Cash for Clunkers: Wasteful and Stupid

This is one of the most wasteful and stupid schemes announced in the last 6 months by the current administration. This program allows people to trade in their old gas guzzling vehicles and receive $3500 - $4500 from the government to buy a new car with a higher gas mileage. The purpose of the program is to encourage higher consumption, so the (auto) businesses start earning profits and then hire more people. Here is the problem: People in this country have engaged in massive consumption over the last 20 years, such that their personal debt levels are extremely high. In 2006, the total household debt in the country was equal to the total Gross Domestic Product (GDP) in the country. In short, the consumer debt was extremely high from historical standards. As the graph below shows, the only time in the last hundred years when the debt reached such high levels was in 1929, the year the Great Depression began.

If the debt is high in the country, consumers become more likely to default on their obligations and also increase their savings. Usually, the process of defaults ends only when the debt levels are significantly lower than where they were during the bubble. Case in point is the debt bubble during the “Roaring 20s”, which saw consumers take on an unprecedented level of debt, and the end of the Depression during the 2nd World War, largely caused by a reduction in the total amount of debt. Similarly, the current Recession/Depression will end only when the debt levels become significantly lower as a percent of the total GDP. Until then, the consumers will demand fewer loans, save their incomes, and default on their mortgages, car loans, tuition loans, etc. This process began in 2007, but is far from over since the debt has only come down only marginally since then. The Cash for Clunkers program, however, attempts to force the consumers to go into deeper debt which they can probably not afford to service if they lose their jobs.

Now, if the government increased the allocation of money to the program from the current $3 billion in August 2009 to $500 billion in December 2009 and started giving away free cars to all who have dropped out of high school in the last 10 years, are obese, or have been divorced more than 5 times, wouldn’t that stimulate the economy? Yes, but in the very short term only. When the government borrows and spends all this money to provide the free cars, this will increase the profits of the auto companies and they will then hire more people to manufacture more cars, so that will increase employment. Later, as the new employees take their salaries to go buy products with, they will not be able to, since nothing was produced by the government with the money that they had borrowed. The government simply used the money for consumption as opposed to production, and that now creates a shortage of goods in the market. As a result of more money chasing fewer goods, prices will rise and the lenders will raise interest rates to compensate themselves for it.

As interest rates rise, less money will again be available for consumption and fewer cars will be bought, leading to lower car prices and losses for the auto companies. Next, the consumers default on their loans to the banks, auto companies default on their loans from the banks and the banks restrict credit again, but also the consumers stop borrowing since the total debt taken by them is extremely high. The consumers default on their loans until the total debt as a % of their income falls, which generally takes a long time. The cycle of lesser borrowing and falling car prices will end once the debt levels of consumers fall to manageable levels.

The cash for clunkers can help the economy in the short term, but it will have simply postponed the problem, which is that the consumers in the country are highly indebted. The only solution to the problem is higher savings, lesser borrowing and also higher defaults. Strangely, the people in the country are doing exactly that, and they will eventually lower their debt levels, though it would mean hardships for the consumers, losses for the companies and banks and higher unemployment. As the graph indicates, it took 10 years for the debt levels to come down sufficiently; this time would be no different.

The other nonsensical part of the program is the plan to crush the old clunkers. Old clunkers, bad as they might be, are still useful to many. They are still of value and could have been used by many poor and old people. Destroying something of value simply to encourage more consumption is as foolish as creating a forest fire in California to burn down the houses so then the homeless can demand more houses and support the Real estate market. If that were to happen, demand for housing will go up, but demand for food, cars, tuition, and clothes will go down since the people will save large amounts as they would then have to pay back their previous debts plus the new mortgage, so the extra spending coming from the new loans will be neutralized by the lesser spending on the necessities from the monthly incomes.

The higher debt that the consumers will take to buy the cars will only pinch the economy even harder since the debt levels must come down first, before they can go up again. Also, since so many chose to raise their personal debt levels to buy cars, the same would now no longer be willing to go into even deeper debt to buy houses, so the demand for houses goes down.

In conclusion, this is a wasteful program that will unnecessarily increase the government debt, to be repaid later through higher taxes.

Comments

[sapereaude:]

The government will get much of that money back in taxes from auto workers, salespeople, mechanics, etc. Presumably it will also get the scrap value of the clunkers. Those who really oppose Government involvement in the economy ought to abjure a federal military presence, FBI, CDC, Treasury, Interstate Highway System, Social Security, Medicare and Medicaid, and all the many ways in which our tax dollars serve us today. Zimbabwe is a nice place for these anti-government catamites of Mammon.

Aug 19 12:49 PM

[VirtualDebt:]

I perfectly agree with your assessment of the cash for clunkers program. I believe it encourages debt binges at the consumer and government level which will ultimately hurt the US internationally as our creditors (besides our self of course) start trading down the dollar due to a lack of responsible Fiscal policy and no plan to deal with the excessive amount of Government debt. This pay raise in ital debt and as far as employment goes, I don't think much hiring will go on considering most companies have plenty of union workers who are currently on reduced hours and they know this program is temporary.

Aug 19 01:04 PM

[VirtualDebt:]

Hey one isnt antigovernment because we want the government to spend and tax wisely, sides if you want the US to be a Zimbabwe, have it spend like crazy and have the federal reserve underwrite it directly (most of its "Special measures" are doing just that) and soon the dollar will be worth alot less and will be a memory in the distant future of when it dominated commerce. Just like the Pound Sterling, the US Dollar will lose its place among reserve currencies, and with it the excessive consumer and government debt leveraging.

On Aug 19 12:49 PM sapereaude wrote:

> The government will get much of that money back in taxes from auto
> workers, salespeople, mechanics, etc. Presumably it will also get
> the scrap value of the clunkers. Those who really oppose Government
> involvement in the economy ought to abjure a federal military presence,
> FBI, CDC, Treasury, Interstate Highway System, Social Security, Medicare
> and Medicaid, and all the many ways in which our tax dollars serve
> us today. Zimbabwe is a nice place for these anti-government catamites
> of Mammon.

Aug 19 01:10 PM

[Aces003:]

I agree with Nikhil, many of the auto's purchased were not made in America, therefor, not many US workers will reap the so called benefits of the "Cash for Clunkers" program. The scrap will be sold to Japan and China which will lead to more imports and a greater imbalance of payments. Rather than crush the vehicles, the government should have given them to legitimate charities so they could make a buck and continue their good work. Many people who can ill afford a new car will purchase one and take on greater debt. The only industry to profit will be the repo men in the future. The lenders will get immediate profit, but will look to the government again as borrowers fail to make their payments.
A better program would give the taxpayer who owes money to the government a $4500 reduction in their taxes if they purchased a car made in the USA with a majority of it's parts made in the USA. It's not perfect, but a heck of lot better than this administrations plan.

Aug 19 01:59 PM

[Donn Soderq...:]

My 1996 Jeep Grand Cherokee was not going to make it much longer, needing around $2000 in repairs to make it last another 2 years. My new KIA Sportage LX V-6 was made in Korea, so the UAW got no help from me. Price was $200 over invoice. $3000 KIA rebate. $4500 Cash for Clunkers. 100,000 mile warranty, not 30,000. I wrote a check for $16,500. Super deal thanks to the financial idiots in Congress and the White House.

Aug 19 02:57 PM

[GeminiAtlas:]

From my understanding, the cars are rendered inoperable by pouring sodium silicate into the engine to seize it. This ruins the drive train (engine, transmission) which is ~30% of the useful scrap parts value. Now the junk yards will have a tough time dealing with all these cars because it might not be worth the effort involved in taking them apart for the other useful parts.
Because many of the cars and parts will then be crushed or otherwise disposed of, the amount of spare parts for older cars will dwindle. Supply and demand people! What will happen? The poor saps..er, I mean people, looking to fix their old jalopies will find that the parts will be harder to come by and therefore more expensive. And I thought Pres. Obama was trying help the po' common folk. I guess not.

Aug 19 05:26 PM

[GeminiAtlas:]

Congratulations!
As they say, "don't hate the player, hate the game"
I also second the statement that our "leaders" (I use this term loosely) have only vague, often erroneous conception of even the rudiments of the dismal science.


On Aug 19 02:57 PM Donn Soderquist wrote:

> My 1996 Jeep Grand Cherokee was not going to make it much longer,
> needing around $2000 in repairs to make it last another 2 years.
> My new KIA Sportage LX V-6 was made in Korea, so the UAW got no help
> from me. Price was $200 over invoice. $3000 KIA rebate. $4500 Cash
> for Clunkers. 100,000 mile warranty, not 30,000. I wrote a check
> for $16,500. Super deal thanks to the financial idiots in Congress
> and the White House.

Aug 19 05:34 PM

[PainfullyAware:]

Government Does Nothing Well.

NY dealers pull out of clunkers program
www.breitbart.com/arti...

Aug 19 07:09 PM

[Aces003:]

The guy buying the Kia made in Korea just added to our deficit. I hope his job is safe and he won't have contributed to his own layoff. He may have contributed to someone's though.

Aug 19 11:40 PM

[TheSnail:]

This Article=Wasteful and Stupid

Aug 20 12:42 AM

[Donn Soderq...:]

I retired on Independence Day 1997, so there is no job to lose.
KIA factory opens in Georgia this year, so most will be made by non-union Americans. American workers are being trained in Korea now.
www.kmmgusa.com
There should be no subsidies or bailouts for any USA company including GM/Ford/Chrysler.
If anything I helped to create jobs in Georgia for Americans as KIA transitions to USA manufacturing.


On Aug 19 11:40 PM Aces003 wrote:

> The guy buying the Kia made in Korea just added to our deficit. I
> hope his job is safe and he won't have contributed to his own layoff.
> He may have contributed to someone's though.

Aug 20 09:11 AM

[fiveweight:]

Sapereaude got that partly right. But people for lesser government aren't anti-government as many would have you think. They just don't want to see gov interfere with or replace components of the free market. When the government is the only entity capable of providing a particular service without what economists refer to as negative externalities, a legitimate need exists such as the case for defense and interstate system. When private industry can handle that, such as the case with UPS and FedEx, the existence of a federal post office only crowds out more efficient businesses. In the case of non revenue-neutral programs, the net is a loss and the cut of GDP that pays for these programs from taxes hampers real organic growth. Sometimes there is a need for them anyway, but they come at a higher cost to the economy than most realize because it reduces incentive to earn more when a higher percent of that marginal increase is taken away. That's why there is a strong negative correlation between percent of countries' GDP consumed by government to rate of growth. France for example experiences 50% less annual growth measured over long periods of time because their gov takes a higher percent of earnings so there is less marginal benefit to their citizens to produce more.


On Aug 19 12:49 PM sapereaude wrote:

> The government will get much of that money back in taxes from auto
> workers, salespeople, mechanics, etc. Presumably it will also get
> the scrap value of the clunkers. Those who really oppose Government
> involvement in the economy ought to abjure a federal military presence,
> FBI, CDC, Treasury, Interstate Highway System, Social Security, Medicare
> and Medicaid, and all the many ways in which our tax dollars serve
> us today. Zimbabwe is a nice place for these anti-government catamites
> of Mammon.

Aug 21 03:31 PM

[jfe9jhf:]

what kind of idiot would spend money he/she does not need to be spending? it is not my fault that the goverment hires idiots to run the country.... if i get a better deal somewhere else bygod i will take it! if the stupid goverment would actually be working like they are supposed to we would not be in this mess to begin with!


On Aug 19 11:40 PM Aces003 wrote:

> The guy buying the Kia made in Korea just added to our deficit. I
> hope his job is safe and he won't have contributed to his own layoff.
> He may have contributed to someone's though.

Aug 23 10:23 AM

[jfe9jhf:]

right on!


On Aug 20 09:11 AM Donn Soderquist wrote:

> I retired on Independence Day 1997, so there is no job to lose.<br/>KIA
> factory opens in Georgia this year, so most will be made by non-union
> Americans. American workers are being trained in Korea now.
> www.kmmgusa.com
> There should be no subsidies or bailouts for any USA company including
> GM/Ford/Chrysler.
> If anything I helped to create jobs in Georgia for Americans as KIA
> transitions to USA manufacturing.

Aug 23 10:25 AM