Be careful what you ask for....

As I've watched the images from New Orleans in awe, my mind keeps recalling the sentence from the Neo-Con manifesto, The Project for a New American Century's Rebuilding America's Defenses: Further, the process of transformation, even if it brings revolutionary change, is likely to be a long one, absent some catastrophic and catalyzing event – like a new Pearl Harbor, and the administration's swift response to the attacks of 9/11. I wonder how long it took, that morning in September, before the phones started to ring, decisions were made, and armies began to move? "This is the moment we have been preparing for," they must have thought, and off they went, milking the catalyzing event for all it was worth.

Alas for the Neo-Cons' plans, and hundreds of thousands of residents of the Gulf Coast, Mother Nature just trumped the airborne attackers of 9/11. I wonder what a different administration, say one "champing at the bit" to rebuild American infrastructure with as much vigor as the Neo-Cons wished to project American Military Dominance in the days before 9/11, would have made of Hurricane Katrina? For in sheer human terms, the effects of Katrina will dwarf those of 9/11, the catalytic effect, if you will, will be much more profound.

Another oft recurring thought popped into my head when I began to contemplate the effects of this disaster, monetary quantification, and the relation thereof to GDP, seems such a useless metric for economic considerations. According to the NYTimes, A risk management firm yesterday offered the first estimate of economic losses from Hurricane Katrina - $100 billion - and said that private insurance would probably cover less than a quarter of that. Federal money and charitable contributions may need to do the rest. Ah, the GDP economist might think upon reading this, $100B is not quite 1% of GDP, more than a blip but not by much. Those unfamiliar with (or worse disbelieving) the argument in Bastiat's Broken Window are already looking forward to all the new construction.

Consider the GDP metric in a new framework, perhaps that of the human body. If a doctor tried to console you by saying that the 3 toes you just lost to gangrene from wading in toxic water represented less than 1% of your body weight, would you feel better? Would you feel that he had a handle on the situation? and could make forecasts about your future quality of life going forward? Then again, I guess it depends on the % about which we speak. Many people could easily, and probably happily give up a few percent of body weight from the right spots and equally most would die if that same weight were removed from vital spots.

New Orleans and the surrounding area, seem to me more than just liposuction material, or as one astute observer put it, a place that "could be bulldozed." As the website of the Port of New Orleans puts it,

Ideally located at the mouth of Mississippi River, the Port of New Orleans is America’s gateway to the global market. New Orleans has been a center for international trade since 1718 when it when it was founded by the French.

Today, the Port of New Orleans is at the center of the world's busiest port complex — Louisiana's Lower Mississippi River. Its proximity to the American Midwest via a 14,500-mile inland waterway system makes New Orleans the port of choice for the movement of cargoes such as steel, grain, containers and manufactured goods.

The Port of New Orleans is the only deepwater port in the United States served by six class one railroads. This gives port users direct and economical rail service to or from anywhere in the country.

From the same site, here is an assessment of damage.

“The Port of New Orleans’ riverfront terminals survived Hurricane Katrina in fairly decent shape,” said Port President and CEO Gary LaGrange. “Although they are damaged, they are still workable once electrical power and manpower is available.”

“In the next several weeks, almost all of the Port of New Orleans will be dedicated to military relief vessels. In the next week to two weeks, commercial vessels will return once electrical power and manpower arrive,” LaGrange said He added that many repairs will be needed though to bring the Port back to full capacity.

One of the more curious pangloissian arguments I have been reading these past few years avers that the United States is less dependent on oil now than, say 25 years ago, because the cost of oil supplied to the country is a much smaller component of GDP. I think we are going to find out just how dependent on oil specifically, and our physical infrastructure in general, the nation is as the effects of this material bottleneck are experienced. The port, the oil rigs, refineries, chemical plants, offices, homes, jobs and lives have all been profoundly effected. Several weeks worth of shipping is in limbo- shipping which is the direct physical counterpart to millions of $ of financial contracts each day that will compound. Inverting the argument above, I wonder, since so much more of GDP is levered on a similar process now than 25 years ago, if its interruption will have a much more significant financial effect? No matter how you slice it, the map of material exchange which is the financial markets is but a reflection of the material world.

A few years back, Federal Reserve Chairman, Alan Greenspan, argued: Even our most sophisticated analytic techniques have difficulty dealing with the interactions among time preference, risk aversion, and uncertainty and with the implications of these interactions for the risk premiums that are embedded in asset prices. It is our failure to anticipate changes in this discounting process that much of our inability to accurately forecast economic events lies. For example, the dramatic changes in information technology that have enabled businesses to embrace the techniques of just-in-time inventory management appear to have reduced that part of the business cycle that is attributable to inventory fluctuations and, accordingly, may well have been a factor in the apparent decline in equity premiums that has characterized the latter part of the 1990s. Whether the decline in these premiums themselves may foster activities that could result in wider business cycles, as some maintain, is an open question.

I expect those "sophisticated analytic techniques" will, in hindsight, be seen once again to have misread, at least initially, "the interactions among time preference, risk aversion and uncertainty" to which Greenspan refers. Interestingly, Wall St. was, at least initially, equally non-plussed about the effects of the 1973 oil embargo (Embargo was announced on Oct. 19 yet the Dow Jones didn't begin sinking until November) a transformational event noted by Daniel Yergin, of Cambridge Energy Associates, in the Wall St. Journal;

Katrina's shock underscores a transition in the idea of energy security. For three decades, the operating concept was "1973 Vintage": In response to the 1973 embargo and then the Iranian upheaval, it focused on securing the flow of crude, primarily from the Middle East, and coping with any disruption. The SPR was created in the mid-'70s for 1973 Vintage reasons (although the idea of such a reserve had first been bruited by Eisenhower after the Suez Crisis). Its proponents, focused on another Middle Eastern crisis, never thought that its second major use (the first being in the 1990-91 Gulf Crisis) would be for domestic disruption.

But a host of developments -- from terrorism to the California power crisis to the East Coast blackout to Katrina -- have emphasized a return to what might be called the World War II model of energy security, assuring the security and integrity of the whole supply chain and infrastructure, from production to the consumer. (The gravest energy threats during World War II were when Nazi U-boats came close to cutting the tanker pipeline across the Atlantic that supplied U.S. military forces). This more expansive concept of energy security requires broader coordination between government and the private sector; more emphasis on redundancy, alternatives, distributed energy and back-up systems; planning and pre-positioning of vital supplies ("strategic transformer reserves" for electric substations); and methods that can quickly be applied to promote swift market adjustment. As with the August 2003 blackout, this crisis underlines the need for modernization and new investment in the energy infrastructure that supports our $12.4 trillion economy. A strong push in this direction may come from the new energy legislation, rather than from the idea of "energy independence."

The PNAC's vision of American Military Dominance fits quite well with what Mr. Yergin calls the "1973 vintage" operating concept of "energy security." But as seems painfully clear now, is much less useful as driving force behind the WWII, or primacy of the nation-state as operating unit, model. Assuring the security and integrity of the whole supply chain would seem to call for a reversal of recent policy. Instead of just in time inventory management and outsourcing to the cheapest bidder, a.k.a. globalization, which increases dependency on each element of the supply chain, Yergin argues, we will need broader coordination between government and the private sector; more emphasis on redundancy, alternatives, distributed energy and back-up systems; planning and pre-positioning of vital supplies ("strategic transformer reserves" for electric substations).

Growing public discontent with administration policies have, I believe, found their focus in the effects of Hurricane Katrina and the official response. The trade-offs inherent in any policy choice have been brought into stark relief. Many former administration cheerleaders in the media have had their confidence shattered. The Bush administration faces, in my view, its biggest test. The change in national sensibility invoked by the Hurricane and its aftermath, will, I believe, be profound, far more so than after 9/11. If the Bush team rises to the challenge and puts the same intensity into rebuilding the area, helping people get back on their feet and making the nation's transport and energy infrastructure more secure, they could still pull a rabbit out of the hat. If instead, they opt to continue, what in the aftermath of Katrina might come to be seen as tilting after windmills in Iraq, they may yet follow in the footsteps of the Nixon administration.

More to the point for those playing the financial markets, the bet that the Iraq War would make the world a better place for commerce seems to have been exposed. In their wildest dreams, neither Osama nor Saddam could have dealt the US commercial machine a heavier blow than the lack of preparation for a significant hurricane in New Orleans. While it is yet early, I speculate that Federal Reserve efforts to reduce some of the imbalances in the financial system by raising the cost of funds will be terminated. How the nation's creditors respond to that will be key.

As Mr. Yergin made clear above, the Arab Oil Embargo was a transforming event. Rewind the clock back to 1973. Despite years of widespread, by virtue of fear of the draft, anti-war sentiment among the young and rising costs from whose effects the economy was being insulated, the policy of "stopping the spread of communism" was in full swing. Then the Arab oil embargo, the catalyst of 1973 if you will, painfully demonstrated that the nation's military assets had been engaged in the wrong theater. It was seen that the biggest threat to our nation's security was not the spread of communism in SE Asia but the flow of oil from the Middle East. The malinvestment of the Vietnam War was exposed for the world to see.

The men behind the PNAC asked for a catalyzing event and in this case they may have gotten more than they bargained for. Unlike the attacks of 9/11, the media will not need to show images and descriptions of the event to bring the effects home to those not in the immediate vicinity, they will be felt on their own. In one of his final interviews in office, President Clinton wryly noted that "They'll (the Bush team) have the microphone." In the aftermath of 9/11 they also had the story to transmit. I certainly hope they have a new narrative now.