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Having grown up in QLD I, like some of you have family, friends and even clients directly affected by the floods with some being isolated, however generally speaking OK.   Hopefully yours are also.

Whilst the human impact of these floods is significant, the purpose of this article is to address some of the myths many “so-called” experts are already sprouting about the likely economic impact of these events.

There’s no shortage but I’ll deal with the main ones,

  1. The rebuilding will is positive for economic growth in Qld, particularly as much of the funding will come from Federal coffers or overseas “reinsurers”
  2. Increased food and commodity prices will mean higher inflation which may lead to interest rate increase.

Whilst these headlines may even be accompanied by some “numbers” and analysis to justify the conclusion, a simple look at the full story quickly reveals how ridiculous such statements can be.

These claims will be accompanied by estimates of the amount of money required to rebuild and then these numbers will be fed into the building & construction contribution to GDP and of course the result will be bigger than before.  Clearly then this higher GDP number will mean more growth for QLD.

Well at least this is what’s seen, now let’s consider the unseen consequences.  Firstly, where will the money come from? Either insurance claims for those with cover or “government assistance”[1] for those with insufficient or no insurance cover.  How come when it’s insurance company paying it’s a “claim” but with government it’s “assistance”?  In either case we either paid for it in the first place through premiums or taxes and we’ll pay more in the future because we haven’t paid enough.

Neither the insurance company nor the government have any money other than what they get\take from us.   Therefore if they don’t have enough they’ll simply increase payments in the future, i.e. premiums or taxes.  No matter what, we the taxpayer will pay the bill.  At least with the insurance company we get a contract so we know what we get and how much we pay.

Most importantly, because we pay for this in one way or another, we will have less money to spend on other things than we would have had we not had higher taxes or premiums.  Therefore whilst this may be a boon for the construction industry, other industries will suffer an equal reduction in spending.  Eg there’ll be a drop in retail spending, holiday etc.

The problem with the unseen is, well it’s unseen and therefore impossible to show – no one knows what we would have done with the money that will now go to rebuilding QLD.  Therefore whilst one sector of the economy will boom (construction) others will suffer (collectively) an equal reduction which may or may not be so obvious in the “official GDP numbers”.  Quite obviously though, it’s there, otherwise we would have found a “free lunch”.

Increased food and commodity prices means higher inflation

One of my all-time favourites as it goes to one of the most basic and fundamentally misunderstood issues of all – inflation.  My apologies for those who have heard all this before (see last month’s My 20c) but its importance cannot be underestimated.  This confusion between the “meter reading” and the cause is the basic problem.

You need to add some, (dare I say it), common sense to this mechanical, mathematical measure to see if the measure can be explained by something else.  Yes prices will rise in some areas, but others will drop because we don’t have too much cash.  Just because we can’t easily measure where the drop occurs doesn’t mean it won’t occur.

The CPI[2] is NOT Inflation

The CPI is a measure of the price movements of a select basket of goods & services, nothing more nothing less.  It simply tells you when overall, the prices of these goods & services goes up or down.

The other reason prices rise however is lack of supply.  If supply becomes too tight then prices will rise to the point people are prepared to pay and they will sacrifice other expenditure to offset.  If this price rise is in more essential items like food or transport, then the sacrifice can be significant and prices can rise substantially.

This is exactly what happened last time a natural disaster hit QLD in the form of cyclone Larry.  The resultant spike in fruit prices (especially bananas) was soon followed by a spike in petrol (caused by speculative trading in Oil).  The RBA used this resultant change in the CPI to justify a series of interest rate rises which also fed the CPI and ultimately all but ended in recession.

The graph below shows the difference between the RBA measure and the same measure adjusted for the non-inflationary factors above.

3171049_orig

Not only does this show no underlying inflation for the last 5 years but it also shows the RBA performance in “managing the economy” has made our Test Cricket team look good.  The RBA’s measure (red line) didn’t really start rising until after they began raising rates and didn’t start falling until after they cut rates.  This is the exact opposite of what their actions are supposed to achieve, yet it happened anyway.

If they got it so badly wrong so recently, how can we be sure they won’t do it again?  November’s increase shows they haven’t learnt their lesson on the Phillips curve and unemployment[3] so we can’t be too hopeful.  In any event, as always we will monitor this closely to ensure our client are positioned accordingly.

In the meantime don’t be fooled by fancy calculations, floods aren’t in any way good for the economy, but they won’t ruin it either.

 

[1] Why is giving us back tax we paid “assistance”?
[2] Consumer Price Index
[3] See My 20c December 2010

Matt Battye

Matt Battye

CEO, Financial Adviser

Analysing what can seem to be like complex issues, Matt is effective in using analogies to better explain scenarios and truths to the rest of us. This is what Matt enjoys – educating clients on the truths and debunking the commonly held (wrong) view.

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