One clunker of an idea

I usually try to stay away from political commentary, but the “cash for clunkers” idea needs to be addressed from an economic standpoint.

If you haven’t heard about it, the “cash for clunkers” program gives cash to people who trade in their low mile per gallon vehicles to purchase newer, higher mile per gallon vehicles. From the way I understand it, you get $3,500 to $4,500 (depending on the mileage of the vehicle you purchase) for “cashing in” your “clunker.”

Now, let’s trace this idea from beginning to end and understand what’s going on. The government is paying people cash to throw away functioning cars. Where does the cash they are giving away come from? It comes from issuing government debt.

That means the government is raising money from someplace (China, Japan, Middle East, U.S. investors) that would otherwise have been invested in some other way, and using it to pay people to throw away functioning cars. Why?

(I’m sure it has nothing to do with the fact that the U.S. government has become a huge investor in Chrysler and GM. Note: I’m being sarcastic).

One reason is that most economists look at economic growth in terms of new things being sold instead of return on investment. Gross Domestic Product (GDP), which is the figure most economists and government employees watch, will show an increase because of the cash for clunkers program. GDP increases whenever things are sold, the government spends money, or we export more than we import.

Using this magical math, the economy grows any time consumers or the government spends, whether or not that’s positive return on investment spending.

But, let’s think further about this issue. Say you buy a car because of the cash for clunkers program. Because you are now making payments on a new car, and those payments are almost certainly higher than the payments on your clunker, then you have less money to spend on other things. In other words, spending has simply been taken from one place and put in another. GDP will show a spike because you spent a lot money today on a new car, but then you’ll have payments plus interest in the future which you can’t spend. Is that positive return on investment growth? Not likely.

Plus, the government has incurred debt to finance this spending. That won’t show up in GDP figures, so everything seems peachy. But, borrowed money needs to be paid back, with interest, and where will that money come from? It’s simply been borrowed from the future!

When I make an investment, the issue isn’t just: does growth occur? I must get a return on investment more than what was put into it.

Suppose I bought a company for $100,000 and had to put $10,000 into it in the first year. Suppose I only netted $5,000 in earnings. No one would consider that a wise investment. Suppose I put $15,000 into the business the next year and made $7,500. That would be growth, right, from $5,000 to $7,500, but I don’t think anyone would rejoice in putting in $25,000 and getting $$12,500 back over 2 years.

So, why would someone consider it a good investment to borrow money to pay people to buy something they don’t need? I don’t get it.

By such reasoning, it would make sense to burn down all the houses in my neighborhood so we could spend money to build new homes. If that’s considered economic growth by someone, then cash for clunkers makes sense.

But, to me, it doesn’t.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Economists are like diapers

Economists love to make forecasts. The problem is: most economists are like diapers, they require frequent changing and for the same reason (i.e. they are full of crap). Don’t spend too much time thinking or worrying about economic forecasts, they are seldom if ever right.

This may seem like an overly harsh judgment, but I cannot think of any profession that has a worse track record (even politicians seem to do better, and from me that’s quite a concession).

Most economists are either from or in academia. Their focus is on an other-worldly fantasy that has few similarities to the world we live in. Not surprisingly, this ivory tower approach leads to terrible forecasts.

You would think this would bug economists, but it doesn’t. Most seem quite happy to profess theories based on assumptions they will gladly admit are false. They are more concerned with theoretical elegance and mathematical precision than with accurately predicting reality.

One school of thought is that markets are always efficient–they are always rational in the sense of an unemotional investor with all the facts at their disposal. I don’t know any unemotional investors, and any experience with markets would quickly convince any honest person that markets are not rational in the short term (though they definitely are over the long term).

Another school of thought is that markets are irrational and thus require government intervention. But, if the human beings in the market are irrational, what prevents government employees–also human beings as far as I know–from not also make irrational decisions in their intervention? No answer is given.

Another school of thought is that the government printing money can solve bad lending. But, if printing money fixes problems, then why not just print it all the time and make everyone happy always. Sounds like a perpetual motion machine to me (more accurately: hyper-inflation).

Another school of thought is that the government can cut taxes while continuing to spend recklessly. But, if it’s dumb for an individual to spend beyond his means forever, why would it be smart for a government to do so? Because the government exists on another plane of reality?

Another school of thought refuses to make precise predictions because it acknowledges the impossibility in the realm of human endeavors. Paradoxically, this seems to be the only school that correctly foresaw the Great Depression, the inflation of the 1970’s, the Internet Bubble, and the Housing/Credit Bubble. No one listens to this school, it’s considered fringe by many, and is taught in only a handful of colleges (Auburn is one).

Next time you hear or see an economist make a prediction–on the radio, in print, on TV–keep in mind the field’s lousy record. Remember they are mostly academics with little success in predicting real world events.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.