The Oldest Fallacy in Economics

From CBS Marketwatch, we have Could Calif. fires draw a line under housing crash?

Economists have noted the perverse reality that in the wake of disasters, re-construction spending helps the economy, even as people are still struggling to recover from their personal losses.

For once, I have no interest in the bubble but I wish to address the above fallacy, namely, that disasters help the economy.

Disasters do NOT help the economy!

Why?

If it were true, then we should logically go around creating disasters so that it would help the economy.

Put like that, it sounds absurd, doesn't it? That's because it is absurd.

Why?

It ignores the hidden in favor of what can be observed.

After this disaster, tragic as it is, the insurance companies will fork out to rebuild the houses. That means that cash is not doing something else productive somewhere else (this would be the unobservable part.)

Instead of the economy getting both the house and the investment, it only gets a replacement house.

Let's review this again just to be clear.

Suppose I throw a party, and in the course of the party, my guests break two wine glasses. Now, the next week I need to go out and buy two wine glasses from my budget which was originally allocated to say buying a book.

Instead of two wine glasses and a book, I have ended up with just two wine glasses. Obviously, I have lost.

Of course, the wine merchant is happy but the (unobservable) book merchant is unhappy.

This is the oldest fallacy in Economics, and the above explanation dates back to Frédéric Bastiat. It is so common that investment managers, politicians, and CEO's make it daily.

However, I've never seen Buffett make this mistake.