Some thoughts on Katrina and the economy

I understand the reasoning behind the standard argument that big storms have less impact on an economy - particularly a large and diverse economy - than one would expect looking at the scale of the devastation.   And that devastation truly is extraordinary, whether viewed from the ground or from space.

Insurance checks and rebuilding offer a boost to the local economic activity, even if the rebuilding just offsets the wealth lost in the storm (see DeLong).   And the US economy is just so big that the loss of the output of even a major city hardly registers in the national data.   According to Dan Gross, "Louisiana and Mississippi have a combined population of 7.5 million and account for about 2 percent of the nation's economic activity."  And not all economic activity in these two states takes place on the coast.

But it also seems clear that Katrina was not just any storm.  A city of half a million is basically underwater.   The government's response to the crisis - at least to date - seems inadequate and disorganized.   Right now, we are struggling to get people out of New Orleans.  It may be three months or so before people can move back in, let alone start to rebuild. 

That makes Katrina rather different from the typical hurricane.  And the impact on the economy probably will be a bit different as well.  As Lex notes in the FT, 1% of the US population may be out of work for some time.   And then there is the impact Katrina had on the United States' oil, refining and transportation infrastructure.  (More follows)

It has been hard not to notice that southern Louisiana is a hub for both US oil production and the refining of crude into gasoline, jet fuel and other "products."    It now looks like some refining capacity may be offline for some time.  See Calculated Risk.  Look for the US to import even more refined products from Europe.

The ports of Louisiana are also an essential part of the infrastructure that supports US agricultural exports - something like 55% of US grain exports (and 60% of corn exports) go down the Mississippi before being transferred to bigger ships.

In some broad sense, the tradables goods producing part of America (i.e. the agricultural and industrial Midwest; for the time being I am setting aside Seattle's plane and software factories, and the Los Angeles' film studios and parts of Silicon Valley) is connected to the world through two great corridors - one running along the Mississippi river, and another running through the great lakes and the St. Lawrence.  The low cost of transporting grain out of the US Midwest by barge is one of its core competitive advantages; compare the US v. Brazil in the soybean market.    Or as Dan Gross puts it, New Orleans is at the intersection of the oil and the new economy.  It is easier to replace corn production with imported corn than the infrastructure we rely on to move corn around at low cost.

I have no idea how quickly the infrastructure of the Louisiana ports can be brought back on line.  I sort of doubt that there are viable (at least commercially viable) alternatives to the Mississippi though - the infrastructure for handling about 1/8 of the total US grain harvest doesn't materialize overnight (1/4 of US production is exported, over ½ through the Mississippi).   Sure, some grain might be able to go through the Great Lakes.  The Port of Indiana has high hopes.  Or be shipped to the West Coast by truck.   But those alternatives cost more.  Put it this way - they take a lot more gas than floating a barge down the Mississippi, and gasoline is not exactly cheap.

Farmers in the Midwest are gearing up for the corn and bean harvest, grain elevators are clearing out last year's crop to make way for this year's crop - though I gather the real crunch on the Mississippi won't come for several weeks.   That is all part of the normal operation of a vast economy.  New Orleans is more than just a tourist destination.

Right now, grain prices are down a bit and gas prices are up a bit.  Harvesting grain the American way uses a lot of gas.  Someone is gonna get squeezed just a bit here.  If not the farmer, then the Federal government.

No doubt we will adjust if the infrastructure around New Orleans cannot be quickly repaired.  But those adjustments will, in some cases, be costly.

That may be a suitable broader metaphor.  We can all adjust to $3 a gallon gas.   But doing so won't necessarily be pleasant.

There is little doubt though, that should the US consumer ever respond to higher gas prices by cutting back on their spending on other goods, not by dipping into their savings, the US - and the world - economy would look rather different.   I agree with Kash -  "the current situation contains the seeds for such a shift in sentiment."  Who knows if those seeds will take root and grow.   They might, or they might not. 

The average American doesn't have a lot of savings to fall back on when the going gets rough - though nothing prevents the American consumer from dipping into their accumulated assets and running down their net worth to pay for their (soaring) gas bill. Minimizing the short-run economic impact of Katrina requires getting the region's infrastructure back up and running quickly - and convincing America's consumers to save even less as they spend ever more on gas.

The federal government also is likely to save less - which is another way of saying spend more.  I suspect the today's A4 Wall Street Journal story "Washington Gears Up for Disaster Relief" is right - hopes for further falls in the US government deficit "were battered by Hurricane Katrina."   Obviously, the fiscal impact of a crisis like this should be the last thing on our minds right now, but it does illustrate - to paraphrase one of Alan Greenspan's principles - that forecasts are unreliable.  The unexpected happens.   The US has not taken advantage of the recent recovery to build a large fiscal buffer against the unexpected. 

I suspect that the final federal bill for Katrina will prove to be substantial.  In addition to the direct bill for disaster relief, the federal government could be called on to make up for the disaster-related short-fall in state tax receipts in Louisiana and Mississippi.    Casinos provided a shocking a shockingly large share of Mississippi's budget; and I would be surprised if Louisiana's tax revenues do not plunge in a big way even as its expenses soar.   And as higher oil and transportation costs ripple through the economy, from farms out - that too will have an impact.

UPDATE:   I recommend Richard Berner's attempt to lay out the economic impact of Katrina.  One fact jumped out at me:  the Port of New Orleans is more central to US exports than to US imports.   All that Midwestern corn.

The Port of New Orleans is a major shipping gateway for the Midwest.  Although it is overshadowed by other US ports measured by value of trade (accounting for 8.9% of exports and 3.6% of imports), flooding has snarled logistics for important bulk cargos comprising the majority of New Orleans' trade, like grain, steel, forest products, coffee, rubber, copper, and agricultural chemicals. 

UPDATE 2: More on the importance of the New Orleans port complex from Statfor.  It puts flesh around the bare bones I sketeched out above.