Economic effect of the tragedy is yet to be seen

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We know from previous 'world changing' events that tragedy can be followed by costs that may spread wide

We know from previous 'world changing' events that tragedy can be followed by costs that may spread wide

America's tragedy is so awful, so painful, that economic analysis seems almost to trivialise the event. What can anyone usefully say after such a huge loss of life? Yet, to write about some other subject – to avoid the issue – would be even worse, callously ignoring an event that will become one of the defining moments of our generation. The dominant feature of last Tuesday's tragedy remains the human cost, the loss of life, the painful bereavements. We know, however, from previous "world-changing" events that human tragedy can be followed by economic costs that may spread far around the world.

In the immediate aftermath of Tuesday's horror, perhaps the best that we can do is to dwell on the tragedy and think about it in some form of historical context. Even then, there is a danger of providing a parade of awfulness. My intention, therefore, is simply to think about why only some "world changing" events have apparently had significant economic effects whereas others, no matter how traumatic, have left economic behaviour relatively unscathed.

There have been plenty of "world changing" events over the last 40 years. Some have been positive: the first moon landing, the collapse of the Berlin Wall. Sadly, however, it is easy to recall other events that were either negative in themselves or, alternatively, had negative consequences. In the 1960s, the defining moments included the Cuban missile crisis in 1962, the assassination of President John F Kennedy in 1963 and the Arab-Israeli Six Day War in 1967. In the following decade, the 1973 Yom Kippur War and the Iranian revolution in 1979 are obvious "global" events as was the Soviet Union's invasion of Afghanistan in late 1979. The 1980s, perhaps, were less eventful but, by the beginning of the 1990s, another "world changing" event took place in the form of the 1990 Iraqi invasion of Kuwait and, subsequently, the 1991 Gulf War.

Do any of these events stand comparison with the events of the last few days or, indeed, with each other? The answer must be "no": each is specific and of its own time. Moreover, there is no common thread in terms of the economic consequences which stemmed from them. Neither the Cuban missile crisis nor the assassination of President Kennedy had much discernible impact on the United States or, for that matter, the global economy. In contrast, the Yom Kippur War and the Iranian revolution were associated with recession both in the US and elsewhere. Given these contrasting reactions, it is unwise to draw strong conclusions from the carnage in New York and Washington. There may be risks and dangers but previous episodes hardly provide an unambiguous guide.

Nevertheless, placing each of these events into their specific economic context makes it a little easier, perhaps, to disentangle likely effects. In each of these cases, two issues need to be clarified. First, on each occasion, to what extent were the US and other economies already vulnerable to economic dislocation? In other words, to what extent did each "world-changing" event simply add to what was already a domestic economic crisis where both business and consumer confidence were already falling? Second, to what extent did each event change the economic landscape through a change in supply conditions? Was there, for example, a sudden shift in the relative scarcity of a particular resource and, if so, was the subsequent trajectory for the economy altered?

Using this approach, the various world-changing events can be categorised in economic terms more easily. In the case of the Cuban missile crisis and the Kennedy assassination, the US economy had been picking up strongly from earlier recession. Moreover, there was no obvious supply disruption. As a result, the economic impact of these events was small.

The Yom Kippur War, however, is an entirely different matter. The US economy had started to contract in the third quarter of 1973, before the war, which took place at the beginning of October that year. The uncertainty created by the conflict may have exaggerated the weakness of the US economy in the second half of 1973 but it certainly cannot be considered to be a cause. The Yom Kippur War also led to massive supply disruption, most notably through a quadrupling of oil prices as a result of the Opec oil embargo. As a result, there was a further, severe, downleg to activity in 1974.

Contrast this story with the events surrounding the 1991 Gulf War. Once again, the conflict began at a time when the US economy was already entering recession. Consumer confidence may have fallen further as a result of the conflict but other indicators had been signalling the onset of recession many months before the Iraqi invasion of Kuwait. On this occasion, however, economic dislocation was not followed by major supply disruption. True, oil prices did rise dramatically for a short period. However, with the Saudis and most other Opec members allied to the West, there was little chance of a permanent and damaging upward shift in fuel costs.

What about the current position? Unfortunately, there had been plenty of signs of economic dislocation in the US ahead of last week's frightening events. The collapse in manufacturing activity through the year so far is already a familiar story. More recently, however, there have been growing signs of consumer strain. In August, the unemployment rate jumped to 4.9 per cent, higher than market expectations. Meanwhile, the September University of Michigan consumer confidence survey – carried out before last week's tragedy – showed a dramatic decline, suggesting that consumers have finally cottoned on to the broader economic risks associated with the collapse in share prices and corporate profitability.

What about supply conditions? To what extent does this tragedy provide economic after-shocks beyond the – hopefully short run – impact on confidence? At this stage, there is likely to be only a limited impact on oil prices – too many Opec countries have expressed their sympathies with the US to suggest that there should be any major disruption to oil supplies. But there are many other potential sources of disruption: there will be a major impact on transportation; there may be an overhaul of defence expenditures with a diversion of resources from other plans; there will be a potentially dramatic fall in output from New York; there will be rebuilding costs; and, at the end of the day, there will be dangers associated with US retaliation and heightened terrorist threats. Most of these effects are, at this stage, essentially unquantifiable.

What we do know, of course, is that there is a steely determination to keep markets running. If that requires central banks to inject liquidity and to cut interest rates, then so be it. We may also suspect that foreign investors will think again about the safety of their investments in the US, threatening a decline in the dollar. Over the long haul, however, the most sizeable impact on financial markets may come from a reassessment of risk. If the 1990s benefited from the "peace dividend" and the associated collapse in the equity risk premium, perhaps the first decade of the 21st Century will see that process partially unwind.

Reaching conclusions on the full economic implications will obviously take some time. Whatever the conclusions, however, they pale into insignificance relative to the very real tragedy which has befallen America over the last few days.

 

Stephen King is managing director of economics at HSBC.

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