Weekend Reading: Harvey & The Broken Window Fallacy
As the waters recede from “Hurricane Harvey,” the rebuilding efforts begin. It will take quite some time before Houston fully recovers from the tragedy, but recover we will. Hopefully, lessons were learned by a city government that has avoided dealing with the drainage and flooding problems for far too long. Despite hundreds of millions of dollars extracted from the citizenry of Houston via a “rain tax,” the money was absorbed by the profligate spending of repeated feckless Mayors who chose to spend on “bike trails,” “green energy.” and other liberal agendas rather than resolving a critical issue that has plagued Houston for years.
We’ll see. But I won’t hold my breath as Houston continues to follow the shining examples of other fiscally responsible governments like Chicago, Detroit, and others. [sarcasm alert]
But that is a story for another day.
Currently, the mainstream story is the “economic boost” which will come from the recovery process. This is the essence of the “Broken Window Fallacy.”
“A window is destroyed, therefore the window has to be replaced which leads to economic activity throughout the economy.
However, the fallacy of the ‘broken window’ narrative is that economic activity is only changed and not increased. The dollars used to pay for the window can no longer be used for their original intended purpose.
There is no free lunch.”
To put a finer point on it:
She is right. Obviously, nuking cities to create economic growth is just plain silly.
However, in the short-term, there will be thousands of temporary jobs created, supplies used, services needed and wages paid which will provide a temporary economic boost. Unfortunately, what is not being accounted for is the offsetting of lost wages, business incomes, and other costs for the individuals and businesses that have been devastated and displaced by this tragedy.
From a market perspective, hurricanes have little impact in reality. In 2005, the U.S. was rocked by three hurricanes over a three month period. The market dipped but recovered shortly thereafter as the event was quickly absorbed by market participants. There was also a quick spat of economic growth which quickly faded over the next several quarters.
In 2008, “Hurricane Ike” made landfall at the same moment that Lehman was forced into bankruptcy. However, what was not known by market participates at that time, because the NBER had not declared it, was the U.S. was already in a deep recession. It only got worse following the event.
“Hurricane Sandy”, much like “Katrina,” “Wilma,” and “Ike,” also provided a 2-quarter boost to economic output which quickly faded as the temporary inputs came to an end. The market blinked, but then continued its advance.
The difference between the outcomes of “Ike” and the other storms was really dependent on the overall cycle of the market. “Ike” occurred with market and economic sentiment already turning negative. That is not the case with “Hurricane Harvey” as overall market and economic sentiment remains very robust, even exuberant.
Over the next couple of quarters, market participants will have their attitudes bolstered by better than expected economic numbers. Such will also give President Trump some cover despite the lack of legislative agenda moving forward. However, it is the trend of the economic growth rates that must be paid attention to. Despite hopes of a never ending “bull market” supported by ongoing “emergency measures” from Central Banks globally, the reality is we are very late in the current economic cycle.
Just like in 2008, it was well after the fact, when the economic data was negatively revised, the recession became clearly evident. Given the deterioration is credit, the rise in delinquencies and plunge in savings rates, the economic back drop is likely far weaker than headlines currently suggest.
While Harvey may extend the current cycle for a little while longer, I would not get overly complacent with highly aggressive allocation models. Like I said, there is no free lunch.
Here is what I am reading this weekend.
Research / Interesting Reads
“Never forget, things change.” – Lowell Miller
Questions, comments, suggestions – please email me.