Syntactical corrections for government mandated bailouts are usually required because such programs usually say one thing and deliver something quite the opposite. That notion is true for the “Cash for Clunkers” program in the US government, which has had the effect instead of delivering Clunkers for Cash.

The difference in the syntax is of course to suggest that what started as a move to get old cars off the road has instead turned out to be a case of putting good money after bad. Another nail in the Keynesian coffin from where I stand, but that’s getting ahead of ourselves.

Late on Thursday, the US Congress decided to extend its Cash for Clunkers program by adding to it a further US$2 billion. The idea of turning old cars (“clunkers” in the American vernacular) to get cash that can be used to fund new car purchases has clearly caught on; and nowhere more so than in the case of General Motors (GM), the car company that is now majority owned by the US government and trade unions.

As of the beginning of August, 18.7% of the clunkers were GM vehicles essentially flattering the company’s car sales; while Toyota came to second position at 17.9% and Ford a distant third. Despite the help provided to American carmakers, 47% of all clunker deals went to these companies, which also includes Chrysler; Japanese companies benefited but not as significantly.

Looking at the government-mandated-program itself, there were a total of over 184,000 clunker deals, costing the taxpayer $775 million in all. That works out to $4,200 per clunker – an amount that is likely far in excess of the actual value of these cars; used car sellers would have been happy to get rid of quite a few of them at $1,500 for example. In effect, the program counts as yet another subsidy being provided by the US government, but perhaps without much regard for the consequences.

Sure, the US isn’t the only country to have suggested or implemented such a program. Many others, including Japan, South Korea, Germany, the United Kingdom, Spain and France have versions of the same program, albeit with different details, including the “nationality” of the car company in some cases. The American program is fairly straightforward in that it doesn’t overtly target for assistance American carmakers, but that isn’t necessarily by design (or intent) either.

What are some of the other consequences of the program, besides the obvious fiscal hole that is being dug at great cost to the American taxpayer?

1. Higher prices for “lemons”: The extension of the program suggests that the US government has driven into yet another temporary arrangement that quickly turns into long-term policy. If the public expect the program to continue indefinitely, the net effect will be to increase the price of old cars that are frequently inefficient and unreliable (an old rule of thumb has it that cars lose about 2%-5% fuel efficiency every year). In turn, this means that the decision to buy a new car becomes more difficult if one has a three-year-old car that isn’t eligible for the program but is otherwise useless.

Overall, it is quite possible that the pace of new car sales will reduce in America as a direct consequence of this program: an unintended consequence if there was one. Secondly, the government program will be scrapped if ever a Ron Paul-type figure (that is, a sensible, Austrian economist-minded person) enters the White House and when it is, the entire “assumed value” of cars in the US will be proved incorrect.

2. Penalizing higher-quality car makers: The average American car has poor reliability compared with the average Japanese or Korean car, leave alone the hordes of more expensive European cars. I know people who have had their Toyota Land Cruisers for the better part of the past 25 years (although why anyone would drive a Toyota is beyond the imagination of a car snob like me). None of these people would want to exchange their cars, especially after paying more as compared with an equivalent American car in the first place. The net effect of all this is that higher-quality manufacturing actually could suffer a setback as a result of this program and particularly if carmakers start working towards a seven-year lifespan.

3. Financial trap persists: The idea of getting debt-addled Americans to visit showrooms and exchange their clunkers for cash and perhaps leave with a new car that usually carries a new debt burden is singularly irresponsible. Instead of encouraging Americans to cut their overall debt load, the government appears to be encouraging a new round of binge borrowing on the back of what are essentially false assurances of future values (as above).

4. Raft of unintended consequences. There are many other unintended consequences of the program, ranging from the prices of scrap steel to the use of old parts from clunkers (other than the engine units which are rendered unusable by the injection of sodium silicate, prices for which have jumped significantly since the program began). So the next time your garage replaces your shock absorbers, the question cannot be far from the mind – “is that from one of those clunkers”?

Bailout parallels

The notion that governments can influence the course of consumer purchases is of course erroneous in the long run and that is precisely why bailouts do not work. One of the more persistent discussions by lackeys of governments in Britain, France, Germany and the United States of late has been the apparent “return to profitability” of institutions that were bailed out by government. Be it the banks in Britain, industrial companies in France or automotive companies in the US, bureaucrats are going blue in their faces explaining the financial recovery of the firms in the first half of the year.

In my previous article this week (see Faith-based Investing, Asia Times Online, August 5, 2009), I covered the point about erroneous analysis and valuations of stocks and earnings. Keeping those comments in mind, there are a few other observations that are pertinent here:

1. Robbing Peter to pay Paul: In most cases of government bailouts, we have seen a radical shifting of previously well-held principles. For example, the US government rescue of GM led to the destruction of creditors’ rights as well as the closure of a number of auto dealerships outside their contractual terms. The positive effect of these moves helped or will help to flatter earnings going forward for such companies; optically providing profits in the case of GM but not so when the losses of creditors and auto dealers are also accounted for.

2. Continued capacity: Whether it is the useless industrial companies of France or the banks in the United Kingdom, disallowing the diminution of capacity that is an essential pre-condition to the return of sensible margins only helps to perpetuate the unstable equilibrium that existed in the first place. That in turn disallows the more important technological and structural reforms that are required in many of these economies.

3. Higher prices: Overall, the profits of bailed-out companies come from their ability to charge prices that are otherwise unlikely. British banks for example have expanded their loan-deposit interest margin since they were bailed out, an ability that they previously lacked because retail depositors had been more choosy (but have consolidated after the government takeovers and guarantees).

On the other side, the banks have been choosy about lending funds, and charged vastly more for their transactions because private-sector players were more conservative. To some extent, this falls back in the “rob Peter to pay Paul” angle above, but also highlights the data dissonance (for example, higher prices of certain items) that will seep through, in turn providing more confusion on macroeconomic data.

4.Core problems unfixed: The government bailouts haven’t fixed the core problems of the entities. British banks still don’t seem to know how to lend money, racking up significant loan losses in the first half of the year; GM car sales were down 19% in July as another example. If such entities – banks that don’t know how to lend profitably, and carmakers who can’t sell cars except with special deals – survive, long-term economic efficiency reductions in turn have implications for broader growth considerations.

Those who can, pay

By far the worst implication of the existence of these bailed-out companies is that companies and individuals who behaved responsibly effectively have to lose by the following additional costs:

1. Higher taxes – most countries that have bailed out parts of their economy are now embarking on higher tax rates (Ireland, the United Kingdom, France and so on), which hurts the people with the highest disposable incomes the most.

2. Lower choices for various products as programs such as Cash for Clunkers eat into consumer choice and perpetuate sub-optimal products.

3. Higher prices for various products and services as the true cost of government bailouts usually translate into lower production and service efficiency in the long term

4. Lower income from banks (as interest rates were cut to zero) means a greater need to speculate than is strictly warranted at this stage of the recession.

Damps the holiday spirits, doesn’t it?

https://web.archive.org/web/20090910041415/http://www.atimes.com/atimes/Global_Economy/KH08Dj02.html