Absurd! Natural disaster can't be good for economy?

Nov 1, 2012

In this issue:
» Is a RBI rate cut on the cards?
» Will gold prices weaken from here on?
» Europe needs solidarity more than austerity, feels Soros
» This famous fund manager is now bearish on iron ore
» ...and more!

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'Super storm Sandy has brought with it a silver lining to the US economy'. Thus goes the claim on one of the leading financial portals. A leading money manager then argues that all the rebuilding that will take place after the storm will really inject life into the US economy. Even someone as reputed as the CEO of fund giant PIMCO then joins the chorus. The immediate decline in GDP and the damage to physical wealth will be offset over time by greater economic activity, the gentleman chimes in.

Well, we are really shocked to know how people, who are otherwise quite intelligent, sometimes show a lack of fundamental economic sense. Do natural disasters like storms or even manmade ones like wars actually boost prosperity? If they certainly do so, as these people have argued, why wait for natural disasters to cause damage. Why don't we just nuke empty cities and then rebuild them in order to enhance our prosperity? Clearly, this is something that even a common man on the street would vouch against.

How is it then that even the most intelligent people on earth fail to comprehend the basic economic logic behind natural disasters? We believe it is a case of studying the first order effect of the whole rebuilding effort and totally ignoring the other consequences. You see, the resources that are used for rebuilding an economy after disaster has struck do not come from thin air. The money that will be spent on repairing the damage from the storm is the money that will be diverted from some other use. Thus, while construction activity will see a lot of boom, few new plants or research facilities would now not come up as the money meant for them has been spent on reconstruction.

Plain and simple, isn't it? The whole rebuilding drama that economists pooh-pooh about may not add one dollar extra to GDP as it is all simply a change in economic structure and not a totally new output. After all, how can destruction be profit? Destruction is destruction, period.

Do you think natural disasters like storm Sandy actually have a positive effect on GDP? Share your views or you can also comment on our Facebook page / Google+ page

 Chart of the day
Today's chart of the day highlights how a late surge in monsoon may have helped India's food grain production prospects but not bring it totally out of the woods. As the chart suggests, food grain production in India is likely to fall 3% in FY13 from the previous year levels. It should be noted thought that this drop should be seen in the context of an all time high production achieved in FY12. As per reports, production is estimated to fall in parts of Karnataka, Maharashtra, Gujarat and Rajasthan.

Source: Financial Express

Known for his value investing and shorting skills, fund manager David Einhorn is currently short on iron ore. Terming it as a 'bubble', Mr. Einhorn is of the view that iron ore prices could fall to US$ 100 next year; possibly touch US$ 80 or even lower thereafter. Current spot price is at levels of US$ 120. What is surprising that the prices stood at only US$ 30 in 2003! And in a short span of seven years, prices shot up.

In 2011, iron ore prices touched US$ 160. High demand from China was a major reason for the price increase. Mr. Einhorn is of the view that with China slowing down and that the forecasts seeming to be overestimated, the demand for iron ore will remain weak. He also believes that China's spending on 'useless' projects (and thereby propping up the GDP) is a trend that cannot be sustained for long. While that takes care of the demand side of things, the supply side data also indicates signs of over capacity. This is considering that more capacities are coming on stream across the world.

This week's monetary policy announcement by the Reserve Bank of India (RBI) was as usual a much awaited one. The Finance Minister kept dropping his not-so-subtle hints on the need for a rate cut. But eventually, the RBI cut the CRR rate and left the key policy rates unchanged. It also revised expected GDP growth downwards and expected inflation rate upwards.

Now everyone is waiting patiently for the next meeting which is scheduled for the next quarter. The RBI governor has stated that he would review rate cuts at that time. So now the question is would he go ahead with a rate cut or not? There are two forces in play here. One the country's economic growth has slowed down. And higher interest rates would continue to play spoil sport. So there is tremendous pressure on this front to ease the interest rates. But the second side of the story is on the inflation front. Inflation rates have come down from the double digit numbers but continue to remain high. In fact, RBI's upward revision indicates that they would not ease anytime soon. Therefore reducing interest rates may lead the monster of inflation to rear its ugly head again.

The thing here is that the RBI would prefer to watch the government's commitment to policy reforms. If reforms go ahead as planned then inflation would come down. This in turn may prompt RBI to cut down the rate. But if the government falls back to its past avatar and starts dilly dallying again, then the RBI would be forced to maintain its hawkish stance.

The economy is very integral to the social and political landscape of a country. Correspondingly, all economic crises have socio-political repercussions. As such, economic problems cannot be solved in isolation. It is imperative to take into account socio-political outcomes as well.

In this context, legendary investor George Soros has raised a pertinent point concerning the Eurozone sovereign debt crisis. As per him, Eurozone policymakers must not focus too much on austerity alone. While dealing with the debt crisis, it is very important to build solidarity amongst all member nations. Why so? Let us explain. Several bailouts have been announced ever since the crisis broke out a couple of years ago. But these bailouts don't come free of cost, especially sovereign bailouts. Such bailouts come tied up with 'austerity' measures. In other words, mandates to reduce government spending or increase taxation. Such austerity measures, though economically vital, tend to push the already ailing economy in a further downspin. The lives of ordinary citizens get adversely affected due to this. In fact, protests in Greece and Spain have already turned violent. These are early signs of revolt and must be dealt with urgency. A continent that has witnessed two major world wars should do its best to avoid a third one.

The yellow metal has seen some correction in price off late in US dollar terms. After reaching a high of US$1,790 at the start of October, it is hovering close to US$1,700 now. So, is this a sign that prices have reached unsustainable levels for a long term correction to seek in? Well, not really.

If one looks at the bottom line of gold mining companies, one would be surprised to know that they make only US$200 per ounce, as acceptable profits. This is when the price of gold is US$1700 per ounce. Rest of the money goes towards the operating cost. Thus, the belief that the current gold prices are in a bubble territory is not true. The cost of extracting gold is increasing which is increasing the prices. Also, it is interesting to note that the production of gold has remained flat or declined since 2000. When similar thing happened in 1970s the price of gold shot up considerably. Thus, with deficiency in supply, prices are bound to remain firm. Another interesting aspect is that even when the production increased steadily from 1981 to 2000, prices were more or less firm. This speaks about the everlasting demand for gold. So, the current correction is not worth fearing it seems.

The RBI had been quite active in intervening in the forex markets in the past. Especially in late 2004 and early 2005 when the rupee appreciated significantly against the dollar and was hurting exporters, the central bank had intervened by continuously buying dollars. This kind of intervention has lessened since then. When the rupee had hit a life-time low of 57.32 in June this year, the central bank chose to stay on the sidelines. And it intends to continue doing so. The RBI has categorically stated that it would only intervene in the market if there is extreme volatility in the rupee. And that bolstering reserves will not be the sole purpose for doing so. Indeed, the rupee's steep slide is more a reflection of the sorry state of affairs with respect to the current government. Once that is corrected through reforms and execution, more money will certainly flow into the economy. This will then raise the value of the rupee.

Meanwhile, indices in the equity market of India have hovered around the breakeven line today with the Sensex higher by 45 points at the time of writing. Consumer durables and auto stocks were seen attracting maximum interest. Asian indices closed mixed today whereas Europe has opened mostly in the red.

 Today's Investing Mantra
"The stock market is filled with individuals who know the price of everything, but the value of nothing" - Philip Fisher

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16 Responses to "Absurd! Natural disaster can't be good for economy?"

Raghvinder Joshi

Nov 4, 2012

What comes to mind is the book 'Everybody loves a good drought' by P Sainath.

There are some very intelligent people who build on other people's misfortunes.

I do not agree with Mr Naik's view. There must be more efficient and less destructive ways of unlocking excess capacities. Must some people die in storms and earthquakes just so that survivors can build on their graves.



Nov 2, 2012

Any disater is bad for the over all economy of any country: But some in US believe that the funds are mobilised to rebuild the devastated areas which will generate employment, consequently this will generate more buying of various goods and services..They think this is the good part. Most properties in the US are insured, therefore, insurance companies take the hit for the cost of rebuilding. Ofcourse, insurance companies will increase premiums on all the property owners in the next cycle, this way cost is born by the entire society, such premium increases are approved by the US government.

This is what happens in US. But it may vary from country to country. If the burden is born by the government, then the government mobilises resources for reconstruction of disaster areas, the funds that were otherwise intended for developmentatl work such as infrastrue projects. If this is true disasters are bad for the society.


sundaravaradan S

Nov 2, 2012

All view points are Good. I especially like Ramachandra Naik's point of view too.
Many Economists/Analyst like to the Country's 'GDP'. Why?
That number signifies Economic activity. Baed-on GDP one invests!
What is the GDP-Number? It is some STATISTICAL number, for economists. What is Statistics? (Bluff, more Bluff..then statistics!)

Destruction is Destruction. But is destruction, subtracted from calculation of GDP?! (I am not Economist)
China is notorious to build Ghost Cities to increase GDP!

Indian Contracters are very Clever in claiming Money by doing Nothing !! (Nothing = digging a lake for Money + Covering the Lake for more Money) You have GDP; costed money to Govt; but can not find where is the Progress!!
Sheer ingenuity of Human race !!


Anupam Acharya

Nov 1, 2012

Well your point is valid in a certain sense only as you have assumed the money supply to be constant for United States but it might be not true here because federal reserve which provides printed money actually prints it without any backing so there is a plenty of cheap money available and also would be justifiable cause. In US paper money is NOT limited, it is unlimited ! They always need reasons to print more money for a justified cause. Your opinion might be true in countries like India as we cannot even handle our fiscal deficit right now leave natural disaster ....



Nov 1, 2012

The logic behind the claim that the aftermath of hurricane Sandy will lead to a degree of economic revival is counter intuitive. After the Second World war, massive reconstruction activity in Europe led to large investments, higher incomes, higher aggregate demand and thus higher growth. You ask why cant this same virtuous cycle prevail in peace time ? The reason is political gridlock ! After a major national crisis, the political opposition feels duty bound to support the rebuilding effort which will be immensely popular with voters. Hence consensus evolves quite rapidly. In today's US and Europe, given the acute economic distress, calls for more austerity only inflicts more pain on the hapless citizen while the fat cats from industry and finance who caused the chaos in the first place get away scotfree given their wealth and political clout. They virulently oppose all attempts to increase public spending even if it increases budget deficits in the short term, as it will entail increase in their taxes and reduction in their profits.



Nov 1, 2012

The theory is totally absurd and perverse. It is simple economy that to rebuild an asset createdearlier needs higher outlay at any point of time and the physical resourses required are not eternal! As you have rightly pointed out it is not going to add up to GDP nor to the wealth of the nation. It is only going to deplete it.



Nov 1, 2012

For that matter we have some wise assess at all times at all places who call themselves Financial experts, economists playing havoc with financial institutions
and with public hard earned money. EXAMPLE...Almost Collapse of American Banks and Financial institutions.



Nov 1, 2012

This is known as the "broken window fallacy" and only economists can come up such weird rationale. The world wouln't be in such a mess if instead of politicians & bankers, true blue engineers & scientists were running it. Go Kejri!



Nov 1, 2012

Yes, I fully agree with the opinion of Equitymaster.


Sai N

Nov 1, 2012

The key thing to remember is that the US economy is currently operating at sub optimal levels. This might explain the unemployment and underemployment. Many companies are still laying off people. All of this speaks of unutilised and underutilised capacity. it is this capacity that can be put to use when a disaster strikes. This usage of underutilised capacity is guaranteed to ADD to the GDP.

While I am usually in synch with Equitymaster's views, I see a lot of jingoism and anti-American populism in your views. I do understand that economists can have multiple view points and am prepared to look at them and listen to them, when these views begin down the slippery slope of populism, I have to look elsewhere.

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