus from government if you delayed. Lower oil prices mean that new, greener models aren’t likely to be much of an incentive either – unless the savings stack up real quick.
So, let’s say the typical postponement of a new auto purchase is likely to be for about 12 months. Let’s say also that typically new cars are replaced every 3 years. So, during the downturn that period goes out to four years.
We have a simple model that tells us a number of things. Short term, there is a fall of one-third whilst buyers vanish. After say a year, those buyers return but the purchase cycle has lengthened so demand remains lower than before the slump. On the figures just given, the short term fall is 33% and the longer term fall 7.5%.
Hence, what looks like a catastrophic fall in sales isn’t so bad in the longer term. It’s “just” a matter of surviving until the market stabilizes.
What about those who give up on owning a new car – for example due to financing difficulties? Corporates are unlikely to switch from new to second hand, though they may postpone replacement. For households, financing of cars has not been subject to the same craziness as houses, since nobody can pretend that new cars are an appreciating asset. But financing has become more difficult. The availability of finance and the willingness of consumers to borrow to obtain a depreciating asset (or take on a leasing arrangement) will depend on liquidity and confidence in the financial sector and beyond. In other words, those giving up on a new car are liable to reconsider in the same circumstances that those who are postponing a purchase will reconsider.
So, suppose the government stimulus package works and the banks stabilise and pre-crash purchasing patterns return or begin to return? Long term everything evens out but short term there is a brief bubble as those who have postponed or abandoned new car purchases return to the market. Suppose that after a year of slump, confidence – and – buyers return. Auto demand returns to its old levels, plus an extra surge in demand from those who have postponed purchase over the previous year. In our example, this surge would provide an extra 11% annual demand over and above pre-crash levels.
But, if confidence and purchasing is being restored, then government subsidies for buyers are liable to be withdrawn. At the same time, auto makers will no longer have the capacity to meet the old levels of demand that are being returned to. Both factors will raise prices for buyers meaning that buyers will now bring forward their purchases in order to grab the good deals whilst they last, resulting in an even bigger surge in demand.
In short, demand for autos (and for that matter other consumer and producer durables) is highly unstable both downward and – in the event of a recovery - upward. Government subsidies are unlikely to blunt the downswing but can exacerbate the upswing; i.e. make matters worse.
This little case study illustrates how difficult it is for auto makers and other manufacturers of capital goods to plan ahead. But it also illustrates how quickly a deflationary scenario with excess supply can turn into an inflationary scenario with excess demand. The main discipline – or control valve – in avoiding the latter - will be a tightening of monetary policy.
Stock position: None.
