Used Car Market Looks Strong

by: Calafia Beach Pundit

Mark Perry has some color commentary on this, but I'll add the observation that used car prices have rebounded to pre-recession levels in a very short time frame: just 22 months. Looking back at the 2001 recession, it took 54 months for prices to recover to pre-recession levels.

That's amazing, since the 2001 recession was far milder and shorter than the recent recession. But it highlights another important fact, which is that the 2001 recession was a classic, monetary-induced recession, whereas the recent recession was a financial-crisis-induced recession. Going into the 2001 recession, Fed policy had been extraordinarily tight for several years: real interest rates were unusually high, commodity prices and gold prices were falling, the dollar was very strong, and inflation was relatively low. The recession we have just come out of was quite different, since the Fed had not been very tight: real interest rates were relatively low, commodity prices and gold prices were quite high, the dollar was very weak, and inflation was rising. Plus, the Fed has been extraordinarily accommodative during the last half of the recent recession, displaying a rare, aggressively proactive stance.

Even though the economy has suffered through a deep recession lasting some 18 months, leaving a so-called "output gap" that is unusually large (i.e., lots of excess capacity), prices for many things (e.g., commodities, used cars) are rebounding in an impressive manner. This suggests that the Phillips Curve/Output Gap theory of inflation is on increasingly shaky ground, whereas the monetary theory of inflation is doing a much better job of explaining the facts. (More on this in an earlier post here.) It also suggests that the Fed, a long-time believer in the former theory, is likely to underestimate the need for tighter monetary policy, thus moving slowly to tighten policy and increasing the risk of rising inflation in the years to come.

The rapid recovery of used car prices also suggests that the economic recovery could be a lot stronger than the consensus view, which calls for a very slow and painful recovery. I've been feeling quite uncomfortable calling for a sub-par recovery, since that leaves me smack-dab in the middle of the consensus. Maybe I should be more optimistic.