To Worry, or Not to Worry?

Will Katrina really have a substantial negative impact on the US economy, or will its effects be minor and transitory? This week’s Buttonwood column gives both arguments:

Supplies of oil and petrol are being released from emergency stocks, some limited refining is resuming in the Gulf of Mexico, and the price of crude has retreated from last week’s record nominal level. The first murmurs from Lloyds of London suggest that insured losses are likely to be manageable, and that the general firming of rates which will follow could be good for business. The betting in the futures markets is that the Fed will raise rates only once more this year, if that. Plenty of people point out that the reconstruction effort will in time produce an upward blip in economic activity. On this reading, the biggest casualty from the worst natural disaster in America’s history may prove to be not its economy but its president.

But we cannot rely on this sanguine interpretation of the situation. High oil prices were already beginning to slow growth around the world and now American production has taken a huge hit. Consumers filling their tanks with petrol at $3 a gallon would have begun cutting back on other purchases anyway. Thanks to Katrina, a million of them have reportedly lost their jobs and will hardly be splashing out at Wal-Mart. And as long as the ports of New Orleans is out of action, it will be hard to move grains and soybeans south, and coal and coffee north, along the Mississippi. Risk Management Solutions, a consultancy, estimates that the economic loss from Hurricane Katrina, one way and another, will top $100 billion.

Buttonwood goes on to write that what really worries her are the risks that the financial system may be facing, thanks to its very large imbalances and the finance industry’s clever ways of shifting, distributing, and perhaps hiding risk.

Obviously, no one yet knows what Katrina’s impact will eventually be. But I will stick by my earlier argument that if the economy does seem to soften in coming months, Katrina’s contribution to the economic weakness will have been primarily psychological, not physical or financial.