Did Terrorists Blow Up the Recovery?Published: September 13, 2001 in Knowledge@Wharton
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."