LA Wildfires, Deficit Spending, and Inflation

Last month, the Fed signaled they may decrease interest rates fewer times than expected in 2025. The reason they gave? Because they believe “events” may create unanticipated price pressure.

What do the Los Angeles wildfires have to do with a ship running into the Baltimore Bridge and blocking access to a major port, missiles being launched at 10% of world trade trying to cross the Suez Canal, and a new president levying tariffs on the world’s largest producer?

These are all historical events creating price pressure and deficit spending in a global economy less resilient than its pre-pandemic predecessor. I’ve been thinking a lot about how events like these create countervailing forces. Pressures on commodity prices, wages, deficits, interest expense burdens, but also how deficit spending stimulates GDP. Like, can it all be added up to “outgrowing inflation” (or not) if their forces interact, dissipate, or morph into something else?

Think about the Suez Canal. We were able to mute its effect on inflation in Europe because, in part, the United States has had a VERY expensive fleet parked and waging war outside Yemen. But that just means deficit spending across the Atlantic and that has its own effects.

My brain went into overdrive this weekend thinking along these lines for the tragic Los Angeles wildfires (and other climate related disasters).

So… Like Yes There Are More Billion-Dollar Disasters Now

One week into 2025 and FEMA’s $23 billion budget is already half gone. The reason is because hurricanes Francine and Milton did not fit into their 2024 budget and were pushed forward.

The number of billion-dollar climate disasters (wildfires, droughts, heat events, flooding, hurricanes, and tornados) per year has grown a great deal over time. In the 1980s FEMA averaged 3.1 such disasters per year, in the 1990s it grew to 5.5, in the 2000s: 6.7, and in the 2010s it jumped to 12.6. From 2018-2020 it was 17.8 per year. And from 2020-22 it was 20.

In 2023 and 2024, we had 28 and 27 billion-dollar climate disasters, respectively. Keep in mind, these are inflation adjusted dollars!

These wildfires can have two pathways to impact inflation: Prices surrounding housing and deficit spending.

Rent Underlies CPI “Stickiness,” So Too Will Workers Wages, Commodities, and (maybe) Insurance

Headline inflation growth has been falling for a year now. Shelter costs seem to be the thing that is keeping it from reaching pre-pandemic 2% *utopia* levels. Many believe that because housing prices are baked into lease agreements which last months/years, and because housing rents are only measured every 6 months, that we are due for a decline in shelter prices any moment now. No one really knows the true true price of housing.

In May, Federal Reserve chairman Powell was somewhat perplexed by its stickiness, saying that “housing inflation has been a bit of a puzzle.” As of December 2024 we are still having this discussion.

The Consumer Price Index (CPI) doesn’t even count home insurance costs and the Personal Consumer Expenditure Index (PCE) gives very little weight to property insurance. The historical reason for this is that insurance wasn’t really that big a deal in household costs. But history has changed that. Premiums for owner-occupied housing were up 11% nationally in 2023. For single-family homeowners, the average price went from $1,081 in 2018 to $1,522 in 2023. Again, these are averages. If you want to talk about hidden inflation making voters in swing states upset here is one starting point.

“It definitely matters for psychology — 100 percent,” Omair Sharif, founder of the research firm Inflation Insights, said of home insurance in particular. “But it amounts to having very little impact on the aggregate inflation data. It’s not really going to move the needle.”

Apparently, 65,000 home insurance polices were not renewed in California in the last 5 years. That number should be met with some skepticism though, because it has a lot more than just “denials” baked into it. More likely we are just going to see price pressure from insurance policies. That risk premium taken on by these companies is going to resonate across the insurance market. What is that number? I don’t think anyone knows.

Moody’s estimated the INSURED damage from Hurricane Helen and Milton were between $35 and $50 billion dollars. Last Thursday, Morningstar DBRS had the figure for the LA fires at $8 billion. These are high-end homes though, occupied by rich people. Folks in Altadena may not have second homes, but I went to high school there and my parent’s live down the street in Pasadena. Those are middle and upper-middle class homes. JPMorgan predicted damages would cross $20 billion. The state predicted a fire in this area would cross the $30 billion figure. Most importantly, these estimates assume current inflation numbers. In other words, we are looking at fires with a record breaking figure for property damage.

California’s property insurance market was already buckling from increased risk and the inability/unwillingness from consumers to pay more. State Farm and Allstate refuse to sell fire insurance in the state after our megafires in 2017 and 2018.

The state changed some rules to try to get insurers back in; by more or less allowing insurers to raise prices based on the cost of their own insurance for their insurance products! So like, price pressure in another insurance market?

The state is the insurer of last resort (the FAIR plans), so there is a double feedback here on deficit spending (more on that below). There is a large concentration of that "PUBLIC OPTION FIRE INSURANCE” in these high-risk rich areas. The state is heavily exposed here, estimated at $24.5 billion in the zip codes impacted by the LA fires. WOW. If a fire breaks out in San Bernardino County where there are a ton of those FAIR plans this problem will get much much worse.

So, if higher insurance only matters for how people “feel” and don’t figure into the way Central Bankers decide to heat or cool the economy then how will this impact inflation?

Those planning to rebuild their homes will face intense competition for contractors. Contractors are intermediaries that control prices through market institutions. Talk to anyone in LA who has remodeled a house and you can bet your ass you will hear horror stories about signing a deal and only shortly later learning their contractor is putting off the work for other deals.

There are some markups there, for sure. However, the truth is the immigrant labor force in the area doing the actual work is heavily competed over. There is stiff competition for good workers no matter their skin color and immigration status. So now we are talking about wage pressure.

I’ve got some writing coming out about the coming commodity shortage in America. Wood will be an issue here. As will copper for all those electrical panels and Tesla hookups.

“It’s immediate,” said Stuart Gabriel, director of UCLA’s Ziman Center for Real Estate, on the effect of mass displacement pushing up housing costs. “It’s difficult to quantify. I don’t think anyone knows what the numbers are.”

I think the estimate is that up to 9,000 structures (business and apartments included) burned down. Only 24,300 homes were given building permits in Los Angeles in 2023. That’s the supply created by the NORMAL demand for housing.

I personally don’t think all those Palisades people are going to want to go live in their 2nd homes in Palm Springs and be away from their communities, workplaces, and west side ocean weather. Just like Nevada City turned into a Bay Area rich suburb during the pandemic we may see the same thing from Ventura to Santa Barbara. It takes about 5 years to build a new home in LA. All these people are going to need to live somewhere… hotels, Airbnbs, rentals, new home purchases. Good insurance will pay for their costs to live in temporary housing. That’s price pressure.

One last thing. California may get serious about clearing bush and controlling wildfires. That’s a good thing. But when we talk about pulling out roots, pruning acres of land, removing dead trees, burning prescribed fires we are talking about labor hours. That’s wages pressure too.

Deficit Interest Payments Crowd Out Discretionary Spending

FEMA has a set budget for annual disaster relief that the CBO has projected will be around 20 billion per year (which has been the level in recent years). That figure was $9 billion in 2000s and around $2-3 billion in the 1980s. THESE ARE INFLATION ADJUSTED FIGURES.

Obviously, these don’t cover costs so each year FEMA has to do supplemental appropriations. In 2024, the supplement doubled the total amount needed for disaster relief. FEMA’s cost per year IN INFLATION ADJUSTED DOLLARS jumped from $20.5 billion in the 1980s to $165 billion in 2022.

Billions of dollars in FEMA payments may seem like a drop in the bucket to a trillion dollar deficit. But that’s not how cumulative interest payments work.

In 2025 we are actually expected to bring in more revenue than our outlays (an additional 33% increase for discretionary spending). The problem is interest expense is expected to grow 54%. This is a mandatory amount. The crowding out effect from that interest expense burden means 520% less for discretionary outlays See the CBO numbers for yourself.

Looming interest debt payments in America are a problem that many are not fully appreciating. Basically, our government has been stimulating the economy for decades on cheap debt, and very soon most of that debt (in order to keep things muddling through) will need to be re-upped at much higher interest payment levels.

This isn’t a problem just because of higher central bank interest rates. The more debt our government takes on the more lenders want a premium to lend it more money. It’s silly to assume the price our government pays to take on debt won’t get more expensive because our federal debt to GDP ratio just exceeded what we had during WW2.

The federal debt is around 34 trillion and the annual deficit is about 1.9 trillion, which means an increasing debt burden of a 5.5% rate more or less (and that’s before refinancing that below-market rate Treasuries at the new market rates as they mature. U.S. nominal GDP growth during the “quantitative easing money creation on crack glorious stock market decade 2010s” was 4.28%.

Sure, I suppose that could go on forever, but that doesn’t mean it won’t crowd out discretionary spending and create some associated political turbulence.

How do we add it all up?

So construction/rebuilding efforts (and the deficit spending to get it done) will increase GDP. Does that mean we outgrow the rising price pressure from these disasters? How much will insurance, commodity, wage pressure from these disasters impact the whole? (Someone may want to start estimating the housing price pressure from the coming climate migration out of the U.S. South, btw). We gotta get someone smarter than me to add it all up. I suppose the dummy equation would start with something like:

+ Gdp from deficit/construction/hiring cocktail

- Gdp deflation from increased Federal interest expense burden

- rising commodity and service prices in wildfire and hurricane affected areas

- (Let’s just ignore property insurance because we don't count it). Perhaps someone can explain to me how to think about rising property insurance and inflation.

= Do we outgrow price pressure or not?