The $3 billion Cash for Clunkers program ends today, Monday August 24, 2009. The US government has repeatedly claimed it to be a success, and the media has done little to investigate this claim. Is it really as successful as they claim? Has it helped the economy?

Certainly the program has been beneficial to automakers. They have been able to sell more cars and make a profit. This came at a critical time when automakers were struggling to survive. Consumers who participated in the program have also benefitted from it. They were able to get up to a $4,500 rebate for a new car.

One might wonder, where is this money coming from? The car dealerships are paying it out of pocket to the consumers. The dealers then file claims with the government for the cars sold under the program, and the government reimburses them. The government, as usual, gets its money from US taxpayers, borrows it from China, or prints it. All methods are effectively a tax on the people.

Like automakers, car dealerships are also making more sales. They will benefit from it when they are eventually reimbursed from the government.

So we have automakers, car dealerships, and consumers benefiting from the program. That makes it a success, right? Well, not necessarily. There are plenty of negatives as well.

Taxpayers are on the hook for these rebates, meaning taxpayers owe nearly $3 billion because of it. The fact that sales surged shows this was not real consumer demand, and thus taxpayers and consumers didn’t feel these cars were worth $3 billion. Even those taxpayers who bought a new car and received a large discount, put themselves further into debt. This is debt that many wouldn’t have taken on otherwise, meaning the government has once again increased consumer debt. Savings, not debt, is a characteristic of a strong sustainable economy.

Car dealerships should be benefiting, but since they haven’t been reimbursed yet and are paying the rebates out of pocket, many are struggling. They may need to make some drastic decisions, such as laying off workers, in order to stay open until they get reimbursed. Many dealers also reallocated their resources, suspending sales early in order to focus on filling out paperwork for the program.

The used car market has suffered due to the fact that the dealers must destroy the cars turned in for the program. This limits the supply of used cars, which results in less choice and higher prices. This has a negative effect on the poor and used car dealerships. The poor generally buy used cars if they’re able, and cannot afford a new car, even with the $4500 rebate.

One potential disastrous effect of this program is the misallocation of resources it created. Automakers were beginning to realign their production to the slowing market and real consumer demand. This program then unexpectedly drove up demand. This caused automakers to increase production of their cars, hire on more workers, and pay employees overtime. This was all done under the assumption that the government would continue the program and thus demand would stay high. However, on Thursday August 20, 2009, just four days notice, the government announced its end. Automakers had anticipated the program to go much longer and allocated their resources accordingly. Even over the weekend, I heard many automaker Cash for Clunker advertisements, and not one mentioned it would end on Monday. This is leaving the automakers with a surplus of cars, too much for the market’s real demand. The cost of production, labor, advertisements, etc is going to burden the automakers as demand suddenly drops.

While Cash for Clunkers was beneficial to a few in the short term, it is negative overall in the long run. The time and energy would have been better spent meeting real consumer demand. The government’s intervention led to the private sector reallocating its resources away from efficiency and real demand, and toward artificial unsustainable demand. This subsidy is like any other, harmful to the economy overall. It’s worse than normal however due to the destruction of the used cars. This combines the harmful idea of subsidies with the broken window fallacy (see That Which Is Seen, and That Which Is Not Seen by Frédéric Bastiat).

“Subsidies…prolong the life of inefficient firms at the expense of efficient ones, distort the productive system, and hamper the mobility of factors [of production] from less to more value-productive locations. They injure the market greatly and prevent the full satisfaction of consumer wants…The greater the extent of government subsidy in the economy, therefore, the more the market is prevented from working, and the more inefficient will the market be in catering to consumer wants. Hence, the greater the government subsidy, the lower will be the standard of living of everyone, of all the consumers.”
–Murray Rothbard, Man, Economy and State with Power and Market (Mises Institute), 2nd ed., p. 1255

Automakers were already struggling beforehand and due to this whiplash in allocating resources are likely to continue struggling. The government stopping the program is a good thing, but its timing will be rough on automakers. Hopefully the government will not restart it again in the future. The fact that the government is stopping it shows maybe they know it’s not so successful like they claim. If it was truly a success and helpful to the economy, why would they end it?

The ending of this program will lead to a drop in market confidence and retail sales. With a medium term view, events like this are likely to cause risk aversion in financial markets. With the large run up in equities recently, expect it to yield a significant drop. The traditional correlation between the US dollar and equities has been a negative correlation, so if that remains the US dollar will strengthen when equities fall. However, we are more biased towards a weakening US dollar, so look for this opportunity to sell the dollar after it has gained strength.