For the video file of this lecture click here.

Cash-for-Clunkers, of course, is the popular term for the Car Allowance Rebate System, which funds down payments of up to $4,500 for new cars if older model cars are also traded in and destroyed.  The program was temporarily discontinued when it ran out of its initial allotment days following its implementation.  Congress refunded the program.

Well, yes, he’s right, I thought, careful not to cut myself.  When you offer $1 billion in free money to people, why was anyone shocked that they went for it?  And if you offer free health care to a supposedly narrow segment of the population that cannot now access it, why do economic planners create budget projections that assume health care demand will remain static?

But that wasn’t what caused me to move the shaver from my face.  That had to do with all of the talk about Cash-for-Clunkers being such a good program.  It clearly isn’t, or at least it shouldn’t be to anyone who remembers the basics of their college economics classes.  From this perspective, there is so much wrong that it’s hard to know where to start.

First, let’s dispense with the notion that this bill had anything to do with improving the environment.  Getting people into cars that get better mileage often leads them to drive more, negating any benefit from the switch.  What’s more, scrapping hundreds of thousands of clunkers en masse while encouraging production of new cars to replace them isn’t exactly an environmental blessing either.

The real purpose of the program is to help car dealers sell off the excess supply of 2009 vehicles that consumers weren’t buying at the prices dealers preferred to charge. Giving people free money to put toward a down payment was a way for Congress to pay back a powerful lobby that produced an unsustainable level of output during the Fed-fueled boom.  It’s reminiscent of those New Deal programs that also tried to thwart falling prices by destroying perfectly good and usable products that otherwise would have lowered prices.  In the 1930s, people rioted when the government forced farmers to pour perfectly good milk down sewer drains.  No one’s rioting today because now the government is more richly compensating those who own the property being destroyed.  (For a fascinating, contemporary account of the Agricultural Adjustment Act and other New Deal programs, see journalist John T. Flynn’s The Roosevelt Myth. For a more-recent account, see Amity Shlaes’s The Forgotten Man: A New History of the Great Depression.)

The result is a situation described by Clemson University economist Bruce Yandle’s “Bootleggers and Baptists” theory for the growth of government.  According to Yandle, government often grows because two otherwise opposite groups are able to join forces to pass legislation that neither would have been able to get passed individually.  His example applied to groups that supported alcohol prohibition: The bootleggers benefited from the outlawing of their “legitimate” competition, and religious groups opposed it as a matter of morals.  When both groups joined forces, legislation became far more likely to pass.  Yandle concludes that dry counties are likely to be Baptist-dominated but also contain active bootleggers comprising its “extra-legal” market.

Applying Yandle’s theory to the clunker program, the bootleggers are car dealers who face low consumer demand and sales revenues at current prices, while the Baptists are environmentalists who believe that older model cars insult Gaia, Mother Earth.  The prospect of an old-car trade-in program unites both groups.

Cash-for-Clunkers, Agricultural Adjustment Act Comparison

That’s not to say Cash-for-Clunkers does not have its share of winners and losers.  Car dealers who are experiencing summer profits are surely winning for now, as are those individuals who otherwise would have gone without a car but can now afford one.  Let’s not forget the banks and finance companies that now have loan assets on their books.  You can be sure the members of Congress who voted for this bill will remind dealers of their generosity in directing other people’s money their way in this old-fashioned shell game.

And it is a shell game, because the losers here are the poor and the lower middle class—the very groups in the most precarious economic shape 18-plus months into the Great Recession.  They suffer in two ways.  First, as primary consumers in the used-car market, they will see supply shrivel.  Many cars that qualify for Cash-for-Clunkers still have long lives ahead of them.  (My 2000 Chevy Astro qualifies for the program even though it easily has another 75,000 miles in it.)  One car dealer in New York—like many dairy farmers in the 1930s—remarked about the immorality of a program that forces him to destroy goods that would otherwise provide benefit to members of his community.

The poor also pay in the form of higher prices resulting from the inflation that will be required to finance the program.  The government is broke, with tax revenues falling while spending soars at levels even higher than those associated with the profligate Bush administration.  In terms of cost, Cash-for-Clunkers is at least twice as expensive as its New Deal inspiration, the Agriculture Adjustment Act  (see table).  This program will be paid for, at some time, with monetary inflation furnished by our not-so-independent central bank, and we will pay for it in the form of higher prices.  This is why inflation is a tax, and a regressive one at that.

Indeed, when I first read about Cash-for-Clunkers, I thought it should have been named the “I Hate the Poor Act of 2009” because—you can be sure—this program sticks it to those members of society least able to thwart it.  In the end they will find maintaining economic autonomy all the harder, making it more likely they will become dependent on government in the future.  The cynic in me wonders if this might be the actual intent.

Nonetheless, Talk Show Guy thought this was a good program.  He liked it!  I bet he got a good deal on a new car too.  Hope he enjoys his ride.

The New Deal did not end the Great Depression. This statement will come as no shock to FEE supporters, but it will to the many people who never encountered it before. Now people are encountering it — in newspaper columns and news-talk shows.

Why, after years of being taught that Franklin Roosevelt’s economic intervention saved the country from disaster, is the general public now being told — by FDR fans, not critics — that this is not the case?

It’s the Rooseveltians’ way of helping President Obama get over any fear he has of deficit spending. Paul Krugman, the newest Nobel laureate, a Keynesian, and a New York Times columnist, is explicit about this. “[H]ow much guidance does the Roosevelt era really offer for today’s world?” Krugman asks. “The answer is, a lot. But Barack Obama should learn from F.D.R.’s failures as well as from his achievements: the truth is that the New Deal wasn’t as successful in the short run as it was in the long run. And the reason for F.D.R.’s limited short-run success, which almost undid his whole program, was the fact that his economic policies were too cautious.”

By “too cautious” Krugman means that FDR’s deficits were too small. Roosevelt ran deficits (except for one year), but they were about the same size as those run by his predecessor, Herbert Hoover. Roosevelt’s biggest deficit, in 1936, was “only” 4.4 percent of GDP, Jim Powell points out in FDR’s Folly. Both Hoover and Roosevelt were big spenders — FDR doubled spending by 1940 — but they were also big taxers, which kept the deficit from growing. This is confirmed by University of Arizona economist Price Fishback, who wrote, “Once we take into account the taxation during the 1930’s, we can see that the budget deficits of the 1930’s and one balanced budget were tiny relative to the size of the problem….”

Roosevelt was quite a tax enthusiast. He levied or raised taxes on liquor, tobacco, gasoline,  corporate dividends, estates, incomes (top rate 75 percent versus Hoover’s 63), “excess” profits, and undistributed profits. (The last tax was repealed in 1939.) And then there was the payroll tax that came in with Social Security. All in all, the New Deal more than tripled the tax burden from 1933 to 1940: $1.6 billion to $5.3 billion. Serious deficit-spenders don’t raise taxes. But Roosevelt did. Is it any wonder that net investment dropped $3.1 billion during the decade or that unemployment was about as high in 1939 as it was in 1932?

Would Bigger Deficits Have Worked?

This raises the question of whether big-time deficit spending would have ended the Depression. Krugman and others think so. But how could it? Deficits are financed either by borrowing or by creating money out of nothing. When the government borrows money, that’s money no one else can borrow and invest. Where’s the gain? Moreover, the money is put to purposes selected by politicians, not entrepreneurs trying to please consumers.

When the government creates money, three things happen. First, the new money lowers interest rates below the level justified by society’s time preference; that produces perverse incentives to invest in longer-term projects far from the consumer-goods level. Second, the money early on changes relative prices (rather than raising prices evenly) because particular economic interests get it sooner than everyone else. Third, prices later rise generally, reducing everyone’s purchasing power. The result is a distorted structure of production and a boom that is unsustainable because it’s based not on real savings but on fiat money. When the inflation stops, the bust follows.

Since the New Deal didn’t end the Depression and a New Deal on steroids wouldn’t have done so, President Obama should pay no heed to Krugman and his Keynesian economic advisers. The way to wake up the economy is reduce the total government burden on producers and consumers by, among other things, slashing spending, taxes, and borrowing.