Markets were back in rally mode yesterday. The Dow Jones climbed by more than 100 points and the FTSE 100 managed to clamber back up to just below its 2009 high.
As Crispin Odey put it in the Financial Times last week, this is a “rational bubble”. Western central banks are effectively getting their cattle prods out and forcing people out of safe assets and into risky ones by slashing interest rates and printing money.
Of course, that means you’re reliant on the government continuing to prop up the economy. And that in turn means you’re relying on outside investors not to lose faith in governments (as the state of sterling right now shows, this isn’t something you can take for granted – but there’ll be more on this in tomorrow’s Money Morning).
The real test will be when the economy has to stand on its own two feet. But governments will put that moment off for as long as they can…
The car scrappage scheme isn’t as good as it seems
The trouble with using injections of money to cure an economic downturn is that it’s pretty addictive stuff. The flood of money appears to make all your problems go away and you can ignore all those nasty, messy structural issues that you need to sort out to genuinely make things better.
Cheap money solutions feel good at the time. And that’s why politicians love them. The threat of pain, even for long-term gain, doesn’t win votes, or so politicians believe – so they’ll keep going for the short-term boost every time they can.
So it’s small wonder that one of the main news points coming out of the Labour party conference yesterday was about more ‘stimulus’. Peter Mandelson declared at the Labour party conference that the car industry will get another £100m worth of ‘stimulus’ – partly taxpayer funded – as the scrappage scheme is extended. It’s good news for car dealerships – although second-hand car salesmen and mechanics might not be quite as pleased.
Is car buying really the best use of public money?
In case you hadn’t heard by now, car scrappage is the new path to economic nirvana. You take a perfectly serviceable old car and junk it. You then take a portion of the earth’s valuable resources and turn them into a new car to replace the old one you just junked. Add a dash of government spin and you have a process that is somehow presented as both economically sensible and environmentally friendly to boot, even although it is clearly neither.
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But because it has pushed up car sales figures across the globe, making economies look that little bit healthier than they otherwise would, governments are in no hurry to abandon this particular stimulus package. And so, as David Wighton says in The Times, the real surprise is not that the government has promised more money to the scheme, but that “the pound didn’t fall further as the news leaked out. What clearer evidence do international investors need” that the Government has no intention of repairing “the wreckage of the public finances?”
But no need to worry about that, say its supporters. The great thing about the scrappage scheme is that the Government actually makes money. No really! The Government is giving a £1,000 subsidy to the buyer of the new car, but it gets 15% VAT on the sale. So if the car costs more than £7,667, then the taxman makes a profit on the sale. As the car industry reckons that the average price of a car in the scheme is £9,000, then that means the Government is quids in.
So it’s a win-win then? Of course not. For a start, as Wighton points out, “the scheme is merely bringing forward sales, which means that when the subsidy is withdrawn there will be an equivalent drop in VAT.” Effectively, all the government is doing is cutting its profit margins on car sales. When your profits fall, that usually means you need to cut your costs too. The money being spent to subsidise the car industry means less money to spend in other areas – or more money being bled from taxpayers to fund it.
Taxpayers’ money is there to pay for public goods that we as a nation, if you like, broadly agree we should club together to pay for. You can find plenty of debate over how much we should be paying, and in what way we should foot the bill, but most people agree that things like health care, a police force, and an army for example, are public goods. When you put it like that, is subsidising someone else’s new car purchase really the best use of public money?
The global car industry is too big
At some point, the global car industry will have to face the fact that it’s too big. Putting this moment off with public money only means that we’ll be that bit deeper in debt and less well-equipped to cope when the day of reckoning comes.
And with sterling looking distinctly wobbly, that day may come sooner than we’d like. We’ll have more on the woes facing the British currency in tomorrow’s Money Morning. As for where you should be investing to diversify out of sterling, there are plenty of places that we like. We’ve been fans of Japan for a long time of course, and Asia in general looks far healthier than the West (you can read more on investing in Asia in our free weekly email, MoneyWeek Asia). But there’s at least one Western economy that looks pretty good to us too – and we’ll be taking a detailed look at it in the next issue of MoneyWeek, out on Friday. If you’re not already a subscriber, get your first three issues free here.
Our recommended article for today
Should you get back into the market?
A lot of people who got out of the stockmarket when it crashed have yet to get back in. But many of them are
now looking longingly at this bear market rally. That’s a mistake, as Merryn Somerset Webb explains.