The waters are receding but Katrina might still unleash an unpleasant surprise

Like the irresistibly foul South Park, the spoof news magazine The Onion confirms that American humour is alive and, well, sick. "God Outdoes Terrorists Yet Again," was last week's front page story. "Louisiana National Guard Offers Help By Phone From Iraq":

"BAGHDAD - The 4,000 Louisiana National Guardsmen stationed in Iraq, representing over a third of the state's troops, called home this week to find out what, if any, help they could offer Katrina survivors from overseas.

'The soldiers wanted to know if they could perhaps send some water via FedEx,' said Louisiana National Guard spokesman Lt Col Pete Schneider. The Guardsmen also 'would love to send generators, rations, and Black Hawk helicopters for rescue missions,' but, said Schneider, 'we desperately need these in Iraq to stay alive.' "

Spot on. What was at first a natural disaster has rapidly turned into the Bush administration's political nemesis. The White House, we now know, slashed spending on the New Orleans levees to help pay for the war in Iraq, ignoring repeated warnings about the city's vulnerability to a hurricane. "Homeland security"? Hurricane Katrina has made a mockery of that always suspect phrase.

The big question, however, is whether or not Hurricane Katrina will cause lasting economic as well as political damage. The Republicans could still hang on to the White House in 2008 if all the political mud currently being slung around sticks to George Bush, since he will not be their candidate. But if Katrina were to trigger a recession, the Democrats would be looking not only at big gains in next year's mid-term Congressional elections but also at regaining the presidency.

Strange to say, the mood among economists on Wall Street and in Washington has been complacent - not to say Panglossian - since the hurricane struck. According to Ben Bernanke, chairman of Mr Bush's Council of Economic Advisers and the favourite to succeed Alan Greenspan at the Federal Reserve, the economic impact of Katrina will be modest. The area affected accounts for less than 2 per cent of US gross domestic product, according to Jason Rotenberg of the market analysts Bridgewater Associates. He predicts that the disaster will reduce growth by less than 1 per cent of GDP in the second half of 2005 and will have a "negligible" impact thereafter.

Some optimists point out that, allowing for consumer price inflation, the spike in oil prices caused by Katrina is still well below the peak reached when the Iran-Iraq War broke out back in 1980. Others cheerfully predict that the Fed will now have to postpone further interest-rate hikes. It's an ill wind, indeed.

I am not so sure. This disaster has struck at a time of extraordinary tightness in the global oil market. Back in December 1998, the price of crude oil was just over $11 a barrel. Even before Katrina struck, it had reached the $65 mark. Driving prices upward is the inexorable growth of international demand combined with real constraints on global production. The Asian economies - above all China - are the motive force on the demand side. Since 1990 Chinese consumption has leapt from 2 million barrels of oil per day to nearly 6 million; nearly a third of the worldwide increase in consumption over the past five years has been due to China.

The rate-limiting factors on the supply side are the steady depletion of easily accessible reserves outside the Persian Gulf region and, more pressingly, a chronic lack of spare refining capacity. Katrina has only made a bad situation worse by knocking out a number of major refineries and reducing gasoline output by around a million barrels day. Small wonder oil briefly hit an all-time high of $70.85 after the storm struck. To the dismay of SUV-driving "soccer moms", resuming their post-Labour Day school runs, gasoline prices in some parts of the United States soared to $5 a gallon.

Now, ask yourself: When was the last time the United States was simultaneously bogged down in an unpopular war and whacked by a jump in gas prices? The answer is 1973.

True, we are not quite back in the 1970s yet. Flared jeans may be back, but male hair shows little sign of running amok and the width of the average tie gives no serious cause for alarm. More to the point, there is little sign of the "stagflation" that made life in the Seventies so miserable. Inflation in the US is just over 3 per cent. Unemployment is below 5 per cent. And the American economy is growing at a healthy annual rate of around 4 per cent.

Yet this may be one of those Wile E Coyote moments, when the coyote keeps running for several seconds after overshooting the edge of a cliff. For what is propelling the US economy forward continues to be the extraordinary profligacy of the average American household. The cost of energy may have leapt upwards, but there has been no detectable slowdown in household consumption.

Americans these days respond to every economic setback the same way - by reducing saving. Right now the household savings rate is close to zero. And, with interest rates low and the property market still booming, the American family has never been so highly geared. Mortgages and consumer credit are at record highs. With the government also running big deficits, the macro-economic manifestation of this amazing splurge is an immense current account deficit, totalling nearly $1.2 trillion between 2002 and 2004.

Is this sustainable? Only if interest rates stay low. Yet there are two reasons to suspect that they won't. Number one is that the Fed has been belatedly raising short-term rates for more than a year now. Today, the Federal Funds rate is at 3.5 per cent, more than double what it was in June 2004. Number two is that foreigners may be getting less enthusiastic about accumulating vast piles of dollar IOUs in return for their exports to the United States. After all, what kind of an economy allows one of its main ports to go the way of Atlantis?

Contrary to conventional wisdom, natural disasters really can cause major economic crises. Nearly a century ago, as the economists Kerry A Odell and Marc D Weidenmier recently pointed out, a huge earthquake in San Francisco led directly to one of the nastiest recessions in all American history.

As in New Orleans, the authorities screwed up; it wasn't so much the earthquake as the subsequent fires that destroyed the city. When European insurers started paying out, the drain of gold across the Atlantic led the Bank of England to raise interest rates from 3.5 to 6 per cent. And as American rates rose in response, there was a banking crisis and a recession that knocked down industrial production by nearly a third.

Sure, those were the days of the gold standard. But a similar sequence of events is still conceivable today. The US will clearly need to import more oil in the wake of Katrina, widening its already vast current account deficit. If foreign investors quail at this, the dollar may take another dive. The Fed, in turn, may have no option but to raise rates further. And American families may finally feel the pain, caught in a pincer between their mortgage payments and their energy bills.

The floodwaters unleashed by Katrina may be receding. But the economic aftershock of the disaster may still lie ahead - with implications for the entire world economy that not even The Onion could make me laugh about.