Katrina’s ripples will spread far and wide through the economy. While the initial damage phase is over, there are several Katrina caused major forces at play that could cause serious damage possibly leading to a recession. The worst part about this “perfect economic storm” is there is little the country can do for it from a policy perspective. In essence, the country made its bed and now may be forced to sleep in it.
First, let’s start with a general, documented observation: Natural disasters are essentially an economiczero-sum game. The Bureau of Economic Analysis analyzed the sum total of all 2004 hurricanes. They did roughly 115 billion in total damage and created about 117 billion in benefits. Look at it this way: if natural disasters were so economically wonderful, we would try to duplicate their effects all the time.
Some people will attempt to argue the post reconstruction boom will be so large it will stimulate the economy, creating economic growth. However, the historical record is clear: the rebuilding process after a natural disaster simply replaces total losses.
Total Damage
The total damage estimates vary. I have seen figures from 25 billion to 125 billion. However, given the size of the area involved (three states) and 1 major US city underwater, I tend to think high estimates are more probable. The most widely sited source of damage assessments is from Risk Management Associates
Risk Management Solutions on Friday raised its estimate of total damages caused by the hurricane to $125 billion and said it expects insured losses of $40 billion to $60 billion.
Previous estimates of economic costs of Katrina by federal and state agencies had hovered around $100 billion, while expectations for the costs borne by private insurers had been in the range of $25 billion. Previously, the most expensive hurricane had been Andrew, with $21 billion of insured losses in 1992.
RMS, based in Newark, California, assesses disasters for more than 400 insurance firms, trading companies and financial institutions. It now has the highest estimate of any of the major catastrophe modeling firms. It had expected $20 billion to $35 billion of insured damages just last week.
“We did a lot of reconnaissance since then and the big variable is how bad it’s been in Louisiana,” said Brian Owens, a director with RMS.
However, there are some people within the government arguing the cost will be higher:
One storm could end up costing almost as much as two wars. Although estimates of Hurricane Katrina’s staggering toll on the treasury are highly imprecise, costs are certain to climb to $200 billion in the coming weeks. The final accounting could approach the more than $300 billion spent in four years to fight in Afghanistan and Iraq.
Analysts inside and outside government agree that the $62 billion that Washington has spent so far was merely the first installment of perhaps an unparalleled sum.
As for the overall toll, G. William Hoagland, the top budget adviser to Senate Majority Leader Bill Frist, R-Tenn., said: “We’re obviously over $100 billion. I just don’t know how much over.”
The cost projections are important because they will add to the Federal deficit which currently totals just under 8 trillion dollars. Katrina’s total cost will most likely send the total debt amount over 8 trillion. As some point, the total US debt will require interest rate increases to compensate borrowers for the increased risks inherent in lending to an already heavily indebted borrower. There is no guarantee increasing interest rates will happen as a result of the federal government’s spending on Katrina. However, it is a possibility.
In addition, the Republican’s reckless fiscal mismanagement will hamper the Federal governments ability to stimulate the economy through federal spending. If the economy needs a federal fiscal stimulus, the money simply won’t be there.
Oil, Gas and Energy
Let me tie together several economic threads.
First, wages haven’t increased in the last 5½ years. According to the Bureau of Labor Services, wages for non-supervisory employees have grown 13.24% from January 2001 to July 2005. Over the same time, inflation increased 11.59%, making inflation adjusted wage growth a paltry 1.6% over a five and a half year period. Therefore, US consumers are spending from a stagnant pool of money.
Secondly, consumer spending represents 2/3 of US GDP. For the economy to grow, the consumer has to spend. Therefore, if a necessary expenditure increases at a rapid rate, consumers will be forced to allocate their stagnant income to the necessary resource at the expense of other consumer items.
Third, retailers derive at least 50% of their total revenue from seasonal sales.
So far we have this equation: the US economy depends on consumer purchases to grow. Consumer purchases spike during the holiday season.
Enter energy prices.
As of this writing, the latest release from the Mineral’s Management Service notes at least a third of overall refining capacity is still off line:
Today’s shut-in oil production is 897,605 BOPD. This shut-in oil production is equivalent to 59.84% of the daily oil production in the GOM, which is currently approximately 1.5 million BOPD.
Today’s shut-in gas production is 3.821 BCFPD. This shut-in gas production is equivalent to 38.21% of the daily gas production in the GOM, which is currently approximately 10 BCFPD.
The cumulative shut-in oil production for the period 8/26/05-9/10/05 is 17,121,430 bbls, which is equivalent to 3.127 % of the yearly production of oil in the GOM (approximately 547.5 million barrels).
The cumulative shut-in gas production 8/26/05-9/10/05 is 84.232 BCF, which is equivalent to 2.308% of the yearly production of gas in the GOM (approximately 3.65 TCF).
The lost production will continue through 2006 for some oil facilities.
Crude oil rose after Royal Dutch Shell Plc and the International Energy Agency said U.S. production will be slow to recover from damage Hurricane Katrina caused to rigs and refineries along the Gulf coast.
Shell said today output may not resume from its Mars field, which accounts for as much as 15 percent of Gulf output, until 2006. Production statistics show the industry will take longer to recover from the storm than from Hurricane Ivan a year ago, the IEA said today. About 30 percent of U.S. oil production comes from the Gulf of Mexico.
U.S. oil production in the Gulf of Mexico yesterday was 40 percent of pre-Katrina output of 1.5 million barrels a day, according to data from the Minerals Management Service. Four refineries may take three months or more to resume operations, Energy Secretary Samuel Bodman said yesterday.
Refineries are already operating near capacity. That means refiners cannot simply move operations to another refinery because all other refineries are already operating at peak production. Therefore, any lost production lowers overall refining operations. This limits energy supply. Lower supply = higher cost.
The U.S. economy will face a tough winter due to high energy prices caused partly by a disruption in oil and natural gas supplies from Hurricane Katrina, U.S. Energy Secretary Sam Bodman warned on Thursday.
“There is no doubt that this is going to be a very tough winter season for the American economy (and) for American homeowners,” Bodman said in an interview on the “Fox & Friends” television news program.
The Energy Information Administration said on Wednesday Americans who warm their homes with natural gas could see their fuel costs jump by as much as 71 percent this winter in some parts of the country.
Consumers can’t simply borrow for Christmas. Consumer debt payments are already at record levels. Consumers won’t chose Christmas gifts over heating and transportation needs. As a result, consumers will cut back on Christmas purchases. If they cut back excessively, retailers profits will decline. This will lower GDP growth, decreasing consumer sentiment… you get the idea.
Let’s sum up:
1.) Natural disasters are a zero sum game. Communities essentially rebuild what was lost. Claims the rebuilding effort will help to grow the economy are counter to the historical record.
2.) The Federal government – which is already in a record amount of debt – will increase its total debt to pay for Katrina’s damage. At some point, lenders will demand a higher interest rate because of total US debt.
3.) An already tapped-out, heavily indebted consumer now faces spiking energy prices going into the economically important Christmas season.
Should all the events play out, Katrina will indeed be the perfect storm.