Cash for Clunkers: A Man-Made Disaster

It has been a while since I have last written a post, and the choice of subject matter for this post has proven to be a difficult decision. On the one hand, there are the ongoing tremors in the financial system, and on the other there are the global shifts, such as the unsubstantiated suggestion by China that they may allow the RMB to appreciate. Added to this, there is the ongoing ascent of the gold price, as investors and governments move into the asset of last resort, and the progressive decline in value of the $US. This from the Wall Street Times:

"The gold market is kind of surprising here," as it holds on to the psychologically important $1,100 level, said Ralph Preston, senior market analyst with Heritage West Financial.

Watching the dollar's next moves will be crucial, Preston said. "It's going to be interesting whether the dollar is developing a bottoming formation or if it is about to fall off a technical cliff."

I will leave such matters alone for this post, as they are being covered elsewhere. Instead I would like to focus on one of the widely utilised government stimuli; the cash for clunkers schemes. I am focusing on this subject, as the scheme has appeared to give a temporary reprieve in the downwards trajectory of many economies. My inspiration was an article in the Telegraph, in which Jeremy Warner analyses the impact of the stimulus on the UK economy.

The purpose of my post is to highlight the absolute foolishness of such government measures in relation to arguments for more government interventions in economies. A long while ago, in a discussion of GDP measures, I pointed out that Hurricane Katrina would have seen an uptick in US GDP. The destruction of infrastructure, housing and other assets would have led to increased activity in the economy, as business and government sought to replace the assets that were lost. In other words, the destruction of a hurricane would appear to be a positive boon for an economy. On such logic, bombing your own cities would be good for the economy.

As it is, we have seen a natural disaster replaced with a man made disaster. Each of the cars that has been scrapped early is an asset with a real value, and useful life. Just as a bridge being destroyed in a hurricane still has an useful potential lifespan, the same might be said of the cars that have been scrapped. Quite simply, the result is just the same.

In some ways it is an identical process to running a production line with a garbage compactor at the end of the production line. As each unit comes off the production line, the compactor simply crushes the item. The result of such a measure would be that the demand for the item might never be met, and the production line would be kept endlessly busy. Output would be maintained, GDP figures would be positive, and the economy would apparently be doing well as the result of this ongoing activity.

What I am discussing is not particularly original, and many other commentators have made similar observations. On this occasion, I am reiterating the point due to comments on my previous post. One of the regular commentators, writing under the name of Lord Keynes, made a robust defence of government intervention in the economy, proposing that governments develop industrial policy. What followed was a heated debate about the relative merits of government interventions, with both sides of the debate arguing their points vigorously.

In light of this debate, the purpose of this post is very simple. I have outlined the principles of a government policy, adopted in many countries, which is just a process of destroying useful assets - governments destroying something and suggesting that this is good for the economy. These governments include the same people in whom Lord Keynes appears to profess so much faith. These masters of our economic destiny actually think that premature destruction of assets is good for an economy. These are people who would count Hurricane Katrina as having had a positive impact upon an economy. Few would say such a thing directly (though I do recall that the Economist magazine came close to actually saying it), but they would see the positive GDP growth from the activity from Katrina as a 'good thing'.

My question is very simple. How can anyone have faith in these people? It is extraordinary that anyone might have faith in people with such bizarre beliefs. Really, can we trust these people with the widespread interventions in the economy, as proposed by Lord Keynes? The very same people who instigated the cash for clunkers policy would be the same people who would devise 'industrial policy'. Lord Keynes is not alone in having such faith in government interventions, and the worry is that those with his views are gaining ground. The advocates of ever more interventions, ever more shift of resource into government hands, are becoming ever more plentiful. That such beliefs are gaining ground is a real cause for worry.

Comments

[notsosmart:]

a lot of europe had to be replaced & repaired after ww2.was this good or bad from an economic point of view? is an forever item bad or good for business? it seems to me that destruction & failure of goods is good if the items have to be replaced.what if we had a forever car? since time began you can destroy in seconds or hours but building & replacing takes a long time.

Nov 15 11:06 AM

[repofinder:]

I've always had a problem with Cash4Clunkers. To me it seems to go against simple supply and demand economics. How can we push all of these new cars into a market already saturated with used and repossessed vehicles (see www.repofinder.com)? Now new cars are worth even less, we have more Americans in debt, and eventually more repossessions

Nov 15 11:13 AM

[Road Runner:]

Cash for Clunkers would be a bad idea during normal economic times because it is a poor use of government money.

But, during this crisis it is a good idea because it causes people to spend money they would not normally spend. For every dollar of government stimulus spent on CashForClunkers, the economy gets some multiple of it in stimulus. It’s an amplified “bang for the buck”.

Anyone who does not understand why government needs to spend now to stimulate the economy to prevent it from spiraling down into a deflationary depression, does not understand economics. A deflation-driven self-reinforcing depression is one of the great "evils" in economics. It has to be studied to be appreciated and greatly feared.

Nov 15 12:55 PM

[Cynicus Eco...:]

Road Runner: You say

"Anyone who does not understand why government needs to spend now to stimulate the economy to prevent it from spiraling down into a deflationary depression, does not understand economics."

You may wish to take a look at a previous post that details why deflation is not an evil of itself. Furthermore, the Austrian school of economics is one which deals with this issue in some considerable detail. I would suggest that, even if you do not agree with the school, it would be difficult to suggest that they 'do not understand economics'. I am not an Austrian myself, but see merit in some of their arguments.

The article I mentioned can be found here:

seekingalpha.com/artic...

More to the point, would you accept the idea of a production line with a garbage compactor at the end of the line. Imagine a product coming off the line, with a value equivalent to the cash for clunkers scheme, and with the same useful lifespan as an older car. Would you really accept the product being compacted?

Notsosmart:

All goods have a lifespan, but destruction before the end of the lifespan makes no sense. The replacement of Europe's infrastructure after the war was not a good thing, as it would have been better if it had never been destroyed. If you were to ask the people who no longer had a house, or whose factory had been destroyed, I think you will find that they would rather that this never took place.

I find it genuinely amazing to see that people believe needless destruction of assets might be a good thing.

Nov 15 01:56 PM

[Road Runner:]

The author said,
>In some ways it is an identical process to running a
>production line with a garbage compactor at the end of
>the production line. As each unit comes off the production
>line, the compactor simply crushes the item. The result
>of such a measure would be that the demand for the item
>might never be met, and the production line would be kept
>endlessly busy. Output would be maintained, GDP figures
>would be positive, and the economy would apparently be
>doing well as the result of this ongoing activity.


But, this is what has been happening to a large part in the private sector for the last 5 years. We have greatly overproduced housing in the US in the last 5 years. But, this extra housing, along with the fact that much of it is expensive and oversized, is a waste of resources just like your imaginary factory that in the final step destroys the product it just created. Much of the housing set idle during this recession, and some of it (even new houses) was bulldozed by the banks because it was more expensive to maintain them than to destroy them.

And, allowing so much money to go to the wealthy in the last several years (thanks to Bush tax cuts which, thankfully, will be rolled back at the end of 2010) leads the wealthy to buy extra houses, to buy multiple expensive vehicles, and to take expensive vacations. These purchases may employ people, but they have no long term economic growth value. From an economic standpoint, this is just as wasteful as your factory that destroys its product in the last stage. These purchases are just “welfare” for the working class.

It’s easier to visualize how a factory that destroys its product in the final stage is a waste than to visualize how a rich person’s third house, that sits idle most of the time, is a waste. That is why the conservative cult gets so much traction among its believers when it rips on government for being so wasteful and praises the private sector for being so efficient. These believers are not thinking through the true economic value of different products. They are only having a naïve, emotional, knee-jerk reaction to the “sound” of issues that is beat into their heads by the conservative cult leadership.

Solid economic theory paints a different picture that is more of a balance between the private and public sectors. The free-market private sector often “breaks down”. The private sector will not take big long-term risks as in developing basic technology or creating infrastructure (like our current electric grid which is in desperate need of upgrade). The private sector will “cherry pick” customers as with insurance leaving the most needy and elderly without insurance. A large private sector and a small public sector creates regular and large boom and bust cycles (study the economy of the 1800s through the Great Depression that was full booms and busts). The private sector will stymie innovation through uncompetitive actions via monopolies, back-room price-fixing agreements, etc. The private sector is not concerned about the “external costs” of some products like pollution from burning fossil fuels. The private sector leads to great inequities of wealth that limits the size of the educated, working middle class. The economic strength of a country is its middle class. The government program of the GI Bill after World War 2 created the educated middle class of the US, and created the great university system of this country that has led to countless numbers of inventions and innovations that made the US the economic powerhouse it is today.

The only counterbalance to these free market “break downs” is the public sector. Sure, the public sector (government) is not an efficient organization, but it is the only alternative.

Nov 15 01:58 PM

[Cynicus Eco...:]

<img class="authors_reply" src="static.seekingalpha.co...">

Roadrunner: You say:

" A large private sector and a small public sector creates regular and large boom and bust cycles (study the economy of the 1800s through the Great Depression that was full booms and busts)"

Take a look at the UK. High government spending and boom and bust. Gordon Brown promised no more boom and bust, even as he increased the government's share of spending. The UK is now facing a fiscal crisis. I am not so sure that 'the solid economic theory' you discuss is so solid. Furthermore, the economic theory you discuss has been the determining the economic policy that led the world into this mess. Perhaps it is time to revise those text books?

As a final note, you have not mentioned whether you would accept the garbage compactor at the end of the production line.

Nov 15 02:10 PM

[Road Runner:]

US Business Cycles:
(from National Bureau of Economic Research)
Years: Pcnt Contraction Months
from Peak Between
to Bottom: Downturns:
1854-1919 (16 cycles) 22 48
1919-1945 (6 cycles) 18 53
1945-2001 (10 cycles) 10 67

Notice how the average depth of the downturns has dropped from 22 percent during 1854 thru 1919 (small, laissez faire government), to 10 percent during 1945 through 2001 (larger and more activist government). The time between downturns has also increased from 48 months to 67 months. This shows how bigger government has greatly dampened the business cycle. Data from www.nber.org/cycles.html for the US economy.

A larger, more activist government does not prevent business cycles, it only dampens them. You are trying to put words in my mouth by saying "High government spending and boom and bust". What I am saying is that this banking crisis would have turned into a multi year depression if it wasn't for the high government spending.

Also, you said "the economic theory you discuss has been the determining the economic policy that led the world into this mess". We have not been living under the economic theory that I discuss. The US government has rolled back many of the protections that were put in place after the Great Depression, such as glass-steagall which separated investment banking from commercial banking.

Also, left unregulated was the credit default swap market. This is the huge market that created the domino-effect collapse of AIG and other banks after Lehman Brothers went under. The credit default swap market allowed betting on the failure of institution, etc. without any relationship with the any relationship to that institution. It was pure gambling. This type of off-market betting was made illegal after the Great Depression. The credit default market should become regulated and visible on an exchange. Another lesson from the Great Depression that was ignored in the lead up to this financial crisis.

Your said, “As a final note, you have not mentioned whether you would accept the garbage compactor at the end of the production line.”. Yes I did answer this question. Wasteful, stimulus-oriented production is good during a severe economic crisis, like now, but is bad during a normal economy that is not dangling on the edge of a deflationary death-spiral depression. Cash for Clunkers in 2010 would be economically dumb because the crisis will be over by then.

Note that I was for bailing out US auto manufactures during this crisis in order to keep people employed. I see Cash for Clunkers as part of this bail-out. But, starting in the second half of 2010, the government should let them fail if they need more money.


On Nov 15 02:10 PM Cynicus Economicus wrote:
> <img class="authors_reply" src="static.seekingalpha.co...">
>
>
> Roadrunner: You say:
>
> " A large private sector and a small public sector creates regular
> and large boom and bust cycles (study the economy of the 1800s through
> the Great Depression that was full booms and busts)"
>
> Take a look at the UK. High government spending and boom and bust.
> Gordon Brown promised no more boom and bust, even as he increased
> the government's share of spending. The UK is now facing a fiscal
> crisis. I am not so sure that 'the solid economic theory' you discuss
> is so solid. Furthermore, the economic theory you discuss has been
> the determining the economic policy that led the world into this
> mess. Perhaps it is time to revise those text books?
>
> As a final note, you have not mentioned whether you would accept
> the garbage compactor at the end of the production line.

Nov 15 10:15 PM

[William Leg...:]

The reason we are in this financial mess is because of free-flowing credit, subsequent market bubbles, stagnant wage growth, and near-zero consumer savings. Now the USG solution is a return to free-flowing credit and artificially low prices thanks to huge taxpayer subsidies, all while the average consumer remains knee deep in high-interest debt, little or no savings, no wage growth (if not wage decline), and imminent risk of unemployment. Yep, "brilliant" move.

Nov 16 01:14 PM

[Road Runner:]

William,

You sound like the Hoover administration after the crash of 1929. They implemented the fiscal and monetary constraints that should have been in place to prevent the 1929 crash. This fiscal and monetary tightening after the crash made the Great Depression much worse.

You are like so many people who don't understand economics. You think there is a “one size fits all” solution to every economic situation. There is not. The economic tools to recover from a deep recession are the exact opposite of the economic tools to prevent, or at least dampen, a coming asset-bubble induced recession. Timing is everything.

It’s just like driving down a road – sometimes you adjust the steering wheel left and sometimes you adjust the steering wheel right. Your focus is not on the act of turning the steering wheel – it is on going down the middle of the road.


On Nov 16 01:14 PM William Legrand wrote:

> The reason we are in this financial mess is because of free-flowing
> credit, subsequent market bubbles, stagnant wage growth, and near-zero
> consumer savings. Now the USG solution is a return to free-flowing
> credit and artificially low prices thanks to huge taxpayer subsidies,
> all while the average consumer remains knee deep in high-interest
> debt, little or no savings, no wage growth (if not wage decline),
> and imminent risk of unemployment. Yep, "brilliant" move.

Nov 16 10:17 PM