Did Terrorists Blow Up the Recovery?
9:00 AM, September 11.
Wharton finance professor
Jeremy Siegel was in his
office in Philadelphia,
looking at Nasdaq futures
prices on his Bloomberg
laptop terminal. Suddenly
he noticed that trading
was down dramatically; the
chart on his computer screen plunged as if it had fallen
off a cliff. "Something terrible has happened, I don't
know what," Siegel told a visitor. Seconds later, the
all-caps headline flashed across his computer screen -
a plane had smashed into the North Tower of the
World Trade Center in New York City. Within minutes,
this was followed by news of a second plane careering
through the center's South Tower.
As everyone now knows, that was not the end of the
attack. A third plane, hijacked - like the first two - by
suicidal terrorists, exploded into the Pentagon in
Washington, D.C. A fourth crashed outside Pittsburgh,
Pa. Then the World Trade Center's twin towers
collapsed into rubble.
Siegel tracked these events as they unfolded,
switching back and forth between the horrific news
stories and their impact on global markets. U.S.
financial markets closed immediately. Stock prices fell
around Europe and Asia. The dollar plunged. Oil prices
spiked. "It was frightening," Siegel said. "It reminded
me of how I felt during the Cuban missile crisis of
October 1962."
A day after the mind-numbing tragedy that is now
being compared to Pearl Harbor, people in the U.S. and
around the world are still struggling to cope with its
trauma - especially the loss of life, which could add up
to thousands. President George W. Bush has vowed
that the U.S. will punish those responsible for the
attacks. In addition to the physical and psychological
damage, however, the terrorist attacks of September
11 have also inflicted body blows on a weak world
economy that already teeters on the brink of a
recession. Wharton professors say that these attacks
will dramatically affect consumer confidence and also
have a major impact on industries such as travel and
insurance. As such, in addition to exercising political
and military leadership during this crisis, the Bush
administration will have to demonstrate strong
leadership on the economic front. That is the only way
to prevent the terrorists from blowing up the
impending economic recovery.
According to Siegel, industries such as travel, tourism,
restaurants and entertainment will be affected directly
and immediately. "Travel to remote locations, such as
the Caribbean, will fall off dramatically," he says.
"Other areas of the industry will be affected as well."
How long these effects will last is difficult to predict.
"It depends on whether the attacks are seen as
one-time events or as part of a recurring campaign,"
he says. "That is a critical factor. Terrorists like to
keep terror alive." If fear prompts large numbers of
would-be travelers to stay at home, especially during
the coming holiday season, that could significantly hit
the travel industry. According to the Travel Industry
Association of America, the industry has annual
revenues of $582 billion. Even a small contraction in
those revenues could send ripple effects across
several industries.
Robert E. Mittelstaedt, Jr., vice dean of Wharton's
Aresty Institute of Executive Education, agrees that
travel will be hit hard. "The airline industry is already in
trouble because of the economy," he says. "Airlines will
see reduced travel for a while as we did during the
Gulf War. I think it will bounce back quickly, but under
much greater security. We will (and should) get very
serious as many in Europe are about protecting
airports, planes, passengers and crews, but it will
mean much longer lines and wait times at airports and
more restrictions on freedoms that Americans have
come to love."
Jerry Wind, a professor of marketing and director of
Wharton's SEI Center for Advanced Studies in
Management, says that the attacks will have an
enormous impact on the insurance industry. Robert
Hartwig, chief economist for the Insurance Information
Institute, echoes that sentiment. He has already told
reporters that he expects the insurance claims of the
two planes crashing into the World Trade Center to
cost insurers "billions of dollars." The insurance impact
includes the loss of property damaged during the
attacks as well as the loss of business while new
facilities are being developed. In addition, both
American Airlines and United Airlines, whose planes
were involved in all four crashes, will face large liability
claims, which will put great pressure on their insurers.
This massive volume of claims will be passed along, in
turn, to reinsurance companies such as Munich Re and
Swiss Re, among others.
As for the stock markets, the impact on U.S. stocks is
uncertain because the markets remain closed. While
stock prices in other markets fell immediately in the
wake of the attacks, Siegel does not believe the
attacks will have much effect in the very long run. "If
the terrorist threat continues, it will have an impact
for many years," he says. "But if the threat of
terrorism fades, markets will return to normal. The U.S.
has prospered during periods of anxiety, such as the
1950s and 1960s when there was a constant threat of
nuclear war."
According to Mittelstaedt, "Stock markets will likely
tank - many will want to go the safety of cash, but
some stocks (security firms, airport x-ray
manufacturers, etc.) are likely to jump temporarily. I
suspect defense stocks will jump as well, because we
will surely be willing to put more into that area.
Insurance stocks overseas have already plummeted -
this is likely to be one of the biggest insurance
disasters in history."
In the currency markets, Siegel says that while the
dollar did drop initially, it did not drop much. "This was
an attack against the U.S., and that is why the dollar
fell, but the U.S. is still the world's strongest
economy." Siegel does not expect much long-term
movement in the currency markets as a result of the
attacks.
Among commodities, oil prices were affected almost
immediately following the attacks. Crude-oil futures
rose by more than $3 to some $31 per barrel. Siegel
believes, however, that oil prices should go down
again. "The reduction in travel will reduce demand, and
that will lower oil prices further," he says.
Siegel emphasizes that a more serious issue is the
negative effect that the attacks could have on
consumer spending. For much of this year, strong
consumer spending - which has persisted despite
layoffs and rising unemployment - has buoyed the U.S.
economy. Accounting for nearly two-thirds of GDP,
consumer spending has been an important buffer
preventing the economy's slide into a full-blown
recession. If consumer confidence falters and spending
declines as a result of fear induced by terrorism, that
could set back the economy considerably.
Earlier this week, a survey of 31 economists of the
National Association of Business Economists predicted
that the U.S. economy would start recovering by the
end of the year. In the wake of the attacks, that
might well be delayed until next year. "Even if the
government steps up spending on defense and
security, the net result will still be a slowdown in the
economy because of the decline in consumer
spending," says Siegel. "The question is, if Americans
don't feel safe, will they be willing to spend on gifts
during the holiday season? That will affect the timing
of the recovery."
The fact that the current slowdown is not limited to
just the U.S. but affects several regions of the world
makes matters worse for the global economy.
"Terrorism is a problem that affects everyone," says
Siegel. "The whole world relies on travel and tourism."
If it the terrorists - emboldened by their ability to
attack landmarks such as the World Trade Center and
the Pentagon- mount attacks in other countries, travel
could see a worldwide decline during the critical
holiday season, softening the global economy. In fact,
"it could cause a very serious recession," says Siegel.
What, then, should happen next? Wind believes that
the attacks should encourage the U.S. to seriously
reexamine the country's intelligence systems. "Once
you look beyond the terrible inhumanity of what has
happened, you see that this represents a massive
failure of the intelligence system. We did not have the
right systems in place. Why couldn't we do this? Why
couldn't these attacks have been prevented? I am not
trying to blame anyone, but this will have huge
implications for the way intelligence systems are built
in the future." Wind says the attacks represent a
turning point in American history. "This is a wake-up
call," he adds.
Mittelstaedt points out that the U.S. "will survive and
continue to be the world's leading economy, but we
will become more focused on issues of security. This
will hurt efforts to liberalize immigration laws. It will
cause debate about our unconditional support of
Israel."
On the economic front, Siegel suggests that the Bush
administration should recognize the negative economic
impact of the terrorist attacks and take steps to
counter it. Although the Federal Reserve issued an
emergency statement hours after the attacks that the
central banking system was "open and operating,"
Siegel believes this is not enough. "I would call upon
the Fed to cut interest rates by 50 basis points," he
says. "The Fed should do this immediately to show
that it is aware of the problem." In addition,
recognizing the global dimension of the problem, the
European Central Bank should also lower interest rates.
Japan already has called for lower rates. These actions
should go hand in hand with an international political
program to combat terrorism, Siegel says.
In addition to cutting interest rates, Siegel suggests
that the government should offer selected tax cuts to
industries such as airlines, travel, entertainment and
insurance, which will be hurt most. These industries
may also have to offer inducements such as lower
prices to customers in order to keep business going,
but these may further depress profits, Siegel adds.
Will any industries do better in the aftermath of the
attacks? Companies that are in the defense and
security business will be clear winners in that regard.
"There will be a big increase in spending on
anti-terrorist security devices," Siegel says, but he
cautions that this will not be enough to revive the
flagging fortunes of the high-tech sector as a whole.
"Security is a small part of the technology sector," he
says, so the pump-priming effect of increased
spending will have a limited impact.
Given all this, what strategy should investors pursue
over the coming months? Siegel, author of Stocks for
the Long Run, offers very specific advice: "Avoid panic
selling," he says. "History shows that selling in times of
high uncertainty is almost always a bad decision." |
