Can the Auto Industry Survive in a High Interest Rate Environment?

Can the auto industry survive in a high interest rate environment? We’re about to find out.

Earlier this month, we reported that the air has started to come out of the subprime auto bubble. Nevertheless, Americans are still buying cars. Last week, we got a Commerce Department report that consumer spending was up thanks in large part to the strongest auto sales in six months. But there is a dark lining in this silver cloud and the long-term prospects for the auto industry could be dimming.

Why?

Rising interest rates.

The price of a new car has risen to the point that the vast majority of Americans simply can’t plunk down some cash and drive off the lot. Even a decent used car is out of reach for most American consumers. The average price for a new vehicle is at a record high $31,099, and the average used car price is also in record territory – $19,589.

This means borrowing and lots of it. Americans have to borrow more for longer periods of time in order to bring home that new car. The average auto loan has hit a record length of 69 months. The average monthly payment now stands at a whopping $515 per month.

From an affordability standpoint, it can’t go a whole lot higher. But it’s going to as interest rates rise.

As Ryan McMaken explained in a recent article at the Mises Wire, the auto industry has survived on cheap money.

Ultra-cheap borrowing costs have allowed auto dealers to push ever larger auto purchases by just telling new buyers to ‘finance it.’ This had been going on well before the current era of post-financial-crisis ‘stimulus,’ but the Fed’s quantitative easing after 2008 helped prolong the era of cheap auto debt far longer than many might have expected. If it weren’t for this, we’d likely see auto sales totals that are far worse than what we’ve been seeing.”

Even with the availability of easy money, the auto industry hasn’t been doing as well as it appears on the surface.

According to Commerce Department data, new and used car sales reached $77.6 billion in January of 2018. That marked a new all-time high — even higher than the previous peak of $57 billion reached in 2007. But McMaken adjusted those numbers for inflation and found that total auto sales have only this year surpassed the old January 2000 peak of 75.6 billion dollars reached 19 years ago.

From the perspective of the automobile industry, that’s not exactly a reason to throw a party. Moreover, if we take these same numbers and adjust them for population growth, we find that spending on autos per capita is still down from where it was in 2000.”

And now the easy money punch bowl is being yanked away. That doesn’t bode well for the auto industry.

We’re already seeing signs or trouble. Earlier this month, Bloomberg reported that 0% finance deals are going the way of the dodo bird.

Carmakers that used zero-percent financing offers to juice sales at the height of the American auto boom are starting to abandon them as rising interest rates lift their own borrowing costs. The average interest rate on consumers’ new-car loans climbed to 5.7% in March, the highest since 2009 and up from 5% a year ago, according to Edmunds. Zero-percent offers fell to 7.4% of auto loans last month, down from more than 11% the prior year and the lowest share in more than two years, the car-market researcher said.”

The auto industry is a key part of the US economy. It’s clearly in trouble, even if the mainstream hasn’t recognized that fact yet. This is another example of what happens in an economy dependent on Federal Reserve monetary policy to keep it running. It’s party-hardy as long as the punch bowl is full. But when it starts to empty out, the party-goers throw a fit.

The big question is will the Fed try to keep the party going. Will it continue pushing rates up even as the economy begins to crumble under the weight of higher interest rates? Will the central bankers let the auto industry collapse (along with many others)? Will they let the stock market crash? Will they let the bubbles burst? Or will they rush back with more quantitative easing to keep the party going?

Neither option is particularly good.

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