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Why Katrina Won't Sink the Economy

The images we are seeing from New Orleans are almost Biblical, combining all of the horrors of flood, pestilence, famine and destruction. The immediate effect of any natural disaster on the local economy is catastrophic. Traditional patterns of business and consumer behavior are torn apart. Homes, businesses and jobs are lost. Much of the business activity that is lost can never be recovered. A local economy so affected will go through the five stakes of grief that are very similar for the individuals who are involved.

These are: Denial, Anger, Rationalization, Depression, and Recovery. We are probably just getting past the denial phase and what we are likely to see over the next several weeks is a lot of anger; anger at the government for not doing enough, anger at the looters for taking advantage of the situation, anger at Mother Nature for taking such a terrible toll, anger at soaring energy prices. That will be followed by rationalization that we as a nation and New Orleans as a city can cope with and will survive this terrible disaster, which in turn is followed by depression over the loss of life and property that has occurred. Given the magnitude of the loss of property and lives, these phases are likely to be longer then what we saw in Florida last year following the succession of hurricanes that hit that state.

If past experience is any guide, the final stage of recovery does come faster than most people expect. In Florida the economy was booming three months after the last hurricane roared through the state. The flooding of Hurricane Katrina is being followed by a flood of federal disaster relief dollars and insurance reimbursement dollars. The Federal government has already promised $10.5 billion in aid with much more to come. Estimates for insurance company payouts are anywhere from $10-15 billion, far exceeding the $7.5 billion paid out last year to Florida residents.

The recovery process can have a very positive effect on a city's sense of community and civic pride as people are brought together in a common cause to make their community whole again. While some past residents will never return to New Orleans, the rebuilding effort will create many jobs for the local construction and building industries, attracting new people to the area. Hopefully, next February's happy news story will be about Mardi Gras revelers in a recovering New Orleans.

For the nation, the disruption of the energy complex in the Gulf of Mexico has already sent already high gasoline, heating oil and natural gas prices up sharply. This kind of supply shock to the economy will take anywhere from 0.5 percent to 1 percent off of GDP growth from now to the end of the year. Much of the hit from energy prices will be absorbed by retail and consumer goods companies. The hit is temporary as the refinery and production capacity will eventually be brought back on-line. Last year, Hurricane Ivan disrupted Gulf oil production sending prices higher. And yet, the economy still managed to turn in a strong performance.

Every company that uses energy will see an increase in their cost of doing business with little opportunity to pass the costs along to consumers, resulting in a weaker environment for profitability. The slowdown in the economy will also force a pause in the interest rate hikes of the Federal Reserve, which will offset some of the negative effects of higher oil prices. Over time, as the oil, gas and natural gas producing capacity of the Gulf comes back on-line, prices will begin to recede and the economy will return to its growth path of 3.5 to 4 percent, consistent with what we have experienced over the past three years.

Impact on Retailers
For the immediate future, however, rising prices for gasoline and home heating will cut into consumer purchasing power. The impact of higher energy prices will be felt most dramatically by middle market food retailers. High-end consumers are not income-constrained and their purchasing behavior outside of those directly affected by Katrina will be little changed. Price-driven retailers will experience a decline in sales per customer, but a pickup in the number of customers who downshift to cheaper brands and cheaper shopping venues. The losers in all of this are the middle market food retailers who will lose both customers and spending by customers to the down market food retailers.

As for the c-store/petroleum marketer, spot shortages of gasoline have already been reported. The downshifting of consumers from premium to regular is also causing supply mix problems. The extreme volatility of prices will make managing margins all the more challenging. These disruptions should be temporary as gasoline is brought in from Europe and the Gulf production is brought back on line. Higher prices will produce of windfall of revenues. They will also make in-store sales growth more challenging.

While gasoline and oil prices are at record levels, their impact will be much less negative then what the US economy experienced in the past. Since the oil price shocks of the 1970s and early 1980s, oil productivity has soared. U.S. oil consumption today is only 7 percent above the peak levels of consumption reached in the late 1970s even as the U.S. economy has grown 115 percent.

The difference between economic growth and the growth in oil consumption is productivity. American consumers and businesses have learned to do a lot more with a lot less energy. When overall inflation, up 183 percent since the consumption peak, is taken into account, a true measure of the impact of rising oil prices can be derived.

Carl Steidtmann, chief economist for New York-based Deloitte Research, is a recognized expert on economic forecasting of retail sales activity, consumer trends, and general economic conditions.

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