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Barron's
Walking on the Brink
A look at the economic problems that attend disaster
By Peter Navarro
We must pray, and we must grieve. But we must also prepare for the
havoc that the terrorist attack on America may wreak on our economy and
financial markets. Will this attack drive the U.S. and global economies further
into recession? Will the attack trigger a total stock market collapse -- or be
the catalyst for a new bull market?
Or, in the wake of this horrific event, might some sectors, such as defense and
technology, prosper while others, such as airlines and insurance, plummet?
We must first understand the nature of the beast. The attack creates three
types of macroeconomic problems.
First, in the wake of the bombings, the entire air-transportation network was
shut down, many factories and businesses were closed, and the nation lost
several days of GDP. Such an intense but very short-run shock comes at a
most inopportune time. But our economy is more than resilient enough to
weather it.
Second, the incident itself may depress an already declining consumer
confidence. It may also cut off any rising hope among business executives for
an upturning economy warranting plans for increased investment. A sharp and
sustained falloff in aggregate demand could create a much deeper and more
prolonged recession and possibly even global depression.
The Federal Reserve must support aggregate demand. Immediately, it should
lower short-term interest rates by another 50 basis points. As the Fed has
already promised, it should throw open the liquidity window much the same
way as in several previous precarious occasions, notably the Asian crisis of
1997-98 and the Market Meltdown of 1987.
Catastrophic possibilities
The third and potentially most catastrophic problem is that the terrorist attack
may trigger a chain reaction: A military response against the terrorists alienates
oil producers; an OPEC boycott or other supply disruption raises oil prices;
soaring oil prices drive down the dollar; a falling dollar creates domestic
inflationary pressure; the fear of inflation constrains the Fed from further
action; Fed immobility results in a drain of foreign dollars from the stock
market; the departure of foreign investors drives down the stock market; the
decline of markets creates a negative wealth effect that pushes the economy
over the edge to depression.
President George W. Bush and his advisers are supposed to avoid this
catastrophe. They must provide a swift and mighty military response, but do it
in a manner that will not disrupt the stability of the international oil markets.
The U.S response may include more than military strikes on individual terrorist
encampments. It may also involve striking out at the foreign governments that
harbor them. While a mishandling of this mission could be the powder keg
that finally blows the lid off of the Middle East, it need not be.
Diplomatic courtship
The key for President Bush will be to practice a diplomacy that fully informs
all of our allies of our intentions and plans. No ally in this effort will be more
important than Saudi Arabia. No matter what we do, the U.S. will be
denounced by Iraq, Iran, Libya and other states that sponsor terrorism. But
this rhetoric notwithstanding, these countries will continue to pump out oil to
the world for the simple reason that they need the money to feed their people.
If, however, we lose Saudi Arabia as a partner in any solution to this crisis,
the U.S. runs the risk of an oil-market meltdown the likes of which we haven't
seen since the 1970s. But the U.S. has managed the pain of stomping on
Saudi diplomatic toes before. During the Gulf War run by the President's
father, the Saudis were effectively offered a choice between American
intervention and destruction of the ruling dynasty.
If this crisis is handled well by the President and Chairman Greenspan, any
recessionary shocks can be contained. The U.S. stock market may well
emerge from its bearish slumber and begin its next bull run.
In the bullish scenario, Greenspan and the Fed are spurred to swift action by
the crisis to cut interest rates and open the liquidity spigot; the U.S. military
response results in a spur to confidence; bailouts of airlines, insurance
companies banks and any other suffering economic institutions provide
short-run fiscal stimulus; Congress then passes anti-terrorist defense legislation
that revamps the national defense, increases defense spending and produces a
long-term fiscal stimulus.
The real risk in the bullish scenario will not be recession but rather inflation. In
these very dark days, that's a risk that Bush and Greenspan should and
probably will take.
Investors' analysis
How should individual investors react as these policy developments unfold?
Whenever an unexpected macroeconomic event strikes-an earthquake, flood,
currency collapse, or a terrorist attack-investors are faced with grave dangers
and unique opportunities.
In the wake of the Chernobyl nuclear reactor meltdown, as radiation drifted
over some of the most fertile grain lands on the planet, the broad markets
plunged and grain futures skyrocketed. The stocks of nuclear-reactor
manufacturers such as Westinghouse and General Electric fell sharply while
the stocks of grain processors such as General Mills and Quaker dropped in
reaction to the prospect of their profit margins being squeezed by higher grain
prices.
Similarly, when a mammoth earthquake registering 7.6 on the Richter scale
shook Taiwan, it not only killed more than 2000 people. It also led to power
blackouts that shut down production at many of Taiwan's factories. In the
wake of this quake, the share prices of both Apple and Dell, which had major
production facilities in Taiwan, fell. But even as Taiwanese semiconductor
manufacturers were hit hard, the share prices of Korean competitors such as
Samsung and Hyundai saw their share prices rise.
These were temporary dislocations, and the opportunity for long-term
investors to play an arbitrage game -- selling the winners and buying the
sufferers -- was significant.
Last week everybody knew that no matter what the President and Alan
Greenspan do, the airlines will take a major and sustained hit. Fear and
prudence will keep many Americans on the ground for weeks or months even
as rising oil prices eat deeply into the airlines' profits. Other energy-intensive
sectors likely to be affected if oil prices are not contained include chemical
companies that use petroleum as a key production import and, of course, the
automobile industry. As for other losers, certain companies in the insurance
sector will face huge payouts on both the Trade Center claims and air-crash
death benefits -- much as this sector did in the wake of Hurricane Andrew.
Brokerage stocks will likewise take at least a short-run hit if Alan Greenspan
is unsuccessful at stabilizing the market through an aggressive strategy of easy
money and high liquidity.
Energy stocks should rise, particularly domestic exploration and
production-related stocks. Defense stocks should also do very well, while, at
least in the short run, both food and agricultural stocks will outperform the
market as pure defensive plays.
These are likely to be dislocations that last a year or less. The opportunity for
long-term investors to buy low and sell high should be significant.
Future winners
Longer term, Internet and technology-related stocks may wind up being the
biggest winners, even though they may first wither in fear of recession or
depression. The Trade Center terrorists not only destroyed a mammoth
physical location for the world's financial markets. They also drove a stake
through the heart of the old centralized financial markets run on physical
trading floors.
Indeed, this horrific tragedy will rapidly accelerate the trend toward a highly
decentralized, global electronic trading network for stocks rivaling that for
bonds. The Nasdaq Market is well on its way there, while the New York
Stock Exchange, with its floor traders and quaint historic location, is more of
an Old Economy anachronism than ever. The key beneficiary of such a trend
will be New Economy sectors such as Internet architecture and storage,
fiberoptics, broadband and software.
As government leaders and investors face a changing world, there are always
perils and opportunities. If the President and the Fed chairman have the right
policies to deal with the peril of terrorism, investors will find opportunities in
the markets. |
