Financial panic is terrorism's silent partner. When terrorists struck the World Trade Center in New York, financial markets immediately fell in panic, with stock prices plummeting everywhere as the prices for oil and gold soared. Many feared that, given the already precarious state of the US economy, the shock would send the world economy into recession. Yet, a scant two days later, European financial markets have seemingly stabilized.Deep global recession no longer seems a certainty. But business as usual still seems a long way off. The big unknown remains America's response, for how it strikes back will have a profound impact.
Slowdown in the US can, indeed, mutate into global recession. The main transmission mechanism is the dependence of other economies on exports to the US and on global credit markets centred on the US, mostly in New York. The more a country depends on exports to the US for growth, the more that economy will slip into recession when the US does. Similarly with finance, the more a country depends on external refinancing of maturing debt, the more adversely it will be affected.
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With a slowdown in US consumer demand, imports will slow down, and this will hit exporting countries -- mainly in Latin America and Asia -- depending on the level of their export dependency, but also on the nature of their exports. A reduction of export will incite a deterioration in a country's current account. This, in turn, could lead to difficulties in financing say, the external debt, because other sources of revenue will be hard to find and expensive to fill in an environment so severely damaged in confidence. The debt burden of the countries affected in this way will inevitably increase as the cost of borrowing rises.
Oil exporters may be relatively unaffected and may even benefit. This will depend on whether or not the slowdown results in open conflict that brings increased turmoil to Middle Eastern oil producers.
In any case, the blow to confidence from so horrific and unprecedented a terrorist act will undoubtedly have a sharp short-term impact on real demand as well as unsettle financial markets: but it cannot in itself lead to long term recession or chronic destabilization of financial markets. A prolonged conflict, however, would have this precise effect on the economy. So everything hangs on the manner in which America retaliates.
So the waiting game begins. European financial markets stabilized because of investor reluctance to sell shares at the lowest levels they had registered for years. Moreover, the prices of bonds and gold dropped back as calm resumed. Oil prices, too, stabilized. Key central banks including the European Central Bank promised to ease monetary policy to stave off a global recession, and injected immediate extra liquidity into the financial system, which should prevent any settlement or credit crunch caused by the disruption to America's financial system. Both markets and policymakers have risen to the occasion.
How long their actions will count depends on consumer confidence. Some observers fear that the attacks in New York and Washington may act as a catalyst for US consumers, who have kept spending despite a recent parade of grim economic statistics, to finally tighten their belts. Until now, consumer demand has been the last bastion before against the onset of recession
Prior to the terrorist attacks, US economic indicators were increasingly gloomy: economic growth was barely positive in the last two quarters of 2000. US unemployment figures released the Friday before the terrorists struck showed a sharp increase in new benefit claimants, reinforcing fears that consumers would soon retrench, and so tip the economy into recession. The fear now is that the terrorist attack will deter consumers from spending, and thus accelerate the ongoing slowdown.
Still, the consensus forecast before the attack was for a rebound in growth from 0.2 percent GDP in the second quarter of 2001 to 1.5 percent due to successive Fed interest rate cuts and nearly US$$40 billion in tax cuts. As of yet, there is no clear case for downgrading this forecast. While sectors such as insurance, tourism, and airlines will likely suffer, others stand to benefit. For example, European utilities and pharmaceuticals stocks quickly rallied. Also construction, energy and defense industries will benefit. Even in the sectors that felt the impact most severely, share prices rebounded after initial heavy losses.
Historically, little evidence suggests that such shocks actually send economies into depression. Rather the opposite happens. During the Gulf War, stock markets, after initial jitters, soon became bullish. Should a sharp downturn take place, it may still be argued that such a correction has been long expected, and that a sharp shock is preferable to a slow and agonizing adjustment. The asset price bubble (especially in US equities) has taken months to burst. Highly leveraged households will feel great pain, but this may have the merit of delivering a necessary market correction. A sharp downturn therefore may provide the correction that everybody has been waiting for.
Should oil prices continue to surge, however, the downturn among major oil consuming economies could be more prolonged. But OPEC signalled immediately after the attack that it would not take advantage of the situation, and would increase production to stabilize the market.
Oil prices stabilization, indeed, may only be vulnerable to a large-scale military action by the US. If US military retaliation comes close to major oil producing regions in the Middle East, oil prices would jump as in the 1991 Gulf War. But in the more plausible event of Afghanistan bearing the brunt of US ire, the effect on oil prices would likely be less dramatic.
So for now, it seems unlikely that the terrorist attack on the US of Sept. 11 will cause world recession.
Brigitte Granville is head of the international economics program at the Royal Institute for International Affairs, London, but she is expressing her own views in this article Copyright: Project Syndicate
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