Q&A: The attack's economic impact

Peter Navarro teaches MBA students about the effects of macroeconomic shocks on the economy at the Graduate School of Management, University of California-Irvine. He is the author of "If It's Raining in Brazil, Buy Starbucks: The Investor's Guide to News and Other Market-moving events."

Professor Navarro was interviewed by The Christian Science Monitor's online producer, Ben Arnoldy.

csmonitor.com Care to give a ballpark estimate of what the total cost of damage will be in this attack? Is it comparable economically to events such as Pearl Harbor, the OPEC crisis, major hurricanes, etc.?

Peter Navarro: America has lost two large buildings, several smaller buildings, four large aircraft, and thousands of souls. Of these losses, no price is high enough to set for the lives lost. As for the property, while not inconsequential, it is likely to be of a much lesser value than the property damaged by Hurricane Andrew or the Watts riots.

The larger price tag for this event will come, however, if the attack triggers a deeper national and perhaps global recession. And perhaps the largest costs will come from the increase in military expenditures and national security measures that will be taken in the wake of the attack.

As for the Pearl Harbor analogy, the loss was far greater in that instance because what was lost was a significant portion of the naval fleet that was essential to defending the nation. While the Pentagon sustained very serious damage in this attack, it is unlikely that the damage will materially affect national security.

csmonitor.com Before this attack, the US was teetering on the edge of a recession. Is recession much more likely, even a virtual certainty now? Why or why not?

Navarro: Whether this terrorist attack plunges the economy deeper into a recession or, perhaps ironically, becomes the catalyst for a renewed expansion will be determined by how the President and Federal Reserve Chairman Alan Greenspan.

The most pressing problem facing us now is the possibility that the attack will further weaken consumer confidence even as it dampens the enthusiasm of corporate executives for new investment. A reduction in both consumption and investment would be a severe macroeconomic blow that would likely deepen and extend our recession.

To avert this economic disaster, the Federal Reserve must move swiftly to further lower interest rates and expand liquidity in the markets. If this wielding of expansionary policy is done with conviction, it will set the stage for a swifter economic recovery. Such a recovery will be aided by expansionary fiscal policy which is likely to come in the form of a dramatic increase in defense expenditures both in the short run and over the longer term.

A key point: The attack did NOTHING to harm our productive capacity as a nation. As it was in the 1930s and in FDR's words, "we have nothing to fear but fear itself." There is a way out - but the path is fraught with peril.

csmonitor.com What industries will be most effected by the attack and its aftermath?

Navarro: Two sectors - the airlines and insurance - will bear the major brunt of the attack. The airlines will be hurt by reduced travel as well as perhaps higher fuel costs. (Higher fuel costs will also hit energy intensive sectors like chemicals and plastics hard.)

Selective insurance companies will be hit hard by claims in much the same way that Hurricane Andrew did while brokerage firms are likely to see further declines due to reduced stock market activity.

Finally, if consumer confidence plunges, the retail sector will be hit. On the up side, the military and defense companies will see their stock prices rise as will oil and gas exploration companies. "Defensive stocks" like those of food, tobacco, and pharmaceutical will perform better relative to the market as investors see them as safe havens.

Over the much longer term, Internet and technology-related stocks will also benefit as we move to a more decentralized, electronic financial market.

(I have posted Chapter 19 of my book "If It's Raining Brazil, Buy Starbucks on my web site at www.peternavarro.com This chapter illustrates how to think about how catastrophes like war and drought move the markets.)

csmonitor.com There are already reports of rising gasoline prices. If military actions are taken in the Middle East, can we expect these price hikes to continue? Is this the single biggest economic threat during this fallout period?

Navarro: Rising oil prices reflect expectations of a possible supply disruption in the Middle East. Such a disruption could come about because of war.

Alternatively, it could be a political event such as an oil embargo. It is the president's job to respond to this attack militarily but to do so in a way that doesn't disrupt the oil markets.

Note that NOTHING has changed regarding either the supply or demand of oil as a result of the attack. The only thing that has changed is expectations about the future. Here, again, prudent government action can stabalize the oil markets.

As for rising gasoline prices, both Congress and state legislatures should monitor the situation carefully for price gouging and profiteering.

csmonitor.com Is there a big difference between consumer confidence and investor confidence these days? Do you expect either or both to drop significantly both here and abroad?

Navarro: As I stated in my response to the first question, one of the biggest dangers of this crisis is a blow to consumer confidence and business investment. Prior to the attack, consumer confidence had been the bulwark of our economy - but had fallen in the weeks just prior to the attack.

As for business investment, it seemed poised for a recovery as at least some executives believed a bottom had been reached in the business cycle.

If the President and Federal Reserve mishandle the crisis, the bottom will drop out of both consumption and investment. It is all in the policy makers hands now as to what happens but actions must be swift.

csmonitor.com To what extent is the damage in New York City damage to the "linchpin" of global trade? Will the crippling of businesses in the World Trade Center and the downtown cleanup period hamper the flow of trade enough to damage world markets?

Navarro: The disruption will be significant but surmountable. Trade should resume relatively swiftly. The broader lesson here perhaps is that it is imprudent to rely on a centralized model of financial trade. Look, then, for a rapid movement to a world of electronic and decentralized financial markets immune to physical (but not technological) attack.

csmonitor.com Any chance that rebuilding efforts and military spending could offset some of the negative impacts on the economy?

Navarro: As I discussed in the first question, there will be both a short- and long-run fiscal stimulus from increased defense expenditures. The short-run stimulus will occur as we expend missiles and other materiel during any retaliatory efforts. The longer run stimulus will likely be the result of new anti-terrorist and perhaps missile defense legislation that will dramatically increase defense expenditures.

My cautionary note here: Expansionary fiscal policy during the 1960s in the form first of the 1962 Kennedy Tax Cut and later by the Vietnam War set the stage for the rapid inflation and recession in the 1970s. We must be very careful here to coordinate both fiscal and monetary policy and not overreact.

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