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The National Association for Business Economics was holding its annual
meeting in the Marriott Hotel at the World Trade Center when disaster
struck. "The chandeliers shook, we heard a concussive sound, and as we
were herding out, we could see that one tower was burning," says Carl
Tannenbaum, the chief economist of LaSalle Bank in Chicago, who was
attending the meeting.
Just the day before, a panel of NABE economists had predicted slow
growth, but no recession. That forecast was obsolete, however, the
moment the first plane hit. In addition to destroying thousands of lives
and billions of dollars in property, the terrorist attacks forced the
shutdown of the financial markets, the temporary closure of U.S.
businesses, and the grounding of air passenger and cargo traffic. Around
the country, customers vanished from stores. With the U.S. already near
zero growth, these impacts themselves are almost certain to tip the
country into negative growth. "People are going to pause. And that pause
is going to have a real impact on the third quarter and probably the
fourth quarter," says Fred Poses, chairman and CEO of American Standard
Companies.
If the experience of the August, 1990, Iraqi invasion of Kuwait is any
guide, consumer confidence and spending are likely to plunge. In the
four months after the Iraqi attack, the Conference Board index of
consumer confidence dropped by 40%. Consumer spending held up a bit
longer, but it, too, eventually tanked, hitting its low in January,
1991.
"COLD WATER." This crisis could be even worse. "We'll see a huge drop in consumption,"
predicts Brian S. Wesbury, chief economist at Griffin, Kubik, Stephens &
Thompson Inc., a Chicago investment banking firm. Before the attack,
Wesbury expected third-quarter GDP to fall at a 0.3% rate. Now he
expects it to drop 1%. The stock market could dive as well, as a
contracting economy drags down profits by as much as 10% to 15% in the
fourth quarter.
A U.S. downturn will have repercussions all around the world. With Japan
imploding economically, Asia in trouble, and Europe struggling, a
recession in the U.S. would remove the last remaining source of demand
from the global economy. "It's like throwing cold water on any prospects
for a recovery," says Chang Il Hyung, senior vice-president of South
Korea's Samsung Electronics Co., the world's largest memory chipmaker.
With people around the globe watching the carnage in New York, consumer
confidence and business investment could be hit everywhere. "Since the
global economy is interwoven through trade and investment, all of us
will be worse off," says Sung Won Sohn, chief economist at Wells Fargo &
Co.
Not everyone agrees. "My initial reaction is that it won't have a
significant economic impact," says Lawrence A. Bossidy, chairman and
chief executive officer of aerospace and industrial giant Honeywell
International Inc. "Undeniably, this is negative" in the short term,
adds Minoru Makihara, chairman of Mitsubishi Corp. But "unless there is
a series of continued attacks, there is a chance that things will settle
down in a few days or weeks."
CYCLE OF TURMOIL. It is possible for the economy and financial markets to bounce back
strongly from negative events. The 1990 Iraqi invasion pushed down stock
prices by 15%. But after U.S. tanks started to roll, markets rebounded
sharply. That signaled the start of the 1990s' bull market, notes Steve
Leuthold, chairman of Leuthold Weeden Capital Management in Minneapolis.
The long-term impact depends on whether the attack is a onetime event or
the start of a new period of high uncertainty. The danger is that
further terrorist attacks and military retaliation could start a cycle
of turmoil, forcing dramatically tightened security and new barriers to
travel and trade.
Those restrictions would strike the heart of the
global economy, which depends on open borders and open markets. "The
process of globalization is based on the idea that the world economy can
be secured against threat," says Philip Poole, chief economist of
emerging markets at ING Barings in London. "This has now been
undermined." Adds Joseph E. Stiglitz, a Columbia University professor
and former chief economist for the World Bank: "The borderless world
through which goods and services flow is also a borderless world through
which other things can flow that are less positive."
DEVASTATION. All this has the U.S. economy entering uncharted waters. "We're really
going to go through a period in our country where things are never going
to be the same," says Marvin J. Girouard, chairman and CEO of Fort
Worth's Pier 1 Imports Inc.
Part of what makes this tragedy different is the unimaginable human and
emotional devastation of the World Trade Center collapse, which makes
its eventual impact on the economy much harder to predict. "When events
become too complex and move too rapidly, human beings become
demonstrably less able to cope," Federal Reserve Chairman Alan Greenspan
said in a speech in 1998. "The failure to comprehend external events
almost invariably induces disengagement, whether it be fear of entering
a dark room or of market volatility."
There may be a tendency to overreact. "Will there be a form of mental
panic, with consumers feeling that everything is liable to come apart?"
asks Louis Schweitzer, ceo of France's Renault. If consumers and
executives hesitate before making spending decisions in the short run,
the auto industry, for one, would suffer. After record sales of 17.3
million vehicles in 2000, most industry executives had looked for sales
to slow to a rate of about 16.5 million units for the rest of this year.
Now, says David L. Littmann, chief economist at Comerica Bank in
Detroit, auto makers will be lucky to see a 15.9 million sales rate in
the second half. "Consumers are far less confident than they were a year
ago," adds George Pipas, director of sales analysis for Ford Motor Co.
"The potential impact is cause for concern."
NO MOOD FOR SHOPPING. The struggling information technology industry is at risk as well. "I'm
really concerned about the timing," says Frank C. Huang, chairman and
CEO of Powerchip Semiconductor Corp., a Taiwanese producer of memory
chips for customers such as Mitsubishi Electric, IBM, and
Hewlett-Packard. Powerchip had been hoping for an upbeat fourth quarter,
which traditionally accounts for 35% to 40% of total PC sales. Now that
seems less likely. "People just won't be in the mood for Christmas
shopping," says Huang.
They probably won't be eager to buy new homes, either, if the
uncertainty lasts more than a few weeks. After Iraq invaded Kuwait, new
single-family housing starts fell by more than 25%. A similar drop this
time could hit one of the few remaining pillars of economic strength in
the U.S.
So far, one positive is that the price of oil has stayed stable. The
supply of oil has not been interrupted, unlike 1990, when the Iraqi
invasion temporarily hiked oil prices from $20 to $40 per barrel. OPEC
is offering reassurances that it will keep pumping oil. Meanwhile, state
and local officials in Illinois, Michigan, and other states vowed to
crack down on gas stations that are boosting pump prices during the
crisis. That means consumers and businesses are unlikely to see a sudden
surge of energy-fueled inflation.
Yet low inflation will not protect the financial markets from the
effects of the attack. The U.S. stock market is likely to be in a funk
for the near future as the economic slowdown forces investors to lower
expectations for profits. What's more, the devastation in New York
City's financial district will create a somber mood among traders.
ASIA TROUBLES. Global stock markets are already being hit by the
tragedy. The Frankfurt stock market dropped almost 9% on the day of the
bombing, although it recovered a bit the next day. And the Nikkei went
down almost 7% on Wednesday, Sept. 12, pushing the Tokyo stock market to
its lowest level since 1983. Damage was even worse in other countries
such as Korea, where the stock market plunged 12%.
The falling markets evinced the looming possibility of a synchronized
global recession. The attack came at a moment when the global economy
was teetering on the edge of a downturn. Japan, the world's
second-largest economy, is contracting, and its markets are in disarray.
Meanwhile, industrial production in Germany, the third-largest economy,
plunged 1.5% in July, and manufacturing orders fell 1.4%.
The bad news doesn't stop there. The biggest losers are likely to be in
non-Japan Asia, argues Frank F.X. Gong, a Hong Kong currency strategist
at Bank of America. "Over the medium term, if you do have a prolonged
slowdown, Asia will be hurt very badly, because Asian countries are the
most export-dependent economies in the world."
DOLLAR WILD CARD. Meanwhile, the very functioning of the U.S. financial markets is a
concern. Even when the stock and bond markets reopen, the damaged
financial system faces a daunting backlog of orders. At the same time,
insurance companies will have to pay out claims amounting to tens of
billions of dollars, forcing them to raise money by selling assets or
issuing large quantities of bonds. "Can the financial system handle all
these problems?" asks Sohn of Wells Fargo. "At least temporarily, the
financial system could be frozen, further damaging the economy."
The economic wild card is the behavior of the dollar. Given the mammoth
trade deficit, most economists agree that the dollar will eventually
fall. That would make imports more expensive and U.S. exports more
competitive. But despite that expectation, foreign investors have
continued to pour hundreds of billions annually into the U.S. They have
been attracted, in part, by its reputation as a stable country with
faster growth. The resulting flows have provided cheap financing for
U.S. investment and consumption while buoying the dollar.
The attack triggered a nearly 2% slide in the dollar against
the euro. If that continues, foreign investors would be more reluctant
to put their money into the U.S., leading to higher interest rates and a
worsening of the U.S. recession. "In periods of uncertainty, the U.S. is
normally seen as a safe haven," says ING's Poole. "But the dollar is at
risk in this environment." One sign of this: When the news of the attack
first came out, there were long lines outside currency exchange points
in Moscow as Russians ran to sell dollars for what they temporarily saw
as a safer currency -- the Russian ruble.
MONEY FLOOD. Facing such a crisis of confidence, the dimensions of U.S. economic
policy needs are obvious. On the monetary side, the Fed did the right
thing by sending a message that it stands ready to provide additional
liquidity, says F. Ward McCarthy Jr., managing director at Stone &
McCarthy Research Associates in Princeton, N.J. The morning after the
attack, the Fed injected $38 billion into the money market, compared
with the normal $5 billion. All told, the central banks of the U.S.,
Europe, and Japan pumped nearly $120 billion into the financial markets
on Wednesday to assure liquidity. On the fiscal side, the debates over
the surplus will give way to more willingness to spend on defense.
Moreover, President George W. Bush has asked Congress for authority to
spend whatever it takes to deal with terrorism. That will stimulate the
economy, too.
But in this situation, the political and military response is as
important as the economic one for maintaining confidence. For the
economy, "it usually doesn't matter what the President says -- but this
time it will," says Griffin, Kubik's Wesbury. "If we can be tough and
show some reaction to this, we can avoid a long-term impact on the
economy."
Once it became clear, in 1991, that the U.S. was winning the Gulf war,
confidence and consumer spending rebounded, and the recession ended a
couple of months later. But with the enemy far more elusive and the U.S.
economy already struggling, the ending may not be so neat this time.
By Michael J. Mandel in New York, with Laura Cohn in Washington, Joseph
Weber in Chicago, Christine Tierney in Frankfurt, Stephanie Anderson
Forest in Dallas, Catherine Belton in Moscow, Amy Barrett in
Philadelphia, and bureau reports
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Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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