Yesterday I wrote to you about the silly headline in The Age newspaper. It was this:
Look, we love it when we see this kind of nonsense written. Simply because it gives us an excuse to again read Frederic Bastiat’s, “That Which is Seen, and That Which is Not Seen”.
You can click here to read it for yourself.
I won’t reprint it because you should read the entire essay. But in a nutshell, it’s economic nonsense to suggest that a flood will be beneficial to an economy.
Only an economic ignoramus would argue such a thing. Floods destroy things. Floods make no distinction between the destruction of brand new goods and goods that are due for replacement.
The last time we brought up this subject we were told it is good for the economy because money comes into Australia from insurance companies. That this money hasn’t been taken from elsewhere in the economy.
To borrow from the title of Bastiat’s essay, it only considers that which is seen but not that which is not seen.
Even so KPMG chief executive Michael Andrew is quoted in The Age article:
“This will release a lot of cash from insurance company balance sheets, many of which aren’t in Australia. Many are reinsured offshore in Europe or the US, so the extent to which they have to fund loss-of-profit claims, a lot of money potentially flows into Australia.”
It’s the idea that Australia is getting a free lunch from the insurance companies.
The fact is, Mr. Andrew couldn’t be more wrong if he tried. But let’s run through the argument in more detail…
Think about it, how do insurance companies raise money? They charge premiums. Premiums paid for by Queenslanders and others.
Now, how does an insurance company pay for the claims made by policyholders? It covers the costs from its reserves but would also issue bonds to investors which it will then repay over time from insurance premiums.
Here’s the problem for the insurance company. Aside from the big payouts such as the Queensland floods, or the Christchurch earthquake, the insurance companies also need to pay out other everyday claims.
So, the insurance company will need to rebuild its cash reserves.
How will it do that?
Simple, it’ll need to increase insurance premiums.
And who pays for the insurance premiums? Individuals and businesses. In other words, money that would otherwise have been spent elsewhere or saved will be now spent on increased insurance costs.
Yes, some industries may benefit as claimants buy another item of furniture to replace the item that was destroyed. But it is at the expense of say, the clothing store where someone may have spent money but they are no longer able to do so because of the increased insurance premium.
But what about this idea that foreigners are actually funding the rebuilding as the cash flows in from overseas.
While that may be true, it ignores the attitude of those overseas investors. If a reinsurance company has to fork out more money than expected to pay for a major incident then it will naturally demand an increased return or premium before it invests more money.
That means the Australian insurance firm paying a higher rate on the bonds it issues or on the reinsurance policies. And that means passing on higher premiums to policyholders.
In economics there’s no such thing as a free lunch. If something is destroyed and needs replacing then there will be a cost to replace it. That cost will either be a direct or indirect cost.
Think about it this way. If there really wasn’t a cost, then why wouldn’t you just crash your car and write it off at every opportunity? I mean, that’s the logic Mr. Andrew is using.
The reason you don’t write your car off is because you know there will be a cost to you in the form of an increased insurance premium when you get your next car.
There is no difference between this example and the costs of the Queensland floods. To the Australian economy as a whole, and to anyone who holds any kind of insurance policy there will be a cost.
Claiming that foreigners will pay for the flood damage without any impact on Australians is just another childlike example of the Australian mainstream falsely believing that ‘Australia is different.’
One day they’ll get it through their thick skulls that Australia isn’t different. Australia has benefited from an extraordinary boom in the resources industry which has helped prop up the entire economy.
When that boom stops, the Australian economy will suffer. Only then will the mainstream numpties realize that the Australian economy is no different to anywhere else.
Monday: You’ve got your eye on a stock – but you’re not sure if it’s the right time to buy it… You’re holding another stock that just went up – or down – significantly… but you don’t know whether it’s time to sell… The solution to both of these dilemmas will become a lot clearer once you’ve watched this video (turn on your speakers). Click here for more…
Tuesday: No wonder Diggers & Drillers editor Dr. Alex Cowie looked jolly as he bounded into the office this morning. The “Stock Doc” has been long coal stocks since March last year. Click here for more…
Wednesday: We see the lazy Aussie retailers have launched a media campaign. They were clearly influenced by the success of the miners’ campaign against the Resources Super Profits Tax (RSPT). Except they forgot one very important thing… Click here for more…
Thursday: But speaking of non-robust and flaky, much to our surprise we received a reply to our Freedom of Information (FoI) request from the Reserve Bank of Australia (RBA). Click here for more…
Friday: This ‘George Soros tipoff’ could make you 226% to 389% in 24 months. (Just don’t share it with anyone else). Click here for the most intriguing stock story of 2011. Click here for more
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Written by Kris Sayce
Kris Sayce is Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning. (You can subscribe to Money Morning for free here).
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
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