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.