Econbrowser

JDH: As a heads up, the U.S. production rate for autos is going to slow down even more in December. A number of Tier 1 suppliers for U.S. automakers are going to suspend production for the year as early as next week. Without the inflow of parts, the OEMs will follow shortly after.

By contrast, "normal" would be to shut production down only for the last week of the year (from December 24 through January 1, coinciding with the holidays).

Unprecedented would be the correct term.

The interesting thing to me is that Honda and Toyota took a big hit as well. Combine this with the yen trading at 92 to the dollar as we speak, and they have to be taking an enourmous hit to earnings.

Everybody is concerned with Detroit, but Detroit more than likely is getting bailed out. What are the prospects for the Japanese transplant operations? Like, for example, that big, new Toyota Tundra plant in Texas.

OTOH, if the yen keeps dropping, maybe it makes sense to shift more operations over here. What would it take for Honda to become an American company? Move the corporate headquarters to Ohio and list on the NYSE?

Declining market share for the big three has been a reality for years - regardles of who is the CEO.

Legacy costs and hubris are part of the picture. Another part of the problem is the role of the U.S. stock market. Every quarter the stock market gives the CEO a grade, shares up or down, depending upon the profits reported that quarter. Ownership response dictates the short term focus of the CEO's and the companies.

Japan and Germany have a more complicated ownership structure. Is it better than ours?

Another part of the big picture which should not be ignored is the role of the government of Japan and Germany in structuring their tax system and other governmental actions to support exports. Imports are discouraged by a tradition of excellent domestically produced products. Germany also has a tradition of refusal to lower interest rates, which discourages comsumption, which discourages imports.

These issues (short term focus from the stock market, trade policy and policy to stimulate consumption) influence all U.S. manufacturing activities. The automobile industry is merely the most visible.

It's basic retail. If you have a sale people will buy. If you have a great sale you will get people who were going to buy, but not yet. If you have a really great sale and offer special financing, cash back and MEW $$, even people who where not going to buy, buy. At some point, now, you have no one left that needs to buy or can afford a new vehicle.

If you look back over the last 3-5 years this has been going on, in some form, almost no stop. Add in the lack of leasing and fleet sales to rental companies this is what happens.

I owned a small retail SCUBA business years ago and had to deal with this very very basic retail fact.

PS

It's was interesting to me that the Mitusbushi did this but not the other foreign car makers, but they are trying now. I think it's too late for any big moves, even for them.

As a followup to Buzzcut, why not just let the US manufacturers declare bankruptcy and be taken over by the Japanese. They are much better at producing and selling cars so the transition would be virtually seamless with minimal loss of jobs or production. It could be done without shutting anything down. All it would do is restructure their debt and bring in good management.

Time to start looking at the parallels with the Lesser Depression, Professor.

I'm in the middle of 'Manias, Panics, and Crashes,' and I read that in '30, industrial production dropped 30% or so in six months or so.

This drop in auto sales sounds a lot like that.

Greater Depression, here we come.

Outside of PCguy, I think all of you are missing the point. Car sales are down because debt is way up. Detroit, Japan and Germany sold 2008/2009 production in 2004/2007. High debt and no income growth is not sustainable and has to end consumption, PERIOD.

Just a note about the $38.7 billion that GM "lost" last year...

They didn't actually lose $38.7 billion, they simply lost that much in claims on future tax benefits. Kind of like when you invest in a stock and lose money, you get a capital loss, with which you can average with your actual gains to reduce your tax burden. Since the capital loss actually has a value equal to the tax savings rendered, those "tax deferrals" need to be added to the balance sheet.

Due to accounting rules that stipulate how long you can carry over those tax shelters, GM had to write most of those tax shelters down since they didn't have the hundreds of billions of dollars in profits to utilize those tax shelters.

They actually only had a operating loss of $23 million.

Of course, in 2008, they might actually lose $38 billion based on operations seeing as how things are going...

I am no GM booster, but that widely quote 37 billion dollar loss needs to be explained a little better by the people citing it.

Imports are discouraged by a tradition of excellent domestically produced products.

Now, this is a strange sentence. Germany is a more open economy than the US, so what you write is basically: We can't compete.

Germany also has a tradition of refusal to lower interest rates, which discourages comsumption, which discourages imports.

Higher interest rates increase the value of the DM/Euro and those make imports cheaper...

Assisting the Poor and Middle Class by Clearing the Air and Assisting Auto Companies

The glut of cars in the U.S. provides an opportunity to remove old polluting cars from the roads and help the working poor and middle class. France recently bought old cars from owners to permanently remove them as a way to improve air quality. Unfortunately older cars are owned by people who cannot afford to replace their cars with newer models. So the impact of a government purchase program is limited, especially in suburban, exurban and rural regions of the country where mass transit is not available.

The auto industry is overloaded with new and used cars that it needs to sell. Every day the value of these cars is falling and prospects for selling these vehicles are dim. What if people could trade their old (ten years or older) cars in for a used (5 to 7 years old) car? That would allow owners to continue to drive, but would take the polluting cars off the road. These polluting cars would have to be destroyed and materials recycled. Title transfer would be to owners or the financing company of the old car. Although the value of the car will go up, payments will not increase and interest rates will fall under federal guidance for financing companies that participate in the program.

The federal government could also create a second tier subsidy for owners of cars 5 to 7 years old, allowing them to trade up for a new car much like a rebate. Government would pay the difference to the dealers. The auto industry would do its part in reducing the base cost of the cars to the dealers, who would have to operate on a lower margin to make the project successful. This program would have a 12 to 18 month lifespan depending on the state of the economy. This program would allow the auto industry the time to retool for green transportation.

Auto companies and dealerships would receive tax credits on a portion of their lost margins that would not expire for several years, which would help them as the economy recovers in the future.

It’s apparent that this program will cause price distortions in the auto markets, but it would be temporary; the current auto inventory would disappear and the air quality would improve.

Professor,

You said "I believe that lost income and jobs in the auto sector tipped the U.S. economy into recession this summer,..." But the recession is now said to have began in December of 2007, when sales were only moderately lower than the previous year. Isn't it more likely that the plunge in auto sales this year is more of an effect than a cause?

JDH wrote...

As a heads up, the U.S. production rate for autos is going to slow down even more in December. A number of Tier 1 suppliers for U.S. automakers are going to suspend production for the year as early as next week. Without the inflow of parts, the OEMs will follow shortly after.

By contrast, "normal" would be to shut production down only for the last week of the year (from December 24 through January 1, coinciding with the holidays).

Unprecedented would be the correct term.

I have sold parts into the automotive supply chain for close to 25 years and I can't remember a time where the lower tier suppliers dictated to the upper tiers (in this case tier 1 to OEMs) when and how long there is a shutdown EXCEPT when there were strikes at key suppliers.

Usually if a lower tier shuts you down - they pay stiff penalties... in some cases as high as 'thousands of dollars per minute'.

Dr. Hamilton - is there more to this story you can share with us? I am just stunned.

I think this has a silver lining.

1) The auto industry will be forced to improve its products dramatically.

2) This keeps oil prices low.

3) People are making older cars last longer, which is ultimately better.

Dryfly: That comment was from Ironman, not me.

Foreign automakers have a protected market at home. This is issue number one.

They also have a state medical system that provides health care at a much lower cost (about 1/3 the cost, actually), making their corporations more competitive.

Automobile companies are allow to ‘cooperate’ with suppliers in ways that are forbidden here in the US.

The unions overseas are strong, but seem to work with the companies more than here in the states to keep the corporation competitive. They have seats on the boards, for example.

Also, the VAT tax system gives preference to exports.

The cheap gas here in the US is a disadvantage in that US cars can't be sold overseas due to heavy gas consumption. Fact is, Ford and GM sell OK in Europe, but they are not the same cars so there is no economy of scale.

Dryfly: That comment was from Ironman, not me.

Sorry - saw the lead (JDH) and thought it was you.

Ironman - link please? If true that is a bigger story & more indicative of just how bad things are than the slow sales story alone.

Anyone have more details?

Buzzcut: That Toyota Tundra plant has resumed new production, but at a much lower rate than previously.

Their plans are to consolidate their North American production of the Tundra/Sequoia at the Texas plant. That's bad news for New Jersey, good news for Texas. Note the relative attitudes of the respective state governments toward business in general in both places.

I am no GM booster, but that widely quote 37 billion dollar loss needs to be explained a little better by the people citing it.



I thought the same as I read it. I was short GM at the time so I'm no booster either. In fall 2007, GM lost $39B, taking a ~$40B charge for taxes. From GM:



Special items included a net non-cash charge of $38.6 billion due to a valuation allowance against deferred tax assets related to operations in the U.S., Canada and Germany as required under SFAS No. 109, Accounting for Income Taxes.

Fixed costs and an inflexible labor force leads to overproduction. Overproductions leads to overfinancing. Overfinancing leads to bankruptcy.

Long form:

Pretend you have a company with 100 employees, each of them making 1 car a day. You put out 100 cars a day and they sell.

Now, someone new moves into town and starts selling 4 cars a day. Your market doesn't really need 104 cars a day, they only need 100. But you can't fire your bottom 4 employees without paying them 90% of their salary, so you might as well keep them on and have them make cars. Even though the market only needed 100 cars, you still find a way of pushing those extra 4 cars out every day. Fleet sales, giveaway, contest prizes, what-have-you.

Gradually the market becomes saturated with your cars from all the extras you were giving out. The resale price of your cars totally sucks because of all the extras dragging down the value. So you need to cut back a little bit more, to 94 cars a day. But you still don't because of the same issues. Oh, and the new person in town is now selling 6 cars a day, so you really need to cut your production rate down to 92, but you stick at 100.

So you stuff your channels more and more. As PCguy said, you borrow sales from the future by having awesome bargains today. And when the future gets here... um, now what?

Well, now you give financing to anyone with a pulse. And when they come back into the office three years later and are $6,000 upside-down on their existing car? Hey, you just roll that into a brand new car loan.

Then one day you cannot sell on credit.

Does the december data look suspicious to anyone? 3 years, exactly the same number? WTF?

I would assume the jump in light truck sales each December over the last several years was tax motivated: any small business person can expense the cost of a commercial vehicle (truck, which due to contrivance includes SUVs.)

Because of falling income and greater anxiety, it's probably reasonable to expect the tax effect to be negligible this year, so the yoy numbers for December could actually be much worse.

JP: Actually, they're not quite the identical number, just look that way on the graph. Here's what Wardsauto reported for Dec 2005, 2006, and 2007 respectively: 436.7, 436.8, 437.6.

Thanks JDH. I'm still suspicious though. Dec is higher than either Nov or Jan, and is spread by +/- 0.1 % or so.

I would suspect that somebody's bonus structure or securities are tied to increasing sales in that month. But maybe I'm just too suspicious.

Where's my hybrid minivan? I'll buy it right away...

Oh, they don't have them in the U.S., do they?

And they wonder why they can't sell anything right now... maybe they need to make what people really want, instead of trying to sell us whatever they happened to make.

dryfly: If you follow what the OEMs have announced with respect to when they'll suspend operations at various facilities, back out about a week from that and apply it to the Tier 1 suppliers that supply them. I'm afraid I cannot be more specific at this time.

"The wrenching changes that might be immediately ahead could mark the beginning of a frightening new phase in the economic downturn." from the ordinarily careful, conservative and understated JDH...don't expect me to leap in here with the details of that new phase.
I know a vacancy when I see one.
No, I feel compelled to go back over the bar graphs and look for any upward signals...any less downward signs then...
This B it: the unstated return to public transport and social interaction that comes from riding the bus (even if it is a seat battle), that is the intimacy, however harsh, needed to break though the encapsulation and irresponsibility and insanity you get from bouncing down the road in your F150.
Sometimes a wrenching change is a good change.

"I believe that lost income and jobs in the auto sector tipped the U.S. economy into recession this summer (2008)".

-----------

1] The economy has been in recession since November 2007.

2] No home equity growth + no buying power growth = no consumer credit for car loans

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This is the driver of the off-the-cliff drop in car sales. Consumers cannot rent cash to buy cars.

The mismanagement of GM, Ford, Chrysler as well as the misallocation of capital to these companies for their overpriced generic cars is a separate problem from consumers lacking rented cash to buy cars.

The U.S. car makers have lost the competitive advantage to manufacture cheap, generic cars.

Thus, the per car costs that support union labor is too high, unrealistic in fact.

Ford, GM, Chrysler executives and investors must get out of the generic car business and into specialty cars á la BMW, if they want to make cars on American soil.

One consequence of the end of the auto industry: cars will be a lot more expensive in the future.

Look at the cost differential between, say, a Ford Focus and a Honda Civic. The Civic is much more expensive that the Focus. 15% or more more expensive.

Now, take away the Focus from the market. What's going to happen? It's just supply and demand.

There is a massive over capacity in auto manufacturing and has been for years. Overcapacity is a normal thing to have happen in capitalism. A bunch of companies (and countries) competing to stay ahead of each other, without regard for the big picture. This is taken care of by crashes (depression), relentless expansion (British Empire, China's interior ?), or war (WW 1 or 2).

A big part of the problem is that the average American simply can't AFFORD most of the cars being made. A typical family sedan is $25K these days, and many SUVs are in the $30K-$50K range.

Before the economy crashed, dealers enticed people to overspend, but reality has hit home and Americans are now distinguishing between WANTS and NEEDS. Even when the economy picks up, I don't think as many middle-class folks are going to go back to buying a $25K car every 5 years.

I bought a Honda Accord new in '94 and am still driving it. I have great credit and no consumer debt and can easily AFFORD a new car, but I'm simply don't WANT one enough to pay $25-$30k.

There is another reason why there is a massive overcapacity in car manufacturing: It's cheap (or more precise, it is only a small share of the total costs)!!

Final assembly of the car is only around a $1000. That is only a small share of the total cost of a car and it includes variable costs like overtime, the paint, etc.

I agree with anonymous.

I drive an 11 year old car. I spent *way* to much on it 8 years ago. I simply cannot face spending 50% more for a not-quite-as nice *used* version of the car, much less %100 percent more for a new not-quite-as-nice new version. It freaked me out even thinking about it last summer (2007), before the excrement hit the rotating oscillator.

I remain unconvinced that a bailout to maintain the current structure of the U.S. auto industry is a good way to spend money.

JP: My father (self-employed electrician) has bought 4 new service trucks in the past 18 years. He bought each of them in Dec. For self-employed folks, particularly those who have extremely variable income, can use accelerated depreciation, can't income average, and have such variable income that they routinely move between tax brackets, this is an important tax management strategy. They can't run the numbers accurately until Dec, usually.

James Hamilton wrote: A number of Tier 1 suppliers for U.S. automakers are going to suspend production for the year as early as next week. Without the inflow of parts, the OEMs will follow shortly after

James: you have the situation backwards. The Tier 1s respond to OEM customer demand, not the other way around. My customer Chrysler Saltillo Engine Plant is going down on the 11th, restarting on 5 Jan. GM Romulus Engine goes down on 19 Dec and starts up 5 Jan. As a Tier 1, I have adjusted my shutdown plans according to this schedule. I would expect the assembly plants to follow a similar schedule. Most tier 1s will be following their OEM customer shutdowns, as the supply chain is very short for tier 1s in the auto industry (from minutes to at-best 2 days.)

One consequence of the end of the auto industry: cars will be a lot more expensive in the future

Buzzcut

Ask the Cubans (Cuba) how that worked out when they could no longer afford a new vehicle. Did they go up or did the people find ways to get around with old vehicles that were just fixed up.

It seems like everyone seems to think things are going back to the same in a few months. Unless we go back to easy credit, leasing cars for nothing, mew's....etc. it will not work.

How many times do you have to hear "since the GD/wwII till you get it. Its not like the 1990's its not like 1987, its not like the 73 oil spike it's like all 3+ at the same time.....now add all the bad things for each of those times and add to that the Financial FUBAR.

Car prices will go down or we, as a country, will make more money.

Now I ask you, which one is more likely, because I do not belive you can have both.

Powertrain Parts Guy, dryfly:

The production suspensions at the Tier 1 suppliers are in response to the OEMs own suspension plans, such as the Chrysler and GM plants Powertrain Parts Guy noted. My apologies for the lack of clarity in my original comment, which did not identify which party was driving the suspensions.

The relative timing of how the Tier 1's suspend operations depends more specifically on the parts supplied and the Tier 1's own supply chains and the effect on a Tier 1 facility may vary - a facility that produces components that go to another facility for additional processing before being delivered to an OEM would suspend operations before the facility closer to the OEM would. That's also something that will vary by supplier.

One final note - I know we look a lot alike online, but I'm not JDH. ;-)

One more vote for PCguy.

Same story in housing and auto:
Current record high ownership rate.
Four years of record high inventory turnover.
Current record low equity (factoring for MEW auto purchase).

There are 86 new homes in my neighborhood, and about 172 new cars in the garages.

My truck and one neighbor's 200k mile Civic are the only old beaters. I'd buy at a big discount (not the baloney in TV ads), but we do not represent sufficient demand to save any manufacturer.

George K: If America wants to buy me a car I'll take it, but I wouldn't lie and say its the best for anyone. Next you'll want "them" to issue "us" all efficient lightbulbs, ZIRP mortgage rates and digital televisions. Luckily "they" pay the bills, not "us".

Thanks for the heads-up, James_Hamilton. Because obviously the American carmakers have the right, the inalienable right, to a certain sustained, consistent level of sales, irrespective of what quality or actual consumer financial sense dictate.

Yes, our very economy is predicated on people mindlessly blowing all their money, and that's a good thing, and we should encourage it with "stimulus" packages, so we can get the GDP numbers to look rockin'.

*banging head on table*

Jim,

As you know, we are witnessing a complicated economic downturn unlike anything most readers have ever experienced.

I will not be surprised to observe automobile sales continue their YOY slide well into the second or third quarter, 2009. And perhaps beyond.

If automobile sales can be sustained at 50% of previous annual levels for the next few years, we may be fortunate. That is a strong statement, but perhaps within reach.

The situation is grim with more to come.

My .02

The auto industry is in a state of serious overcapacity world wide & in the US. Too many cars are being made, too many plants, few are flexible plants, car companies, models, platforms. System wide the auto industry consumes too much capital, labor, investment etc.

The big three are in effect worthless from an equity standpoint. Their liabilities are $100's of Billion, they have lost $100's Billions the last 10 years from an earnings standpoint and they consume as an industry ecosystem too much labor, capital.

We need to let the big 3 merge or be bought on a product line basis, take over the long term liabilities for the Unions and help manage them out of the BK protection. Have a special industry unemployment/retraining programs
(18 months instead of 9, $15k training education credit, $10k relocation credit)

Auto demand for all of 09 will be Q3/Q4 08 like numbers for 4 quarters. The cash burn is over 10B a month at those numbers. 2010 will be slow growth so they need $100-200b in cash flow support through 2010 to help them stay in business. They still will sell half their auto product lines, fire half their workers and close 50% of their plants.

We could help them manage a BK and get this industry much smaller more nimble and ready for the 2010-15 marketplace

All those who have been predicting hard times ahead are finally right - after years of being wrong. So take satisfaction in it.

Years ago, decades ago, I read Keyenes 1936 ma gnus opus. I remember his foil was a person who argued that depressions were self correcting after prices adjusted enough - that supply creates its own demand.

Of course, that idea is not rejected. However, we might considered a modernized version. The current depression is quite different from the 1930's because our economy is much more dependent upon services than goods production and we have retired people with steady incomes from pensions and investments (that are shrinking but still provide purchasing power), we have social security, we have a larger local and state government, we have more insurance firms and banks that will not go broke - in short, I see a floor to the downward spiral rather than indefinite continuation.

Now if I could just persuade Paulson that all firms that cannot meet their debts should be allowed to fail, we would soon hit the floor and begin the upward rise that we all seek.

Paulson and Bernanke are standing in the way of quick recovery because they are fighting the last war. Hoover waited for the floor to appear because he believed, along with Keynes opponent *Say's the name* that a floor existed. No floor existed in Hoover's time. A floor does exist today.

Let AIG go. Let GM go. Nationalize Freedie and Fannie and restrict their duties. The quick decline of the economy will put many more people out of work but it will reduce our trade deficit, shrink the financial and auto manufacturing sector to a size that can be supported by all the money coming in monthly to the consumers cited above. The turnaround will happen when house prices come down enough to get 94% of our houses occupied by tenants that can pay the freight.

Correction - Of course, that idea is now rejected.

I'd love to buy a new car. My car is a '95 and my wife's is a '96, and they're both high mileage. I'm sure I could get a loan, but I've been laid off in too many recessions to have any confidence that I won't be stuck with car payments and no income to pay them.

See GM data about the US automotive market:

http://www.sec.gov/Archives/edgar/data/40730/000095015208009421/k46994k46994z0005.gif

The worldwide overcapacity in automotive production has sent out its first major tremor into the US market.As cars from China and India begin to enter the market in the next ten years,we are going to experience an even more serious contraction of the domestic auto industry.

The question is: do we keep trying to make buggy whip production more and more efficient as the markets for cars becomes oversaturated and the US is the highest cost producer in the market?

When I see Honda's Fit and see the outlines of what Tata is doing with its $2500 Nano, I see nothing but trauma for Detroit and may be even the Japanese and the Germans.Time will tell.

Given the numbers presented, i am wondering whether the bailout package of 15bn will do anything at all, besides help a cash flow problem. If GM posted a loss of 39bn in a good year, what will happen in 2008 and 2009? Anyone know what the true cost of the bailout will be? Im sure we are going to end up with a situation where good money is chasing bad money!

Greg Mankiw wrote on his blog today:

"Bailout...

An economist might suggest letting a few producers fail, so supply shrinks, prices rises, and the remaining producers become more profitable. In fact, that same logic might apply to some other industries as well."

I've been wondering why gasoline prices rose in 2007 and 2008. I'm indebted to Greg for explaining it. Now can someone remind me the names of the few huge oil producers/companies that failed in 2006, so supply shrank? Also, did gasoline prices just fall hugely because a few oil producers/companies recently unfailed themselves?

Way to explain economics. Helpful. Not.

@Iccheh - The 15bn bailout package, taken from funds set aside for tooling and investment for MORE FUEL EFFICIENT CAR production, will take money away from real American car manufacturers that are actually producing and developing viable electric and plug in hybrids (yes, the batteries are ready, NOW). So, mission accomplished for keeping our heads in the sand. The true cost will be more consumer's money spent on gas than otherwise, polluted watersheds, continued heavy dependency on imported oil with our money going to volatile parts of the world and our kids in the military at daily risk to keep it all sputtering along. I don't care how cheap gas is - I care how volatile and unpredictable gas prices are and how dependent we are on militarily supported (add that to the price, a bunch of trillions) imported oil.

Notice I didn't even have to mention climate, even though 2007 was among the warmest years on record (though who cite heavy snows confuse precipitation with temperature) and 2008 was the 2nd most destructive ($) hurricane season ever, a fact that seems to have been brushed under the carpet by the media and outgoing politicians.

@ klatoo - Yep, welcome to the world of market saturation (it took the automakers a century to get good penetration with gassers). What they need is NEW product. Folks will buy two each, even if they are pricey, they have to double their productivity and pay cash to get them. The unemployed might even start installing huge wind turbines if that's the best job growth out there to get that freshness. How about high performance, fuel efficient electric and plug in hybrid vehicles (prefer series)? Electric torque (with proper motors, power packs and controllers) and linear acceleration is addictive. Once you taste that, you won't go back.

this is a great forum. learned more in five minutes than two courses in economics.