On the Alert for a Category-1 Recession

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American economy will suffer as a result of Katrina. So will you
as a taxpayer. Your future earnings, not to mention your children’s
future earnings, will be taxed to pay for the $60+ billion in unscheduled
expenditures by the U.S. government. There are no free lunches or
free cities.

In addition
to the $10.5 billion already passed a week earlier, the new bill
added $51.8 billion. There was hardly a whisper of protest against
this overnight budget overrun. The red ink flows, but no one says,
“Halt!” Well, not quite no one. Ten Congressmen voted against it.
No Senator did. The legislation rolled through Congress like a tsunami.

The Tsunami
of 2004 was correctly seen as an economic disaster of monumental
proportions. Why should Katrina be seen as any less of a disaster,
except insofar as fewer people were killed?

The tsunami
wiped out poverty-stricken villages and coastal towns. The population
loss was massive because there was no warning. Katrina wiped out
New Orleans, ruined a great port, and forced a million residents
to leave. The population loss was minimal because of the warning.

It is not
just the loss of physical capital. Productive workers have lost
their jobs. It will take years for most of them to recover the level
of earnings (productivity) that they enjoyed. They must start over
in new locations and new careers.

Houses and
businesses can be rebuilt by productive people and sold to productive
people, who are funded by productive people. When you lose people
to a catastrophe, the economy loses productivity.

This economic
fact was perceived with respect to the tsunami. When poor people
die, those who survive are even poorer. Common sense ruled the economists
in 2004. I saw no articles about the economic benefits of the tsunami.

Why should
this not be true when much richer people die? When economists talk
about the economic impact of Katrina as if rebuilding were somehow
productive, net, compared to the pre-catastrophe conditions, they
expose themselves as unreliable sources of investment advice.

Problem: economists
are giving such advice, and investors are taking them seriously.


Today, we
see the stock U.S. market stable or even up a little. It provides
no evidence that there has been an enormous economic loss. In fact,
we are seeing economists and economic forecasters cheering the hurricane’s
effects: more investment, more growth.

When I spotted
an article about a pair of economists who said the hurricane would
be good for America’s economy, I sent a copy to my friend Walter
Williams, who writes a widely read national column. I knew it would
be grist for his ever-cogent mill. He did not disappoint me. He
used the news report to jump-start his essay, whose title got right
to the point: “Economic

to a couple of poorly trained economists, there’s a bright side
to Hurricane Katrina’s destruction. J.P. Morgan senior economist
Anthony Chan believes hurricanes tend to stimulate overall growth.
As reported in “Gas Crisis Looms” (Aug. 31, 2005), written by
CNN/Money staff writer Parija Bhatnagar, Mr. Chan said, “Preliminary
estimates indicate 60 percent damage to downtown New Orleans.
Plenty of cleanup work and rebuilding will follow in all the areas.
That means over the next 12 months, there will be lots of job
creation which is good for the economy.”

Walter is
not a man to mince words. Referring to “a pair of poorly trained
economists” is not considered good form in the academic community.
Fortunately, he pays no attention to the academic guild’s etiquette
when a hundred billion dollars are on the line.

Let’s ask
a few smell-test questions about these claims of beneficial aspects
of hurricane destruction. Would there have been even greater economic
growth and job creation for our nation had Hurricane Katrina not
only destroyed New Orleans, Mobile and Gulfport, but other major
metropolitan areas along its path, like Cincinnati and Pittsburgh,
as well? Would we consider it a godsend, in terms of jobs and
economic growth, if a few more category 4 hurricanes hit our shores?
Only a lunatic would answer these questions in the affirmative.

Actually, two

He cited the
famous essay by Bastiat on the broken window, as I
did last week
. As Bastiat argued so long ago, we must always
search for the effect unseen when we discuss repair costs, namely,
the loss of investment in other projects when the money is diverted
to repair whatever was unexpectedly broken. As Walter wrote: “Of
course, were it the Tooth Fairy or Santa Claus providing the resources
to repair the destruction of Hurricane Katrina, Mr. Chan and Professor
Woodward would be correct.” But they are not correct.

The capital
markets still operate on the Keynesian assumptions that undergird
the argument that World War II restored the world economy from the
Great Depression. As for the 50 million people who died — mostly
civilians — well that’s “collateral damage.”

Such an economic
outlook teaches that unemployment can be solved by sending productive
men off to war to kill each other. Meanwhile, the home front has
lower unemployment because the girls who stayed behind are producing
tanks instead of cars, guns instead of vacuum cleaners, and caskets
instead of refrigerators.

Is this lunacy?
What else would you call it?

Yet unemployment
fell. How? Because the Federal Reserve created massive monetary
inflation. The war effort allowed the politicians to get away with
price and wage controls. The public accepted rationing by stamps.
People’s real income fell as a result. Lower real wages created
demand for labor services.

It took a
war to get the voters to accept government destruction of their
wealth. They hailed their good fortune: some many deaths, so little

World War
II convinced many Ph.D.-holding economists of the productivity of
large-scale organized destruction. They are now applying their logic
to large-scale unorganized destruction. Like a broken levee that
formerly restrained economic ignorance, Keynesian error has now
flooded our society with stagnant economic theory. The stench is
getting worse. Walter Williams is correct: “Katrina-induced growth”
doesn’t pass the smell test.


We must not
lose sight of what should be obvious: the main asset of the City
of New Orleans is its location on the Mississippi River. This has
been true since its founding in 1719. The port is extremely valuable.
The old slogan about the secret of real estate investing —
“location, location, location” — applies to the port of New
Orleans. I can think of few locations on earth where it applies
more rigorously.

Because most
residents got out alive, they will be able to return to the region
if their skills add to the productivity of the people who will surely
arrive to work on the port and in the port.

The New Orleans
way of life may be gone. I surely hope so. The “Big Easy” was famous
for its political corruption and its debauchery. Out of the rubble
will come a different city. Not 100% different, but different nonetheless.

People with
money will return. They will reclaim what is left of their homes
and their sources of income. If the city’s rebuilding effort were
funded by (1) entrepreneurs looking to make money from the port
and (2) insurance companies meeting their contractual obligations,
I would be even more optimistic about the future of the region,
if not the city proper. I am relatively optimistic as it is.

Today, if
I lived anywhere near New Orleans, I would be a buyer of abandoned
real estate in those portions of the city and the region that are
not below sea level. I think there will be a real estate boom. Lots
of money chasing a fixed supply of land — or, more likely,
a reduced supply of land. The environmentalist lobby will get a
lot of wetlands placed into the Federal government’s hands.


The U.S. government
is now pouring over $60 billion into rebuilding efforts. Taxpayers
are going to pay for this. Immediately, investors in government
bonds will pony up the money. That money will be withdrawn from
other capital reconstruction projects. There are no free lunches
and no free cities.

This money
will be allocated by FEMA, which means inefficiently. If entrepreneurs
were putting up their own companies’ money, I would see the investment
as rational. It would be invested in the hope of restoring lost
productivity based on the existing value of the real estate: its
location on the river. The loss inflicted by Katrina would still
be as real, but it could be restored. The past is past. We must
start with the capital at hand to maximize our gain.

There is no
way that the $60+ billion that FEMA will pour into the region will
match the productivity of private capital that will also pour into
the region.

If the character
of the people who return to the city is superior to the character
of those who departed, then the city will be better off in the long
run. But that does no good for the regions that took in those New
Orleans residents who were ready to shoot at rescue helicopters.

New Orleans could conceivably turn out to be better off as a result
of the hurricane, if that which had been run by the state is reclaimed
by private industry. But the $60+ billion in Federal money that
is about to be spent there is likely to offset what would have been
a gain.

the hurricane imposed a loss. Taxpayers around the nation will wind
up footing the bill for the Federal government’s portion of the
rebuilding. Also, the port will take years to be fully restored.
The income that would otherwise be flowing into the region will
not be.

Those residents
who did not have property insurance will be worse off. They may
never return to the city. It depends on economic opportunities in
their new locations. If they wind up on the welfare roles in their
new locations, then the cost of local welfare programs will rise.
The hurricane will prove to be an added expense on these city governments.

But there
is the outside possibility that a new location in a less corrupt
environment will produce personal changes in the evacuee’s outlook.
I hope this happens. The corruption of the city governments in the
new locations will be less than what the evacuees are used to. New
Orleans was legendary for its corruption, matched only by the state
government, which goes back much further than Huey Long’s era in
the 1930s, which was bad enough.

Never forget,
Louisiana still operates under the Napoleonic law code, except where
the 14th amendment has been extended by Federal courts. You are
guilty until proven innocent in Louisiana. Only the U.S. Internal
Revenue Code is comparable, with similar results.


The hurricane
has made recession more likely, not less likely. The borrow-and-spend
policy of the U.S. government is still in full swing. Congress did
not think twice about committing the rest of us to the program of
re-building New Orleans. We can expect the government’s debt to
rise. We can expect property insurance premiums to rise, especially
in the gulf regions. We can expect energy costs to stay high through

We will see
if Federal Reserve monetary policy changes. I do not think it will.
I see no change in policy regarding the adjusted monetary base as
a result of the hurricane.

You can see
this readily if you look at the various charts published by the
Federal Reserve Bank of St. Louis. I have assembled them in one
place on my website. Go to www.garynorth.com.
Look under FREE MATERIALS: “Federal Reserve Charts.” Check these

Monetary Base: Short-term
MZM: Short-term
M2: Short-term

The “Adjusted
Monetary Base: Short-term” indicates that the FED has not changed
its monetary policy. The other two indicate that the market does
not expect any changes.

Once you see
these charts, you will be less likely to get confused by all the
talk about whether or not the FOMC will announce an increase of
the federal funds rate at its next meeting. Please, look at the
charts. See if there has been a change in policy or the market’s
implementation since Katrina hit. This is what matters for the economy,
not an announcement by the FOMC. As Nixon’s Attorney General John
Mitchell said a generation ago, “Watch what we do, not what we say.”

The charts
let us watch what they are doing.

If monetary
policy does not change, then the upward move of short-term interest
rates will continue. There soon will be more demand for loans by
the U.S. government to pay for the re-building. This money has to
come from somewhere.


The happy
face that the stock market bulls have been wearing ever since Katrina
is one more example of the power of Keynesianism in the thinking
of the experts. They cannot shake off the tax-and-spend, borrow-and-spend
outlook of John Maynard Keynes and his post-war academic disciples.
Always, government spending is seen as the engine of prosperity.
In this analytical framework, major disasters are regarded as allies
of economic growth.

Capital markets
may weather the shock of bad weather, but they will not do this
at zero price. All of the projects that might have been funded by
the capital that it will take to re-build will be lost. The money
that the U.S. Treasury will suck out of the capital markets will
be spent by the wonderful agencies who designed the levees.

In New Orleans
a century ago, a band would play mournful music on the way to a
funeral and play jazz on the way back. I perceive that the American
capital markets will reverse this procedure.

The saints
of the capital markets today go marching in. They will come marching
out poorer than they went marching in.

14, 2005

North [send him mail] is the
author of Mises
on Money
. Visit http://www.garynorth.com.
He is also the author of a free 17-volume series, An
Economic Commentary on the Bible

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