Why You Shouldn’t Invest in the North American Automobile Industry

I know this doesn’t sound terribly patriotic, but after the head gasket on our brand-new Oldsmobile Alero literally melted (because it was made of plastic???), we decided never again to own a North American car. Now we drive a Toyota Highlander Hybrid, and let me tell you, what a difference!

But, the reason why investors should steer clear from investing in the automobile industry in North America is not based on personal experience. Again, there is a bit of macro and global economic analysis that may come in handy when making your investment decisions.

By now, most of you are aware that our freely floating currencies have great impact on our respective economies. When our dollars depreciate, prices of foreign goods and services appreciate. As a result, our exports get a boost, while imports decrease. This in turn expands our respective gross domestic products, but, (oh yeah, there is a “but”), it also increases prices of domestic goods and services, creating an inflationary ripple effect.

Now, all of this happens in the short run. In the long run, however, domestic consumers typically adjust to the fact that foreign goods are price inelastic and again shift to buying more expensive imports, even though there are cheaper domestic products still available. This is called the “J-Curve Effect,” because the curve literally looks like a letter “J.” This type of curve is very likely why a while back the former Fed Chairman Greenspan embarked on the greenback devaluation spree.

But, what happens when consumers ignore the J-Curve Effect and stick to more expensive foreign goods, in spite of the domestic currency depreciation and in spite of the fact that domestic goods are cheaper? Well, the result of this sentiment is identical to what is happening to the automobile industry in North America.

It appears that North American consumers care very little about Toyotas and Hondas being more expensive than GM or Ford vehicles. Foreign cars are price inelastic, the U.S. dollar has depreciated in general, yet sales of domestic cars are still dwindling. It is obvious that the J-Curve Effect didn’t “take” in case of the domestic auto industry. And the talks of a merger between GM and Ford or GM and Chrysler are not likely to fix anything either. I’m afraid that in this case, the laws of algebraic signs are not going to resolve two negatives in a positive.