Hurricanes' Gravest Hit Is Psychological

It's the psychological damage, not the physical, that could determine whether we tip into recession.
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The U.S. economy has dodged a bullet.

After taking dead aim at the heavy concentration of oil refineries and chemical plants from Houston to the Louisiana-Texas border, Hurricane Rita delivered only a glancing shot. The physical damage from Hurricane Rita following the devastation of Hurricane Katrina will not be enough to push the U.S. economy into recession.

But that doesn't mean the U.S. economy is completely out of danger. Recessions are as much psychological as economic events. They're caused when people -- consumers and CEOs alike -- decide to stop spending because they feel the future is dark and dangerous.

We'll only know the full extent of the psychological damage to the economy as the efforts to rebuild unfold over the next few months.

If, come December, consumers and CEOs are looking at the depressing effect of higher prices for gasoline, heating fuels, food and other basic goods, and if we're still seeing news stories and pictures of refugees in tents, then Katrina and Rita will have indeed delivered the kind of psychological wallop that produces recessions.

Economists now estimate that the destruction caused by the two hurricanes will be enough to send U.S. economic growth in the fourth quarter of 2005 down to just 2%. That compares with the economy's strong 3.6% growth in the first half of the year. Before the storms, economists had been projecting growth of 3% to 4% in the last quarter of the year.

Hurricane Math

But economists note that in prior natural disasters, the immediate drop in GDP -- when economic activity in the devastated regions decreases -- is followed by a boost as rebuilding starts.

Do the math yourself: Katrina removed $50 billion in annual output from the national economy by putting New Orleans out of action, but the federal relief and rebuilding effort is now pegged at $200 billion to $250 billion. Check out the spending pattern after 1992's Hurricane Andrew: About 1% of the obligated federal funds was spent in the first fiscal year (which ends on Sept. 30), and 70% was spent by the end of the second fiscal year. That means 2006 is likely to see a big boost from post-storm spending.

It's not hard to figure out which storm caused more economic damage. Estimates for insured damage from Katrina are around $35 billion; for Rita, early figures put damages at roughly $5 billion.

If you look beyond those numbers to try to assess the damage to the nation's stressed industry infrastructure, I'd call the primary damage from Rita wider, but not as deep, as the damage caused by Katrina. That's because the second hurricane lashed a region that includes Houston, the fourth-largest metropolitan area in the U.S. and which accounts for roughly 2%, or about $250 billion, of the national economy. That regional economy includes about half of the country's chemical industry and 15 refineries, which account for 23% of U.S. refining capacity.

Contrast that to New Orleans, a $50 billion metropolitan economy, and Gulfport, Miss., a $10 billion economy. With nine major refineries, the area represents the second-largest concentration of refining capacity, next to the Houston/Gulf Coast region of Texas.

In New Orleans, five of the area's refineries were still out of operation three weeks after Katrina passed, because flooding made it difficult to reach the plants to assess damage and then to restart operations. And the plants remained dormant because electric power still hadn't been restored and because pipelines to get oil in and out of the refineries were either not running at all or running below capacity.

And, of course, new flooding that Hurricane Rita brought to the New Orleans area hasn't made it any easier to get these plants up and running.

Comparing the ports of Houston and New Orleans produces roughly the same conclusion: Houston is the busier port, but the damage at New Orleans runs deeper. The port of Houston is the largest oil-tanker port in the U.S., with about twice the annual volume of No. 2 New Orleans. Together, the two ports account for about 20% of all U.S. petroleum deliveries. It looks like Houston's petroleum docking, storage and transportation systems suffered little damage from Rita and will be back in operation quickly.

Recovery at the port of New Orleans has not been as rapid. Yes, on Sept. 13, the Lykes Flyer became the first ship to unload at the port since Hurricane Katrina struck. That was encouraging news, because some experts had estimated that it would be six months before the port reopened for business.

But the news isn't nearly as good as it seems. The Lykes Flyer unloaded containers -- truck-trailer sized boxes -- of plywood and coffee from the ship by crane and put them on trucks for transport along recently reopened highways. But this kind of cargo is easier to unload and transport. Resumption of grain shipments, where New Orleans plays a critical role for U.S. farmers, will lag until grain elevators are back in operation and barges have a place to unload. And unfortunately for energy prices, there are few ports that can pick up significant slack in petroleum shipments.

Attitude Adjustment

Now let's shift from the physical damage done by the storms to the hurricanes' psychological impact.

Even before Katrina and Rita, there was evidence from

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that lower-income consumers, at least, had started to cut back on their spending because of higher gasoline prices. And that was before pump prices spiked to near $4 a gallon over the Labor Day weekend before settling back toward $3.50.

If damage from Rita to Texas refineries is as light as it now seems, the most recent hurricane won't send gasoline prices much higher. On the other hand, even if the refineries come back on line, it also won't do much to reduce gasoline prices from their post-Katrina, pre-Rita levels.

Higher prices for all refined petroleum products are based on a global shortage of easily-refined light sweet grades of crude and a global shortage of refineries capable of cracking the more abundant heavy sour grades. Katrina and Rita turned that shortage into a painful price squeeze, but there's no way in the short run to get more sweet crude to market or increase refinery capacity. The only question now is how fast the industry can get all the Gulf Coast refineries back on line and take us back to "normal" high prices.

Of course, higher energy prices don't show up only in the gasoline we use to power our morning commute. Even before Katrina hit, the U.S. Department of Energy was projecting home-heating oil would cost 17% more this winter and natural gas would climb 16%.

After Katrina, but before Rita, those projections had climbed to a 36% increase in the cost of heating your home with oil and a 21% increase in heating with natural gas. (For next year, the Department of Energy is projecting just a 6% increase in heating oil prices but another 18% jump in natural gas prices.)Higher oil prices affect businesses, too, clobbering chemical companies, airlines, truckers, farmers -- you name it. And at all those companies, CEOs are looking at hard decisions about how much of the added cost to eat and how much to pass along to customers.

Wait, There's More

Nor is energy the end of the cost squeeze. Take health care. A survey by Mercer Human Resource Consulting projects that health-care costs to employers will rise by 6.4% in 2006, after employers shift some of their costs to employees. (And two-thirds expect to do that kind of cost-shifting in 2006.)

And how much extra can employees expect to find in their paychecks in 2006? The average raise for salaried employees will be 3.6% in 2006, according to Hewitt Associates, and 3.3% for hourly employees.

This kind of squeeze on consumers has been going on for a while now, and consumers have kept up spending by borrowing on credit cards and, more importantly, on their homes. But consumers' attitudes toward future borrowing, especially when they're already as indebted as U.S. consumers are, depends on how they feel about the future.

Consumers will borrow if they think the world -- or at least, the parts of it they care about -- will be a better place tomorrow. If incomes are going up, if home prices are going up, if peace is more likely, consumers will borrow. If the world looks like it's headed in the wrong direction, more people will decide to sit on their cash (or credit lines) instead of spending.

A Thing Called Hope

And that's why how quickly we see real progress in New Orleans, along the Gulf Coast, in Houston and in Galveston will decide whether or not Katrina and Rita will tip the economy into recession. Recent public opinion polls show that a majority of Americans think the country is headed in the wrong direction and a majority now feel we're bogged down in a war in Iraq. The federal government, from the Federal Emergency Management Agency to the president himself, has looked shaky at best and incompetent at worst in dealing with the storms.

If in December, when consumers are supposed to open their wallets in the annual buying binge that provides half of the annual sales at many companies, we're still seeing pictures of New Orleans streets empty except for armed National Guardsmen and body bags, if we're still reading stories about families living on cots in temporary shelters, if the headlines still speak of the death of the Louisiana fishing industry, then the economy will be in trouble. And the economists will be talking so loudly of recession that they're likely to scare us right into one.

If we get to that place, it won't be because two hurricanes named Katrina and Rita destroyed and closed refineries and disrupted pipelines. Or even because they sent millions of people fleeing for their lives and then destroyed their homes so they had no place to go back to. It will be because we've failed in the way we as a nation responded to these horrible but natural events. It will be because we couldn't provide that most basic foundation for economic growth, the one ingredient that leads us to save, and invest, and work hard: hope that tomorrow will be a better day.

At the time of publication, Jim Jubak did not own or control shares in any equities mentioned in this column.