A war with Iraq could give the global economy the boost it needs to get out of its rut
The third quarter ended with such a thud and host of honoraria, the worst quarterly performance since 1987 for many European bourses, investors, economists and analysts were left wondering how we will ever get out of this mess.
The Economist featured a special pullout section on 'Doldrums: The World Economy and How to Rescue It.''
In the Financial Times, Martin Wolf opined that Federal Reserve Chairman Alan Greenspan's decision to ignore the bubble in stock prices will either be a model for central banks in the future or reason to assign Greenspan to the dustbin of history of failed Fed chairmen, depending on whether the economy revives or deteriorates.
Recently, I participated in a money market outlook panel held at Bloomberg's headquarters in London. During the Q&A, a woman in the audience posed the question, what gets the global economy out of its rut?
Another panelist jumped in before I had a chance to respond. While he was talking, I reconsidered my intended comments and, thinking they might sound too crass, passed. What I was planning to offer as a way out of the stock market slump, at least to the extent that it's being driven by negative sentiment rather than fundamentals, is war.
I'm not suggesting a Wag the Dog scenario, with the Bush administration orchestrating a war with Iraq to deflect attention from the economic malaise at home. I don't have to suggest it. New York Times columnist Paul Krugman already did.
What I'm suggesting is that an attack on Iraq could be bullish for the US stock market, lifting the pall of uncertainty and reversing the momentum that seems to be feeding on itself and has become self-reinforcing, a falling stock market creates uncertainty, which causes business and consumer confidence to decline and prompts a further drop in stock prices, etc.
Listening to the daily blather about war with Iraq creating 'uncertainty'' in the markets, I had a hunch there was a qualitative difference in the market's reaction when the US or its allies are attacked, especially when the attack is unexpected, and when the US goes on the offensive.
Germany's invasion of France in 1940, the Japanese attack on Pearl Harbor in December 1941, Iraq's invasion of Kuwait in August 1990 and the 11 September attack on the World Trade Center and Pentagon all were greeted with a plunge in stock prices.
The German offensive sent the Dow Jones Industrial Average down 24% in the next 22 days, according to Tim Hayes, global equity strategist at Ned Davis Research in Nokomis, Florida.
Pearl Harbor delivered a mere 2% decline in the following 22 days, 'but the Dow was down 10% 63 days later,'' Hayes says.
North Korea's invasion of South Korea knocked 9% off the Dow, Iraq's invasion of Kuwait 10% and the World Trade Center attack saw the index fall 2% (all changes for 22 days), Hayes says. The sharp 15% decline the first week after the New York Stock Exchange reopened on 17 September was completely eradicated by 9 November.
No surprise when you think about it. When the US is perceived as vulnerable, the future looks bleak to that ultimate discounting mechanism, the stock market.
The reverse is true when the US goes on the offensive. The allied invasion of Normandy in June 1944 (D-Day), the dropping of the atomic bomb on Hiroshima the following year and the US attack on Iraq in January 1991 all ushered in big rallies in stock prices. The increase 22 days later was 5%, 8% and 17%, respectively, according to Hayes.
'When the US is on the defensive, the market worries about dire scenarios,'' says Jim Bianco, president of Bianco Research in Chicago. 'When we start to see closure coming to the war, that eventually we are going to win, the market responds positively.''
In other words, the beginning of the end is good for sentiment and good for stock prices. Strategic victories in wars have tended to be stock-market bullish as well.
The Battle of Midway in June 1942, 'which essentially turned the tide of the war, in the Pacific, in favour of the Allies, produced a 1% increase in the Dow on the first day,'' Hayes said. 'Three days later it was up 4% and six months later, 12%.''
To the extent that the stock market suffers from 'uncertainty,'' as if the future were ever certain, the initiation of an offensive would remove it. One assumes the uncertainty is about timing and method, not outcome.
Unlike the massive mobilisation for World War II, war with Iraq won't entail the kind of build-up that pulled the US decisively out of the Great Depression. But it won't be fought solely from inventory, as Krugman assumes: the same uncertainty afflicting the markets will prompt the Defense Department to ensure it has enough cruise missiles on hand.
Nor is it expected to be a long, drawn out affair, like the War in Vietnam.
Of course, predictions about the course of a war, like most economic forecasts, are fruitless. The only value is in looking at history to glean how the market reacted in similar situations in the past.
This study excludes the state of the economy, the policy response, and the reaction of other financial variables, such as oil prices and the dollar.
Still, the psychological response to offensive action is clear.
So while investors are loading up on two-year notes at miniscule yields, it's far from certain short-term instruments will be the preferred venue when the bombs start exploding over Baghdad.
Bloomberg London newsroom
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