In today's increasingly interconnected economy, the economic fallout from a natural disaster is rarely relegated to the geographic area that it hits. In fact, even natural disasters that take place thousands of miles away can shake up your portfolio here at home.
Besides loss of life, infrastructure destruction is by far the most obvious type of damage that comes to mind when we think about natural disasters. But the economic consequences are rarely considered beyond what the cost will be to rebuild.
The Unforeseen Problem
One of the biggest problems for areas affected by natural disasters is business disruption. With road, communication infrastructure, and building damage common after sizable disasters, it's not uncommon for local businesses to be shut down for some time after the aftershocks settle. Reuters reported that after a series of earthquakes hit Japan, factories for manufacturers like Sony, Honda and Toyota were closed.
The recent, massive Louisiana floods – Livingston Parish had 25 inches of rain in three days – are having a devastating effect on the state's rice crop. Three-quarters of Louisiana's rice fields are in the affected region, and Louisiana State University agronomist and Louisiana rice extension specialist Dustin Harrell estimated the loss to Louisiana rice fields alone to be approximately $14.3 million. That doesn't include the estimated 40,000 buildings that were damaged and destroyed in the 20 affected parishes.
When Hurricane Katrina ravaged the Gulf coast back in 2005, companies reeled from catastrophic losses; millions of workers in Louisiana, Texas and Mississippi were left jobless, compounding the already staggering poverty problem in the region. With this mass unemployment came a severe cutback in consumer spending (at the few places that were open for business) and – consequently – tax revenues needed to aid in the rebuilding efforts. Furthermore, the international impact was especially felt throughout the energy sector as oil prices escalated due to destroyed rigs and refineries. (Learn more in Consumer Spending as a Market Indicator.)
In places where significant portions of the country are decimated by disasters, governments are often left with little recourse; with a fraction of their former tax revenue coming in and deteriorated sovereign creditworthiness, foreign aid becomes an absolute necessity.
The Commodity Effect and Scarcity
But those factors only touch on how much of an effect a natural disaster can have on investment portfolios around the world.
Through the popularity of ADRs, ETFs and other forms of international investment diversification, the ability of U.S. investors to own shares of companies based abroad has expanded considerably in the last decade. Because of that, owning shares of any given company's stock can give an investor an interest in a refinery in Louisiana or a gold mine in Africa – and it can expose investors to the risks associated with these locales.
Less obvious – but perhaps even more significant – are the effects that a natural disaster can have on commodity prices. In the case of Hurricane Katrina, the storm's entry point at the Gulf coast is significant because of the fact that nearly half of the gasoline consumed in the U.S. passes through refineries that were affected by the storm. As a result, oil and gas supplies were affected immediately after Katrina made landfall. With increased gas pump prices, extra effects included diminished margins for industries – from transportation to consumer goods.
Similar things happened in the copper market as earthquakes in Chile choked production and inflated copper prices worldwide.
These kinds of price increases aren't just limited to market-traded commodities. When natural disaster strikes, scarcity rules, and regular staples like food, merchandise and even housing can become commoditized as a result. (Learn more in How to Invest in Commodities.)
The Bottom Line
Ultimately, it's difficult to imagine the extent of the economic repercussions a major natural disaster can bring about. Although there's little we can do to avoid Mother Nature's next catastrophe, we can better prepare for it – both physically and financially. Understanding the economic implications of a disaster is the first step towards that.