Why Are Used Car Prices Soaring?

According to Manheim Consulting, used vehicle prices jumped 16.4% in the first half of 2009 on a seasonally adjusted basis. Once more we are reminded that a weak economy and rising unemployment do not necessarily create deflationary conditions.

The Manheim folks attribute the surge in used car prices to the dearth of new car sales: "The cause of higher wholesale prices does stem from a negative - namely, the significant reduction in potential supply available to the auction industry." I think the rise in prices also has something to do with the return of money velocity. Consumers retrenched violently in the fourth quarter of last year, hoarding cash and repaying debt in the face of tremendous uncertainty. Money velocity collapsed. Now that confidence is returning, money is getting spent again. The economy is recovering some of the ground it lost.

The fact that prices have not collapsed tells us once again that this recession was not the result of a shortage of money (see my many posts re: no shortage of money). It was a lack of confidence more than anything; fear that banks would collapse, fear of counterparty risk. That problem is now being resolved. The Fed responded to the huge increase in money demand, thereby avoiding a depression/deflation such as we had in the 1930s.

One problem we are left with, however, is a massive and wasteful increase in government spending, which promises an equally massive increase in tax burdens. This is the main factor that is now holding back the animal spirits that could otherwise be giving us a V-shaped recovery.

The other problem we have is highlighted by the rebound in used car prices: if that rebound is analogous to the rebound in money velocity, then the Fed is going to have to take dramatic steps very soon to pull back all the money it has dumped into the banking system. Otherwise we are going to find ourselves with way too much money and that will give us rising inflation.

HT: Mark Perry.

Comments

[john s. gordon:]

logic says:
customers who ordinarily would buy a new car can't do it because banks are not making loans.
in order to buy a new car you have to trade in your old one.
shortage of tradeins leads to a shortage of product on the used car lots.
prices of used cars rise in response to demand.
> jack

Jul 08 09:04 AM

[billddrummer:]

I agree with Jack.

The other thing that could be at work is the number of people who got high value vehicles when times were good, and either traded downward to cheaper cars or gave them up (read 'repo'), whether voluntarily or otherwise. These vehicles are now being sold in the used market at much less than they retailed for, but much more than the typical 'used car' sold for just 2 years ago.

So the pool of used vehicles is now skewed toward higher value vehicles, helping to push up the pricing index.

Jul 08 11:25 AM

[prairiedog555:]

This is the new wave, when things get bad, people become more conservative. Which in turn makes things more bad.
When I was younger I spoke with lots of people that were alive in the depression. It took years for people to trust Wall Street again, and to start buying.
I think things will be flat for many years.
Did we not just elect a socialist administration? People are scared, especially the 50+, of which there are a lot.

Jul 08 12:26 PM

[Steve in Gr...:]

Thanks, Mr. Grannis, for the typically helpful analysis.

You are exactly right when you say "The fact that [used car] prices have not collapsed tells us once again that this recession was not the result of a shortage of money...It was a lack of confidence more than anything..."

The problem is not lack of credit availability (at least not to creditworthy people). Instead, people are not buying new cars, and they are selling their new cars to reduce their debt load and interest expense. It is good that Americans are living within their means. It is good that banks are returning to prudent lending standards and repairing their balance sheets.

I wonder how much of the used car buying is in anticipation of being unable to buy safe cars and SUVs after the current administration's implementation of raised fuel-efficiency standards?

Driving is the most dangerous thing most of us do daily. God help you if you are in an accident in a Prius or a SmartCar.

Jul 08 05:51 PM

[a. palmer jr.:]

I see some brand new cars cheaper than some several years old..If you can afford the used one might as well have a new one. I saw a new KIA advertised on tv a couple of hours ago listed at a little over 13000 dollars. Most of the local used cars in the newspaper go for more than that, I think I'd rather have a new car than one someone has put several thousand miles on and probably didn't change the oil.

Jul 09 12:03 AM

[a. palmer jr.:]

If everyone drove a Smart car the roads probably would be safer. If everyone drove like they were trying to get 50 miles per gallon it would also be safer. Around here a lot of them drive the 6000 pound SUVs 80 miles per hour and no one feels safe.

Jul 09 12:06 AM

[TCK:]

I don't look for any decrease in auto pricing. The strategy of closing dealerships was designed to lessen the necessity of price competition on new vehicles. Consequently, the used car prices will remain high also.

Jul 09 07:24 AM

[437339:]

re,
If you in a MVA auto-accident , @ 55-60/miles per hour , you are TOAST , dead or Maimed for life !

Jul 09 05:09 PM

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Jimhenry
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Aug 01 01:49 AM