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When the stock market crashed on October 19, 1987, then-rookie Federal Reserve Chairman Alan Greenspan was on a plane headed to Dallas to give an address to bankers. It wasn't until he landed that he learned the full extent of the turmoil that sent the Dow Jones industrial average down 22.6% in a single day. The Fed, under Greenspan's leadership, quickly swung into action to reassure the markets, ultimately succeeding in keeping the economy on track.
Nearly 14 years later, Greenspan was again in the air when the bad news came: Terrorist attacks ripped through the U.S., closing the stock markets and sending a collective shudder through America's psyche. Returning from a meeting of central bankers in Basle, Switzerland, Greenspan found his plane diverted back to the airport on Sept. 11. Now again, he and the Fed must act as a lodestar for the U.S. economy, guiding investors through what could be panic-driven days ahead.
Within hours of the terrorist strikes, the Fed moved to calm fears of widespread disruptions to financial markets. In a statement reminiscent of 1987, the U.S. central bank said it stood ready to provide the banking system with whatever money was needed to prevent markets from seizing up. The statement was quickly followed by similar promises of support from Europe and Japan. And all three quickly backed up those words with money, injecting more than $165 billion into financial markets on Sept. 12.
"PUNCHED IN THE STOMACH." Much more aggressive action will be needed, however, to keep the world economy afloat. The central banks will have to work together to sharply lower interest rates around the world. They'll also need to join forces to prevent a plunge in the dollar after the terrorist attacks that shook the myth of American invulnerability.
Even before the wave of terrorism, consumer confidence in the U.S. was looking shaky. Faced with mounting layoffs and a sagging stock market, consumers were already pulling in their horns, threatening to deep-six an economy teetering on the edge of recession. "We were punched in the stomach once by the downturn, but now we've been hit even harder," says Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson in Chicago. "We could very easily have a global recession."
Given the enormity of the stakes involved, the Fed and its fellow central bankers can't hesitate to cut interest rates. Even though Greenspan has already cut a key short-term rate 3 percentage points in seven moves so far in 2001, more needs to be done. Rather than waiting for its next scheduled meeting on Oct. 2, the Fed needs to slash rates now in coordination with other industrial nations' central banks.
The European Central Bank is meeting Sept. 13 to mull monetary policy, giving the Fed an early opportunity to act. Only such a concerted display of resolve would have a chance of dispelling the dark clouds now hanging over the global economy.
CRISIS OF CONFIDENCE. Major central banks will also have to band together to head off wide swings in foreign exchange rates and a dive in the dollar by forcefully intervening in the currency markets. The U.S. currency dropped sharply on Sept. 11 following news of the terrorist attacks, plunging nearly 3% against the Swiss franc and more than 1.5% against both the euro and the yen. It steadied the following day, after central bankers and finance ministers from the Group of Seven (G7) industrial nations issued a joint statement saying they were ready to do what was necessary to prevent disruptions to the global economy. With many analysts convinced that the dollar is sharply overvalued, the G7 may find that resolve tested by currency traders in the coming days.
The biggest risk is a global collapse of confidence in capitalism. Consumers, companies, and investors could all become so scared of what the future may bring that they hunker down and trigger a self-fulfilling downward spiral in the economy. It's a danger that Greenspan has confronted before, first in 1987, and then three years ago, when financial markets seized up in the wake of Russia's debt default.
"When events become too complex and move too rapidly, human beings become demonstrably less able to cope," Greenspan said in a speech back 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."
Despite the difficulties, the tragedy may shock the Fed and other fellow central bankers into taking the dramatic action necessary to rescue the global economy. Greenspan's mettle has been tested in the past -- and he came through admirably. The world can only hope for an encore.
Miller and Cohn cover the Fed from Washington Edited by Beth Belton
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Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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