Tuesday, September 06, 2005

Economy shows resilience in face of massive jolt

The US economy's shock absorbers kicked in within days of one of the worst natural disasters in its history, offering hope that the massive jolt to the country's energy and transportation systems won't produce a long-lived, serious economic contraction. The release of emergency oil and gasoline from global stockpiles sent crude-oil prices down to about pre-hurricane levels in European trading. Long-term interest rates fell despite the prospect of higher inflation. Temporary-help agencies began to place some workers displaced by the storm. Hurricane Katrina is the biggest test in years of the economy's resilience. But recent history offers encouraging, though by no means definitive evidence of the US economy's ability to bounce back from shocks. Economic growth has become significantly less volatile during the past two decades. The past five years have witnessed a burst stock bubble, terrorist attacks, corporate scandals, wars in Afghanistan and Iraq, and a doubling in crude oil prices. Yet the economy, after a mild recession in 2001, has embarked on a solid expansion with little inflation. Katrina came at a time when the economy was in solid shape. Employment and output are likely to take a sizable hit in the next few months; the question is the duration and severity of the blow. Economists surveyed last week said the storm would result in growth of only about 3.5%, at an annual rate, in the second half of the year, down from pre-storm expectations of 4%. It grew 3.6% in the first half. And the economy does have some worrisome vulnerabilities. The storm hit when world oil producers and US refiners were operating near capacity and they remain highly sensitive to any loss of supply. Higher gasoline prices will act like a tax on consumers who are already stretched: In July their saving rate turned negative as spending exceeded income. Spending might be further hurt if consumer confidence erodes. As a result, some analysts still believe the economic impact might be severe. "What we're witnessing now is going to turn out to be a really huge shock," said Stephen Cecchetti, a Brandeis University economist.

Oil prices fell yesterday, extending Friday's drop, after the release of emergency stocks. London Brent crude closed down US$1.22 at US$64.84, close to levels seen before Katrina hit. However, a large amount of crucial infrastructure remains offline, leaving the US and the rest of the globe on the brink of a potential energy crisis. The Gulf of Mexico coastal region is home to one-fourth of US oil production, multibillion-dollar floating platforms that were situated far out at sea, refinery complexes that turn crude into gasoline, and a thicket of pipelines that connect them all. A focused picture of the damage to the region's infrastructure remains elusive, but in broad strokes, it is becoming clear the industry faces a two-pronged problem. Its ability to turn crude oil into gasoline is under extraordinary pressure. The storm cut off about two million barrels per day of crude oil refining capacity, resulting in the loss of 1M bpd of gasoline production - or 10% of US demand. Four refineries that together represent about 5% of US oil-refining capacity will be out of commission for at least a month, while another 5% of refinery capacity knocked out by Katrina appears likely to restart in days or weeks. At the same time, offshore facilities that pump crude oil and natural gas from underground reservoirs and carry the fuel ashore suffered widespread damage. Production is returning slowly, and it isn't clear whether it will take weeks or months to return to anything near normal output levels. Whether the looming energy crisis spreads and persists long enough to hammer the economy depends on a variety of factors, among them whether Europe and other countries can supply adequate imports. But with the world facing a refinery-capacity crunch, and US refiners running their plants at full capacity to meet soaring demand for gasoline and diesel, even the slightest sustained outage will likely put considerable pressure on prices. And Eastern US coal prices are surging amid rumors that some Appalachian mines are cutting back production or shutting down altogether due to the scarcity of diesel fuel. "We're about to set record highs on the over-the-counter market," said one broker. Concerns about mining companies not being able to secure enough diesel fuel for their mining equipment were widespread.

Some analysts say the hurricane's devastation will lead to the disappearance of up to 500,000 US jobs this month, the most dramatic decline in 30 years. The job losses would offset the drop in unemployment in August to 4.9%, a four-year low. "There are currently more than a million displaced people, and I don't expect many of them to be back at work by the time of the September payroll survey,” said Ian Shepherdson, chief US economist at High Frequency Economics. The impact of Katrina will not show up until October, but there is little doubt massive unemployment, coupled with the economic damage to the region, will soon be reflected in the economy. Estimates Friday put damage from Katrina at up to US$100-billion, the largest toll in US history. Eventually, rebuilding in the southeast - with at least 500,000 homes needed - should generate as many as 200,000 jobs, according to John Herrmann, director of economic commentary at Cantor Fitzgerald.

Meanwhile, economists in Canada raised their forecasts for the Canadian dollar because they believe the loonie stands to benefit from the disaster. An expected increase in demand for lumber to rebuild the affected regions, soaring energy prices and a weakening US dollar all bode well for the Canadian currency in the midterm and should fuel more gains farther down the road. “We now see more sustained gains for the currency,” said CIBC World Markets' Avery Shenfeld. “The Canadian dollar is viewed as commodity currency and the two important commodities in that mix are energy and lumber.” Crude oil climbed 2% last week, while natural gas and gasoline prices also soared. The Canadian dollar gained about 1% last week to end the week at US84.22 cents. The loonie is also benefiting as the US dollar weakens against other global currencies amid a bleaker outlook for the world's largest economy. Besides high commodity prices, Katrina has also raised the possibility of a pause in US monetary tightening, which should favour the Canadian dollar.
(Dow Jones 050902, Calgary Herald 050903, National Post 050903, 050906, Globe and Mail 050905, 050906, Wall Street Journal 050906)