The U.S. Auto Market Is Running Out of Used Cars

Editor's Note: This column has been updated by the author.

No matter how many times we've been told that the economy is getting better, the most recent Reuters/University of Michigan Index of Consumer Sentiment suggests that the public is not buying it. Coming in at an anemic 73.4 (although up from November's reading), this is a long way from the 100 baseline that denoted consumer optimism in years such as 1985, which led directly into the first year in which U.S. car sales topped the 16 million mark.

In forecasting U.S. car sales for 2010, most prognosticators set the mark only slightly higher than today's level—from 11.2 to 11.5 million sales. The auto industry's dynamics suggest that much higher volumes are attainable. For one thing, the momentum of the used car market—which most new car dealers have promoted to stay profitable over the past seven years—is undergoing a major reversal. The day when new car dealers could pose as used car superstores is likely coming to an end. To survive, dealers will be forced to sell more new cars.

Creating large used car operations was an obvious step for new car dealers. Most were fed up as new car margins were cut to near zero. Constantly changing rebates and incentives meant that few dealers could properly plan their advertising. Worse, the manufacturers were often so late in announcing each month's incentive programs that dealers commonly missed out on the first weekend's sales.

No wonder retailers turned to used cars: They could control that end of the business and be less dependent on their franchise's manufacturer.

Those suicidal incentives had a further major impact on the market's dynamics: They put downward pressure on the wholesale cost of late-model used vehicles. Every time GM would offer $6,000 to $8,000 cash back on a Tahoe model, it lowered the resale value of similar trade-ins. The lower pricing on late-model used cars made them far more attractive to many who had previously purchased only new cars.

February's wholesale used car marketToday that point of equilibrium has passed. The dealers' near-decade-long used car gold mine is fast becoming a memory. Even this year, numerous articles have related that individuals in some major markets were actually paying the same money—or slightly more—for late-model used cars such as the Honda Accord LX than for a brand-new one.

Because new car sales have fallen from more than 16 million to barely 10 million, the availability of late-model used cars is starting to fall by a similar percentage. The situation is only going to worsen over the next three years. Factor in that incentives being offered to the public have shrunk in the past year and we see that the downward pressures on late-model wholesale prices have been reversed. While it may not yet seem dramatic as we enter the winter selling season, watch what happens to the wholesale used car market in February, when dealers are preparing to stock up for the spring market.

Another factor favoring a rising car market is that millions of consumers have deferred buying either a new or used car during this two-year automotive depression. While they deferred purchases, they kept paying current loans, helping to wipe out much of the negative equity in their trades. This makes it easier to purchase a newer vehicle—and thus more likely.

In a nutshell, the best late-model used cars look to be in short supply. Prices will come up, leaving new car dealers with no alternative but to find ways to sell more new models to offset their lower used car sales volumes.

the new Age of UncertaintyBest guess on next year's new car sales rate? 13.5 million.

The likelihood that this will come to pass? Unknown: The American consumer is now living in the new Age of Uncertainty.

Until the average person can assess his or her financial future and feel confident that the assessment is accurate, forecasters calling for a long and painful recovery will probably be right. Much is made of today's unemployment rate, but as I predicted here in February 2009, a reasonable percentage of those still gainfully employed have substantially reduced their buying.

This is what the public, responsible for close to 70% of our economy, faces in 2010. For the average person there are too many questions, and the answers to far too many of them could be ruinous.

If Congress manages to negotiate a final health care bill, most Americans will worry about its financial impact, or that they might lose coverage.

Families don't know what their gasoline or heating oil bills might amount to in the near term, but such analysts as Jeff Rubin, former chief economist for CIBC World Markets, are already predicting that oil will reach $225 a barrel as early as 2012. That would translate to $6 to $8 a gallon for gasoline, depending on a refiner's margins.

Electric utilities across the country have started introducing smart meters to homes. In California the process has given rise to a class action lawsuit against Pacific Gas & Electric as many consumers claim the meters have raised monthly electric bills by hundreds of dollars. Similar complaints on smart meters are already arising in Texas.

Fears of Cap and Trade, VATNews reports that the Federal Reserve will keep key interest rates near 0% offer cold comfort to Americans whose credit-card interest rates have skyrocketed past 20% in many cases. Borrowers inquiring about home improvement loans—even when they possess outstanding credit ratings and huge equity value in their property—are being offered rates of up to 8.95%, plus fees, to close.

If agreements are reached in a climate change deal, Cap and Trade will expand in financial markets. This too, will raise the price of all energy, from oil to electricity. The ultimate burden will fall directly on the American consumer.

Because of the massive deficits we're carrying, many commentators are correctly stating that at some time in the future, Washington will have no choice but to raise taxes to balance the budget. This may be done through higher payroll taxes, but individuals pushing the value added tax are once again being heard. That tax is relatively regressive, meaning that the middle class would bear the brunt of the increased burden.

Most analysts and commentators have overlooked the fact that new car sales from 2003 to 2008 could have been much stronger—possibly an extra million new car sales a year—had dealers kept focusing on new sales instead of doubling efforts to sell used cars. Now, with the availability of late-model used cars declining at a rapid rate, they will have no choice but to steer used car buyers back to the new-model showrooms.

All that's needed for a substantial surge in new car sales for 2010 is consumer confidence that a substantial recovery is underway. So far, that's the missing ingredient.

Before it's here, it's on the Bloomberg Terminal.