On the Alert for a Category-1 Recession

The 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.

EXPERT LUNACY

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 Lunacy.”

According 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 lunatics.

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 unemployment.

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.

RECOVERY

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.

A MAJOR NET LOSS

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.

Regionally, 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.

Nationally, 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.

RECESSION IS MORE LIKELY

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 winter.

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 charts:

Adjusted Monetary Base: Short-termMZM: Short-termM2: 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.

CONCLUSION

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.

September 14, 2005

Gary 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.

Copyright © 2005 LewRockwell.com

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