We are taking a break from the turmoil in equity markets to consider a more parochial question – used car prices.
I have been pondering replacing our current, eight-year-old Honda for something more recent. The search started with the aim of tracking down a functional, bulletproof motor. But having discovered how cheap second hand cars are I have been tempted by more exotic, Jeremy Clarkson-friendly alternatives.
My feeling that used cars are cheap is not an illusion of ageing, like believing policemen are getting younger. The official data show that since 2000 the price of second hand cars has fallen by 35%. Over the same period new car prices have risen 58%.
Taking into account the rise in personal disposable incomes, the fall in prices is even more pronounced. Relative to rising incomes used car prices have fallen by roughly 70% in the last 16 years.
In economics used cars are examples of an inferior good, one for which, as incomes rise, demand declines as consumers switch to more expensive and desirable substitutes (in this case new cars). By contrast demand for normal goods rises with increases in income. Inferior goods are not necessarily functionally inferior. Some buyers, for instance, insist that earlier models of a particular vehicle are superior to later ones. But progress is progress - new cars generally score better on economy, safety, fashion and features. Many of us like owning a new car simply because they are new, independent of any functional improvements.
Rising incomes make once sought after goods less desirable. The growth of charity shops in the last two decades testifies to the weakening demand for all sorts of second hand goods, from clothes to books to furniture.
In the case of cars, favourable financing conditions have led to a boom in new car purchases and increased the downward pressure on the value of second-hand vehicles. New car sales have risen three times faster than retail sales in the last three years. Roughly one in ten households bought a new car last year with sales reaching a record 2.6 million.
Rock bottom interest rates and a plentiful supply of credit have meant that three-quarters of new car sales are on some form of credit. Personal contract purchases (PCPs) have become particularly popular. Car buyers pay an initial deposit and then a fixed monthly payment for a typical duration of three years.
After the end of the period buyers can either make a final payment to take ownership of the car or, as is often the case, use any residual value in the car to pay the deposit for a PCP on a new vehicle. In 2015, PCPs financed almost two-thirds of UK car purchases.
For manufacturers PCP helps boost sales. The fixed three-year term holds open the possibility of repeat new car sale at the end of the period. For lenders car finance is a relatively low risk form of lending.
New financing methods have turned what was once a major capital purchase into a series of monthly payments and brought a new car within the reach of more consumers.
Lower unemployment and rising incomes have helped sales, as have lower petrol and diesel prices. The collapse in car sales during the recession also created pent up demand.
This sort of growth has created a rising supply of used cars. Choosier, more confident consumers with ready access to cheap financing are less inclined to buy second hand these days. Rising supply and weaker demand spells lower used car prices.
For a consumer who views a car solely as a functional purchase to get from A to B this is great news. Other people's growing aversion to second hand cars creates bargains. Assuming incomes keep rising used car prices seem likely to keep on falling.
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