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The Cash for Clunkers program sure gave a boost to auto sales (note: the data in the graph is a seasonally adjusted annualized rate)! I'm not going to get into the details of how much of the increase in sales in August was due to the clunkers program; that's not my field of expertise and there are lots of people out there who know how to run the numbers. My contribution to the issue will be to say this: a) there is no shortage of money in the world, since undoubtedly a significant portion of these sales was financed, b) there is no shortage of demand in the world, since there were hundreds of thousands of people who jumped at the chance to get free money from the government, and c) the laws of economics are still viable: by reducing the price of cars, the government's cash giveaway resulted in a huge increase in sales. There's a corollary to this in the housing market: as housing prices have fallen dramatically in many areas of the country, sales activity has soared.
Thus the power of the free market to fix things: if prices adjust to meet new realities (whether by government subsidy or not), demand responds. There is apparently an excess of commercial real estate on the market today, but at lower prices that excess could evaporate in short order. A restaurant might not be profitable given yesterday's rent, but it can become profitable if that rent goes down by enough. Prices can fix all kinds of problems; that's the miracle of free markets. Some people may not be happy when they are forced to sell their goods or services at a lower price, but it's obvious that the buyer is happy with that lower price. When prices adjust to clear a distressed market, economic activity resumes.
9 comments:
Scott,
Here is a link to an excellent letter to Obama regarding healthcare.
http://www.employersforqualityhealthcare.org/learnmore/
"When prices adjust to clear a distressed market, economic activity resumes."
Absolutely right. But when the prices are distorted by Fed or government actions, people undertake projects and do things that will not be sustainable once the government/Fed action ends. This is exactly what happened during the housing boom years, if we recall. Now the same kinds of distortions are being created by artificially lowered interest rates and government spending. The malinvestments will likely be different this time around, but we will once again be setup for a recession.
Talking about the miracle of "free markets" in this context is dangerous. Just look at all these politicos and even "economists" who are saying that our economic problems are the result of "free market" excesses. When the next, and more severe, recession strikes we will hear the same refrain -- and they even have your blog declaring all this action to be a result of "free markets."
Tom: I'm not sure you can say that mortgage rates are artificially low because of anything the government is doing. Mortgage rates are driven by the 10-year Treasury, and that in turn is driven by market forces outside the control of the Fed.
Scott,
that is a shocking statement. The government is directly buying mortgages and through the government guarantee, have essentially backed every piece of FNMA, FHLMC, and GNMA paper.
There would be no other way shotty credit risks could secure a $400K loan with 3.5% down at 5.75% interest.
In addition, this housing binge got started by the government during the Great Depression. They offered cheap loans to stimulate economic activity and quell civil unrest.
On top of that, there is an eight grand tax credit to "new home-buyers". New means not purchased within the past 3 years btw.
How on Earth can you say mortgages rates are not artificially low? Pull out the government and mortgages rates soar which means housing falls off a cliff.
Sorry for the deletes!
Public: I've said before that I don't see how it is possible for Fed purchases of Treasury bonds to make any significant difference to Treasury bond yields or to mortgage yields. Their purchases represent a very small percentage of a gigantic market.
I agree that the policy bias that favors home ownership is a market distorting factor that creates problems. But those problems climaxed a few years ago and now the pendulum has swung so far in the other direction that the best that government subsidies can do is cushion the fall. We're a long way from seeing another housing bubble.
Treasury yields, and mortgage yields, are low because a) inflation expectations are still very low (and deflation fears still surface here and there), and b) economic growth and profit expectations are dismal. All the pricing I see (e.g., breakeven spreads, credit spreads, P/E ratios) is consistent with a very dim view of the economy's growth potential and a real concern about very low inflation.
Only gold at $1000 and the dollar near its lows are contrary indicators. These are confusing times, and fear is still relatively high, so people are willing to pay a premium for the safety of Treasuries.
The mortgage market is the Government. I see no distinction between public and private.
The bailouts proved this perfectly. In fact, you might say the entire market is the government at this point.
This could be one reason the market is sluggish. The tentacles of government are everywhere.
Public: Consider these facts. The liquid broad investment grade bond market is $14 trillion in size. Mortgages make up $4.75 trillion of that, while Treasury notes and bonds are $3.9 trillion. The Fed owns about 0.75 trillion of mortgages, or a little over 5% of the market. The yield on all the securities in the market is driven by the yield on Treasuries. The spread between Treasuries and mortgages is fully consistent with historical norms. I don't see any evidence that the Fed's purchase of 5% of the bond market has created any significant distortions in the market. I don't believe that 5% is a big enough number to distort the entire bond market.
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