WASHINGTON—A major hurricane devastates the Gulf Coast, dismembers the nation's energy center, sends national gasoline prices to all-time highs and leaves a storied city a toxic tidal pool. Yet there's little impact on the broader economy.
Economists call it a testament to the strength of the U.S. and global economy, which buffered the nation against Hurricane Katrina's damage and should offset any long-term economic ills from the storm.
Oddly enough, Katrina's biggest economic impact may not be the damage it left but the rapid growth it may spark next year when rebuilding begins in earnest along the Gulf Coast. That could fuel a pace of growth that adds to inflationary risks in an already strong economy.
Higher interest rates are the medicine for inflation, and that could lead to higher mortgage rates, which could threaten the nation's housing boom.
"To me, that could well prove a more important issue than the impact of Katrina," said Ken Matheny, a senior economist with Macroeconomic Advisers LLC, an economic forecasting company in St. Louis.
The nation's four-year housing boom has been fueled in large measure by low interest rates and consumer spending that has reduced household savings to nearly zero. The Federal Reserve has been notching up short-term interest rates—now at 3.5 percent. The number of mortgages and levels of consumer credit remain at all-time highs, and some liken the robust U.S. economy to a house of cards that is built on low interest rates. A sharp rise in rates could bring it all crashing down.
"The floodwaters unleashed by Katrina may be receding. But the economic aftershock of the disaster may still lie ahead," said Niall Ferguson, a Harvard University history professor who warns that Katrina may provoke interest-rate hikes down the road that shock the U.S. economy.
For the moment, however, economists are most worried about Katrina's damage to the energy infrastructure. Decreased oil production and damage to refineries has sent gasoline prices soaring to record highs. The cost of heating a home this winter is projected to rise 71 percent in some parts of the nation.
"It undermines growth at the same time that it fans inflation," said Mark Zandi, chief economist for Economy.com, an economic consultancy in West Chester, Pa.
If the price of energy climbs much further, it could set off an inflationary spiral throughout the economy, Zandi said. In such a scenario, rising prices create pressure to raise wages. Consumers spend less, and with declining sales, businesses fire workers or reduce hiring. Higher unemployment leads to even less consumer spending. It's a downward economic spiral.
Energy prices have climbed steadily since late 2004. That has pushed inflation—the rise in prices across the economy—above 3 percent, the top of the comfort zone for most economists.
But core inflation—the rise in prices excluding food and energy—has been surprisingly unaffected. On Tuesday, the Labor Department reported in its Producer Price Index that core inflation in the production of finished goods was unchanged in August. It grew by 0.4 percent in July. Core inflation for both consumer and production prices remains under a 3 percent annual rate.
That suggests that the economy's absorbing higher energy prices.
"It's not leaking into the core inflation rate as it did back in the 1970s," said David Wyss, chief economist for New York-based Standard & Poor's, a credit-rating and research company.
Energy price spikes in the 1970s created stagflation—a stagnating economy with high inflation. But before Katrina struck, the U.S. economy was on pace to grow at about 4 percent this year. Unemployment hovers around 4.9 percent, historically very low. Consumer and business spending are strong and inflation is nowhere near the galloping double digits of the 1970s.
Katrina "rekindles some concerns about inflation," said Wyss, but the U.S. economy depends less on cheap oil than it did during the 1970s. The strong government and private-sector spending expected to finance rebuilding on the Gulf Coast makes "the stagflation part a long shot," he said.
International trade has also softened the blow of higher energy prices. Although global trade has cost Americans jobs in some sectors, cheap imports from China and elsewhere have a deflationary effect. Imported clothing and consumer goods have stayed cheap and offset the higher energy prices.
"For two years, we've seen this tremendous increase in prices, yet the core inflation rate has stayed at 2.3 percent or less and the only explanation for that is globalization means inflation is contained," said Ed Yardeni, an investment strategist with Oak Associates Ltd. in Akron, Ohio. Yardeni also believes higher productivity—more worker output per hour—has resulted in higher savings for companies, which also serves to offset the higher energy prices.
Katrina will clearly have some short-term impact on the broader economy. The U.S. Congressional Budget Office said Katrina might knock U.S. economic growth back by as much as a full percentage point in the second half of this year.
However, economists point to past hurricanes and say reconstruction will bring job-intensive infrastructure projects like levee reconstruction, homebuilding and repairs to damaged highways and bridges.
The good news is that wholesale prices for gasoline and oil on the New York Mercantile Exchange have both returned to pre-Katrina levels—but that's still high. And crude oil, gasoline and home-heating fuel prices are expected to remain high through next year.
The world's supply of oil is nearly matched by global demand, and U.S. refineries couldn't handle any additional oil supplies if they had them, because they are running at full throttle. Another hurricane, a natural disaster elsewhere in the world or a terrorist attack could easily send today's already-high energy prices to punishing levels, sending consumer confidence plunging.
"The combination of three bucks a gallon for gas and what the rest of the country is looking at on TV and hearing about and reading about certainly are not positives," said Ken Goldstein, an economist with The Conference Board, a New York-based organization that publishes a monthly Consumer Confidence Index.
But even before Katrina, gasoline prices were climbing, sparking fears that consumer confidence would fall sharply. Yet the latest confidence index, published Aug. 30, showed it had not.
"We discovered for the umpteenth time that what matters most for most Americans is the labor market," said Goldstein.
As long as employment remains strong, consumers seem likely to continue to spend despite high energy prices.
For more on the Congressional Budget Office analysis of the economic impact likely from Katrina, go to www.cbo.gov and find the report listed on the left of the home page.
For the Producer Price Index, go to www.bls.gov/news.release/ppi.nr0.htm.
(c) 2005, Knight Ridder/Tribune Information Services.
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