Katrina could hurt the economy more than 9/11.

Commentary about business and finance.
Sept. 1 2005 3:42 PM

The Katrina Premium

Why the hurricane may hurt the economy more than 9/11.

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New Orleans' devastation

Economically speaking, Katrina is no 9/11. It may be much worse. In the months after 9/11, stocks rallied. The Federal Reserve slashed interest rates, unleashing a wave of liquidity and paving the way for economy-boosting gimmicks like zero-percent financing. The airlines suffered a grievous blow. But prices didn't jump; there were no shortages of anything. Looking back, the catastrophe of 9/11 had a relatively minor impact on the broad economy.

And the consensus thus far seems to be that Katrina will be much the same. "As long as we find that the energy impact is only temporary, and there is no permanent damage to the infrastructure," Ben Bernanke, chairman of the White House Council of Economic Advisers, said yesterday, "the effects in the overall economy will be fairly modest." Traders are already having the 9/11 reaction, bidding up stocks and buying long-term bonds.

But because of the nature of the damage, the industries it affected, the role the Gulf Coast plays in the national economy, and the place we're at in the business cycle, Katrina could prove to be inflationary. And as a result, the damage it causes could ripple far beyond the Mississippi Delta.

The 9/11 attacks struck at the heart of the New Economy. But the businesses affected—newspapers like the Wall Street Journal,investment banks, stock traders, insurance companies, accountants, and the New York Stock Exchange—were able swiftly to reorganize and get back on track in short order. The physical infrastructure they lost was not essential to their businesses—Merrill Lynch could trade stocks in midtown; the Wall Street Journal could publish from New Jersey. As a result, the businesses and consumers all over the country who relied on these services didn't face major dislocations.

But things are different with Katrina. The hurricane directly affected only a small chunk of the consumer economy. Louisiana and Mississippi have a combined population of 7.5 million and account for about 2 percent of the nation's economic activity. But it will indirectly affect all consumers and businesses, in the United States and abroad.

The problem is that New Orleans lies at the heavily trafficked intersection of the Old and New Economies. The region's economy is based on agriculture, water transport, and natural resources. But moving and selling goods requires an intricate web of supply chains, pipelines, and commercial arteries that connect producers to consumers. The networked economy isn't just about bytes and fiber-optic cable, it's about oil, grain, and sugar. And when the infrastructure of these networks gets damaged, it can't be replaced easily or cheaply.

If New Orleans were pure Old Economy—if, for example, it simply grew wheat—its devastation would not cost that much, because other wheat and grain growers would replace it. If it were pure New Economy, like Wall Street, it could bounce back instantly, because its real assets (information and people) would not be irretrievably lost. But because it's right in the middle, the damage will be enormous.

Katrina, for example, has already created havoc in the energy sector. Nine of the region's 14 refineries are shut, representing 12.5 percent of U.S. refining capacity, according to the Financial Times. This week, the United States also lost about 20 percent of its oil production and a big chunk of natural-gas production. As a result, the pipeline systems that originate in the Gulf Coast region and snake throughout the Southeast and Atlantic seaboard aren't functioning properly. The instantaneous result: higher costs for gas and heating oil in states far beyond Louisiana.

Energy Secretary Samuel Bodman may have announced the release of crude oil from the Strategic Petroleum Reserve. But the bottlenecks in refining and distribution are causing price increases and panicked buying in Atlanta. Maintaining redundant trading floors and offices to be used in a crisis is relatively inexpensive, which is why Wall Street got back to work immediately after 9/11. But building and maintaining redundant oil refineries is prohibitively expensive.

Energy isn't the only valuable commodity that flows through New Orleans. As the Wall Street Journal notes, New Orleans ports "handle roughly half of the corn, wheat and soybeans exported from the U.S., much of which reaches the city on barges traveling on the Mississippi River." Katrina has already screwed up the vital supply chains that funnel goods from the Midwest to global markets and from global markets to the Midwest. Farmers have been floating grain to external markets on river barges since the 18th century not because it offers speed, but because it is the most economically efficient means of doing so. As the Associated Press notes, "The Mississippi River is the cheapest route for shipping many crops and other commodities destined for overseas markets." So, farmers looking to get their goods to market will now have to rely on more expensive modes of transport. And importers will either have to eat higher costs or pass them along to consumers. Until yesterday, about 25 percent of Chiquita's banana imports arrived in the United States at the company's Gulfport, Miss., facility. No longer. The company, and many others, will have to scramble to find alternate (and likely, more expensive) arrangements.

Finally, consider the agricultural staples that are produced in huge volume in the Gulf Coast region and that are used in a wide range of products in the United States and overseas: oysters, chickens, cotton, and sugar, to name a few. Katrina will have the effect of making them more expensive and setting off a scramble among the companies that need steady supplies to find new sources. The shortages will drive up prices here and make our exports more expensive—and less competitive—abroad.

I have no doubt that markets and companies will respond to the disruptions—and respond more rapidly than we can imagine—just as they did after Sept. 11. But it will likely be a matter of months, rather than weeks, before things return to normal. Until then, the flood, which has deflated the hopes of so many, may act as an inflationary force.

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