Tuesday, July 7, 2009

Used car prices soar

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.


Jake said...

if used cars are substituted for new car purchases AND used cars tend to be significantly cheap than new cars AND less people are employed when people use cars longer and then buy the next used, rather than new... wouldn't this be deflationary?

Scott Grannis said...

You seem to be arguing that if people spend less on cars (buying used instead of new) that would be deflationary. It would be deflationary if car prices in general fell as a result of less demand for cars. But since used car prices are rising and the BLS reports that new car prices are also rising this year, then consumer's desire to spend less on cars is not deflationary, at least in the current climate.

Brian H said...

Have you heard of a Federal bill requiring the Fed to be openly audited and the results made public? Sounds good, but what do you think would be the unintended consequences?

alstry said...

I think the rise in prices also has something to do with the return of money velocity.


Not a chance.

My buddy is in the industry and I have attended used car auctions. And yes, used car prices are WAY UP at the auction. Even big SUVs. But not for the reasons you state.

If is very difficult right now to get new car financing. The margins for used cars are soooooo high that they are self-financed in many cases.

If the car must be taken back, there is enough margin built into the sale to make the deal still work.

The primary reason used cars are selling is because it is very difficult to get new car financing. Plain and simple, and sort of a strange byproduct of the times.

Scott Grannis said...

alstry: Your argument boils down to this: used cars are very cheap relative to new cars. That explains the surge in demand for used cars. We are reversing the slump of late last year which left used car prices way too cheap relative to new car prices. As I'm arguing, the world is returning to normal.

Jake said...

scott- thanks for the reply, but if you want to go by BLS data, it shows new car prices up slightly as you mentioned, but used car prices down more than 3% since December (not an annualized #).

Scott Grannis said...

Jake: The BLS data (May) don't contain the almost 5% nominal rise in used car prices in June, and probably don't contain all of the 2% rise in May.

Scott Grannis said...

Brian: lots of thoughts on this, nothing earth-shattering though. To begin with, audits don't ensure anything. Two, auditors probably don't know much more about what the Fed is doing with its purchases than the Fed does. Three, the public probably knows even less. Four, disclosing some of the loans made to banks might raise suspicions that they are in trouble, thus aggravating the credit crisis. Five, the ultimate audit of what the Fed is doing is delivered by the market and the economy, but only long after the event.

More transparency is probably better in the long run than less. But it doesn't guarantee the Fed won't screw up or that the market won't overreact.

No magic bullets.

Brian H said...