Although there are no fixed amounts available, initial reports are coming out regarding the scope of the damage. It is massive. Essentially, an entire city has been wiped out and needs to be rebuilt. Pause for a minute and think about that for a minute: an
entire city is horribly damaged. Many things we take for granted are gone and will need to be inspected and repaired. In addition, the ancillary services the city provides are heavily damaged. New Orleans is a central hub in the
nation's infrastructure. The Port of New Orleans is vital to the Midwest's agricultural and manufacturing interests as a supply and distribution center. Much has been written about the oil situation and the fact the Gulf of Mexico is responsible for 10% of US oil production.
Below I will run through some of the initial economic events that have occurred in Katrina's wake. While no long-term trends have emerged, some initial movements provide some insight into Katrina's effect on the economy.
First, many news reports have highlighted the rebuilding will help to offset Katrina's damage. Technically this is correct. However, as the Bureau of Economic Analysis notes, the net overall effect of a natural disaster is essentially a zero-sum gain. Think of it this way: the entire effort starts in the red. An initial estimate of the damage from Risk Management Solutions puts the price tag at 100 billion. For the economic activity to amount to a growth spurt for the US economy, it must produce over 100 billion in benefits. That's a tall order. Paul Kasriel at the Northern Trust best sums up the situation:
Secondly, although there will be expenditures made to clean up the mess and rebuild damaged/destroyed structures, there will be other expenditures not made that otherwise would have. I doubt that folks will be going to the movies or on vacation as much now that they have to spend more on rebuilding.
There will be a change in the composition of spending, not in its total. Government disaster aid represents a redistribution of income. So, the givers of aid spend less and the receivers spend more - net, net, a wash.
Thirdly, there has been a loss of real wealth. Katrina represented accelerated depreciation. Structures and other tangible assets were destroyed. That means that the services or "income" these tangible assets produced - shelter, transportation - have disappeared. The production of capital assets entails the postponement of current consumption. So, some people are going to have to defer current consumption so that finite resources can be used to reproduce capital assets.
If hurricanes or other natural disasters contained economic silver linings, we wouldn't have to wait for Mother Nature's serendipities. We could create man-made ones.
Interest Rates
No to sound ghoulish, but one of the net financial benefits of Katrina is the possibility the Federal Reserve may pause their recent interest rate increases. This speculation led the 10-Year Treasury to rally last week. There is a feeling that to ease the pain of reconstruction the Fed may halt their hikes at their next meeting. While there is a possibility this would happen, it would be a short-lived pause. The Fed is still concerned about inflation, as evidenced by this statement from the most recent minutes of their August 9, 2005 meeting: the Committee noted that the expansion remained firm, that labor market conditions continued to improve gradually, and that, although pressures on inflation had remained elevated, longer-term inflation expectations remained well contained. Recent price action in the futures markets has added inflation pressure to the economy. Crude Oil is near $70/bbl. Unleaded Gasoline and lumber spiked as well, largely in anticipation of increased demand from reconstruction. In addition, the prices paid component of the Chicago Purchasing Managers Index has risen for the last 4 months.
In short, the rebuilding effort could increase the cost of raw materials needed to rebuild the affected states, adding to inflationary pressure and forcing the Fed to resume its rate increases. In summation, I would expect a pause of interest rate hikes from the next meeting. However, if the upward price pressure continues in the futures markets, expect the Fed to resume its interest rate hikes.
Oil
Oil is still a major concern. According to the most recent statistics from the Minerals Management Service, Gulf oil production is still down, although improving:
These evacuations are equivalent to 30.03% of 819 manned platforms and 29.10% of 137 rigs currently operating in the Gulf of Mexico (GOM). The number of manned platforms that are evacuated declined 25 percent from yesterday.
Today's shut-in oil production is 1,184,747 BOPD. This shut-in oil production is equivalent to 78.98% of the daily oil production in the GOM, which is currently approximately 1.5 million BOPD. This represents a 10 percent improvement from yesterday's figures.
Today's shut-in gas production is 5.779 BCFPD. This shut-in gas production is equivalent to 57.80% of the daily gas production in the GOM, which is currently approximately 10 BCFPD. This represents a 21 percent improvement from yesterday's figures.
The cumulative shut-in oil production for the period 8/26/05-9/3/05 is 9,872,662 bbls, which is equivalent to 1.803% of the yearly production of oil in the GOM (approximately 547.5 million barrels).
The cumulative shut-in gas production 8/26/05-9/3/05 is 53.232 BCF, which is equivalent to 1.458% of the yearly production of gas in the GOM (approximately 3.65 TCF).
The oil market has a reprieve from the recent price spikes. The International Energy Association has released 30 million barrels of oil. This amounts to 3-4 weeks of Gulf oil production. Although it will take 10 days to arrive, the psychological effect should be enough to prevent a massive spike.
With gasoline over $3/gallon in many locations, some economists are speculating consumer spending will slow down. Wal-Mart has already announced high energy prices are hurting sales as consumers cut-back on major purchases to pay for transportation. Wal-Mart made this announcement when gas was still below $3/gallon. It is logical to assume that higher gas prices would further hurt consumer spending. In addition, round numbers (such as $3) provide important psychological markets for people. An increase from $2.90 to $2.97 isn't as psychologically important as a move to $3. Something just clicks when prices cross round numbers barriers. It is possible that $3/gallon will become an important embarkation line with consumers that will make them curtail their spending in a larger way.
The long-term effects on the oil market may be deeper. As the Christian Science Monitor reported before Katrina:
With the price of both oil and natural gas significantly higher than last year, the cost of heating a home will take yet more money out of wallets. Early estimates are that it will cost at least 30 percent more than last year for homeowners in the Midwest who use natural gas to heat their homes, and as much as 20 percent higher for those in the Northeast using heating oil. Those are conservative estimates, however, and expenses could be higher, depending on the weather.
Last December, crude oil was about $40 a barrel. By February, it had risen into the low $50 range. Monday morning, crude oil was more than $65 a barrel.
As for natural gas, last August wholesale prices were $5.41 per thousand cubic feet. Today, they are about $9.
In summation, the rebuilding effort is essentially an economic zero-sum game. Interest rates are still most likely headed upwards to contain inflation, some of which may be caused by the rebuilding effort.
Energy remains a cause for deep concern. The longer gasoline remains above the psychologically important $3/gallon level, the larger the negative impact on consumer sentiment and spending habits. In addition, the winter heating oil market may provide an additional blow to the economy, as Northern consumers are forced to contend with higher heating bills. These two price increases may be enough to do some serious harm to the economy.