analysis
Larry Elliott
It will be weeks, months, even years before the full economic effects of the disaster that befell New York and Washington can be assessed. But one thing is already certain: the impact will be colossal, not just on the United States but on the rest of the world. This was a shock to the very heart of the global economy and, like an earthquake, the after-shocks will ripple out from Manhattan to countries big and small, rich and poor.
Consider the background. The United States accounts for 25% of the global economy and it was in trouble even before Tuesday’s terrible events. Growth slowed markedly during the past year. Share prices were under pressure, the financial sector was reported to be sitting on big losses, corporations had started to lay off staff in considerable numbers, with knock-on effects on consumer confidence. The US’s slowdown has affected the rest of the world so much so that the International Monetary Fund has twice downgraded its forecasts of global growth in the past month.
Bad news for the US is bound to be bad news for everybody. And the news for the US is very bad indeed. Estimates by Giles Keating, an economist with Credit Suisse First Boston, suggest that the US economy could contract by 0,8% in both the third and fourth quarters of this year simply as a result of the drop in air travel and the seizing-up of local economies in New York City and Washington. The five boroughs that make up New York City account for more than 6% of US gross domestic product.
But the effects on the US will be felt well beyond the eastern seaboard. Even if air travel gets back to normal quickly, business meetings have been cancelled and transportation of raw materials and food delayed. Hotels and tourism are already losing business. Disneyland and Walt Disney World closed in the immediate aftermath of the attacks.
This is the second and longer-term danger to the US economy. The willingness of consumers to spend money has saved the economy from full-scale recession this year, but they may now be in no mood to splash out. As was evident in Britain in the aftermath of Princess Diana’s death, traumatic events can have a noticeable effect on consumer behaviour, and in the great scheme of things the death of one princess is insignificant in comparison to the blow to the US’s self-belief from the toppling of the trade towers and the damage to the Pentagon.
So what should we expect? Professor Tim Congdon has it right when he says there is a risk that Bush will boost defence spending, reversing the declines of the past 10 years in which the peace dividend has helped to turn the budget deficit into a healthy surplus. Even more troubling, he estimates that share prices on Wall Street have been inflated by 30% as a result of the end of the Cold War, which convinced dealers that equities were as risk-free as bonds in a world where free-market ideas reigned supreme.
The next few months are likely to see the US economy and stock market suffer badly. The strong dollar will weaken and it will be left to Europe and Japan to take up the slack. Neither is in good shape to do so, especially Japan, where the economy is contracting fast. And the increase in the value of the euro and the yen will do nothing to boost growth prospects.