TCS Daily


In Wake of Attacks, What Happens to Stocks and Economy?

By James K. Glassman - September 14, 2001 12:00 AM

The U.S. stock markets reopen Monday after being closed since Tuesday's attack on the World Trade Center and the Pentagon. What will stocks do? Much depends on what happens over the weekend, but, assuming there are no additional hijackings or serious threats, I doubt that shares will fall dramatically on re-opening day. They certainly would have - probably by 600 to 1,000 points - if markets had stayed open Tuesday and Wednesday. In fact, if the U.S. continues to show resolve, gather an alliance and either retaliate or show signs that a retaliation is imminent, then stocks will may even rise.

Most financial pundits are saying that frightened Americans, unsure of what will happen next, will save rather than spend, tipping the economy into recession. In addition, airlines, hotels and other businesses directly affected by the attack and its aftermath will find themselves in a cash squeeze and be forced into bankruptcy - as Midwest Express was last week. All true. But on the other side of the ledger are four important policy changes that should have happened anyway but that will now occur as a result of the catalyst of tragedy:

1. Fiscal: The crazy notion, held by both parties, that the way to fight an economic slowdown is to maintain a near-record federal surplus, is now out the window. And good riddance. In fact, the way to fight a slowdown is through cutting taxes or wisely increasing spending - even if that means going into deficit. As a result of the attack, the government will be spending - at least an extra $40 billion -- and spending on the right thing: defense, especially high-tech defense. The boost to the economy will come at precisely the right time. More important, we will abandon a dangerous stingy mindset. As economist Lawrence Kudlow wrote Thursday: "Phony lockboxes must be thrown out the window. Unnecessary obsessions over debt retirement must be driven away. Now is the time for aggressive fiscal and monetary stimulus to promote growth and finance freedom." Absolutely.

2. Monetary: The world's central banks are doing the right thing, adding liquidity (that is cash) to the system to insure that financial institutions have the resources to keep shaken businesses alive. More liquidity means lower interest rates, a definite benefit to the economy. The Federal Reserve helped precipitate the slowdown of the past year by its reluctance to cut rates in fall 2000. It will now be forced to move even more quickly, and we will begin to see the effects of the cuts that started in January.

3. Energy: The attacks will lead to a new, more sensible energy policy. With our enemy centered in the Middle East, that area's oil reserves are no longer a stable source of supply for the U.S. - if they ever were. The case for energy independence could not be clearer. To improve this country's security, we will have to have to expand areas for drilling and commit more federal money to basic research for new energy sources. The Bush administration's push for expanded supply will get new emphasis and support.

4. Regulation: On a war footing, rabid antitrusters - both at home and in Europe - will have a difficult time opposing mergers of airlines and industrial companies (like GE-Honeywell). Almost certainly, the lobbying war against Microsoft by its competitors will be put on hold, and Windows XP, a key economic catalyst, will be released next month. In general, regulation that constrains productive businesses will be shoved aside in the war effort.

A fifth policy change - just as logical and important - would be to cut capital gains taxes and allow businesses to write off capital investment immediately. Such a change would lead to more innovation and industrial activity, but my guess is that it won't happen. Opponents will contend tax cuts are unpatriotic.

Am I saying that tragedies like the WTC and Pentagon attacks are a good thing for an economy? Absolutely not, but in this case, they will serve to change misguided policies. But the attacks will also have a depressive effect:

  • Oil prices will rise. David Malpass, chief international strategist for Bear Stearns, says that, while OPEC promises to keep sufficient supplies available, its price target is far too high. Oil price spikes typically precede recessions.


  • Physical and human capital has been lost. Yes, downtown New York will be rebuilt, but it is poor accounting to call the new construction a plus, since it is offset by a massive loss in tangible assets, suffered by insurance companies and the firms in the buildings themselves. But the loss in human capital - the bright minds that worked in the World Trade Center and added economic value by their daily labor - is even greater.


  • "To the extent that people become more risk averse both in their personal lives and in their investments," writes Malpass in a letter to clients, "it is a negative for global growth." The events of Sept. 11 will definitely boost risk aversion. Many investors will be overcome with the desire to stash their money somewhere safe - which, ironically, will be U.S. Treasury securities. On Friday morning, rates on two-year T-notes dropped to just 2.9 percent, the lowest rate since the Eisenhower administration.


  • Overall, however, the economic pluses may outweigh these minuses. This terrible tragedy has changed the main object of America's attention from recession to war - and, with war, to resolution and patriotism and the remarkable optimism that war often brings.

    As the week ended, Americans were rallying around their president, shaken but almost enthusiastic about fighting the enemy. In other words, the psychology might actually be working in the markets' favor. A survey of 4,600 investors by Harris Interactive found that only one percent planned to sell stocks when the market opens next week. Many felt it was their patriotic duty to continue holding shares of U.S. companies.

    During the last three months of 1941, with threats of war and then the attack on Pearl Harbor itself, large-capitalization U.S. stocks fell more than 13 percent - the equivalent of a drop of about 1300 points on today's Dow. But stocks were up sharply in 1942 (20 percent), 1943 (26 percent), 1944 (20 percent) and 1945 (36 percent). Again, this performance does not make a case in favor of war and against peace, but it reminds us that markets look forward, and between 1942 and 1945, markets saw the U.S. finally confronting issues of economy and security that had been ignored. Investors were confident, envisioning, correctly, a rebirth after the war was over.

    The same may happen with the different kind of war we face today. The attack of Sept. 11 could help unite nations, increase prosperity and, perhaps most important of all, spread it worldwide.
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