Dialogue: Economists talk up a tempest

By BANCORP TREASURY SERVICES ANALYSTS

Panic was the response. On the streets of New York and the equity, currency and commodity markets of the world the reaction was the same. Run.

Just as the US military was itching to locate where, and against whom, it should begin retaliating, the financial markets were attempting to grip just what they should be running from, and where on Earth they should be running to. It is this confusion that sets the attack apart from other disasters.

Within the haze of reckoning about which investments should be bought and which sold, the world must try to figure what to do next after all the speculative profits have been reaped.

With no precedent for comparison, the ground is fertile for the shoddy economist and media tart. In this state, anything said is reportable, and baseless opinion is held alongside stunned proclamations and panicked rumour as equals. Objectivity then gives way to the instinct that because this was a bad thing the economic outcome must also be a bad thing.

Apparently the threat of global recession now is greater than before the September 11 attack. The timing of the US attack means that in time this event will be blamed for the ultimate drop in share and economic value across the US.

This will, however, be a convenient ignorance of the facts. If the world heads into recession, it will not be the work of terrorists.

The attacks were attacks on the morale of the US, not on its productive resources. It is important to recognise this, for it avoids foolish and ill-considered judgments.

The rush of economists in the dust of the twin towers' collapse to state absolutely that the US giant was now felled into recession failed to acknowledge that productive assets were not hit. It is this fact, however, that makes the analysis of what will come so difficult.

US growth and industrial production have been in rapid decline for some time, and as the latest consumer sentiment survey showed, there was an 8.6 per cent plunge deeper into pessimism.

Any promise that this could be quickly turned about must be held up against the threat implied by unemployment leaping from 4.5 per cent to 4.9 per cent.

The Federal Reserve's step to close the banking system, which also shut every ATM Machine in the country within minutes of the attacks, avoided a bank run.

The increase in supply and the rush to buy safe-haven assets saw US interest rates tumble, cemented there by the Federal Reserve cutting the Federal Funds rate by 50 basis points on the Monday after. It is notable that, despite the US being under attack, the US Government was still deemed the world's best creditor.

The drop in interest rates, and the formal monetary policy easing that followed, is a counter to the confidence attack. Whether it can be fully offsetting is far from clear.

One thing the US population has in its favour is the self-belief that results from its overt patriotism. The certainty that the US will get through this, and the urge of the nation's leaders to restore normalcy, could see a recession avoided.

The US going to war could also help stave off recession.

Nothing lifts the spirit of a patriotic nation like a battle, especially if your side is winning, and in this age the US will always be the winner, even if it is only of the propaganda war.

For the economy, war is an aphrodisiac: massive shifts of resources with wanton disregard for efficiency, all funded by Government-issued cheap debt. If the action is international, then the US gets to export its military hardware and intellectual property. Simply, the rest of the world must pay for America's warmongering services. In the Gulf War, the US ran a brief current account surplus.

But this is premature. The US is not at war yet.

With the world's media being US-centric, whatever the US does will be an information event, with coverage and consternation fired back at us in disproportionate gulps. War means economic activity, but it also means risk-aversion, and for New Zealand, no tourists, higher oil prices, less demand for our exports and slower domestic growth.

For the US, it could mean avoiding a recession on its shores, but probably does mean exporting it to its trading partners.

The Kobe earthquake in 1995 struck at the heart of productive assets, killed 5500 and levelled 180,000 buildings. Japanese GDP contracted in the March quarter by an annualised 1.1 per cent, but was already up in the June quarter 2.7 per cent and 4 per cent three months later. There will be problems shifting around New York, and air travel reservations the world over will be made with some reluctance for some time, but economics, like nature, abhors a vacuum.

Money not spent travelling will be spent on a television, car or the like or, even better, saved or invested. To talk of the things not done while ignoring the alternative outcome is a fit-up.

The influence of disasters tends to be overestimated by economists, and with this disaster the possibility for exuberance is huge.

* Bancorp Treasury Services is New Zealand's largest provider of independent treasury advisory and outsourcing services.