U.S. economy braces for shock, seeks its balance

Consumers worry, fear a recession

effects could linger

Spending priorities change

Terrorism Strikes America

September 23, 2001|By William Patalon III | William Patalon III,SUN STAFF

The shock waves of the Sept. 11 terrorist attacks will change the face of the U.S. economy for months and perhaps years to come.

In the short run, few dispute that the financial fallout will be enormous. The only question, economists say, is how long the American economy will be scarred.

"We will have to pay the piper one of these days," said Anirban Basu, chief economist of Towson University's RESI research and consulting unit. "This has changed the very complexion of this decade. I don't think that's overstating things."

In the short term, previously shaky air carriers are on the brink of bankruptcy and have announced more than 100,000 layoffs. The government authorized billions of dollars in unplanned spending, with much more to come.

Consumer confidence has plunged, and companies are downgrading already disappointing profit projections, throwing the stock market into a downward spiral.

If the U.S. economy was not already in a recession, it definitely is now, economists say.

"It was almost like extinguishing a flickering light - what little light was left," said Richard Yamarone, chief economist for Argus Research in New York.

The broader and more important issue, though, is whether the economy will suffer in the long term.

There is concern that consumer confidence - a key to a healthy economy - could fizzle, unplanned federal spending will turn budget surpluses into deficits, and inflation and higher interest rates could resurface.

"There will be differences [in the economy] that you can trace back to Sept. 11," said David L. Berman, head of Berman Financial Group LLC in Timonium and president of the Planning Association of Maryland.

One area at risk will be consumer confidence. Consumer spending accounts for two-thirds of the country's economic growth, and consumer confidence is the key to that spending.

When the attacks occurred, uncertainty reigned. Since then, consumer confidence has darted downward, and so has spending.

"Uncertainty is like a tax on the economy," said Steven A. Wood, chief economist for FinancialOxygen Inc., an Internet banking services firm. "It constrains economic [spending] or increases the cost of doing certain things."

Whenever there's a flare-up in the battle against terrorism, uncertainty will resurface. Consumers will keep their wallets shut. The stock market will stutter and stumble. And the economy will slow.

The federal budget might also prove to be a problem.

Although increased defense spending was part of the president's platform from the start of his administration, a disaster-relief package, an airline bailout and a huge anti-terrorism initiative were not.

The terrorist campaign alone could force the government to take money allocated for other programs and redirect it into the coffers of the military, the Justice Department and U.S. intelligence agencies.

Or deficits could arise.

"Federal spending will be greater than ... it otherwise might have been before the tragic events of Sept. 11," said RESI's Basu. "That crowds out private investment and raises interest rates. There will be several years of impact, perhaps a decade. Higher federal spending means higher interest rates."

When the government spends more than it takes in, it runs a deficit and has to borrow the difference. But the pool of money to borrow from is finite, so deficit spending puts the government and corporations in direct competition for those funds.

That competition drives up interest rates, making it more expensive for both the government and corporations to operate. And that's a drag on the economy.

"If we were to move from a surplus to a deficit for an extended period of time, then you would clearly see government spending crowd out private investment," said James Hardesty, president of Hardesty Capital Management, a Baltimore money management firm.

"I hope that's not going to happen."

If deficits get too large or last too long, they could beckon inflation - the absence of which during the record 1990s boom was no coincidence.

Inflation is bad for consumer confidence and deadly for stock prices. Right now, it's all but dead, most economists agree.

When deficits become chronic, the taxman visits - the government might have to resort to a tax increase. But higher taxes could reverse the effect of the Bush administration tax cut - and then some.

Too great a tax increase could serve as an anchor on the economy:

The higher taxes spiral, the more corporate profits are pinched and the less consumers have available from their paychecks to save or to spend.

Tax cuts spur spending, saving and corporate investments in new technologies, said John P. Hussman, portfolio manager of the Hussman Strategic Growth Fund, a new mutual fund that operates from Ellicott City.

"A reduction in marginal taxes, a reduction in capital gains taxes and investment tax credits will help speed up the transition" from recession to economic expansion, Hussman said.

In the months ahead, as the United States develops its strategy for its fight against terrorism, economists and financial analysts caution that the Bush administration must not forget about the effect its campaign will have on the U.S. economy five years or a decade from now.

And it can't ignore the impact of the shock the economy endured not quite two weeks ago, experts said.

"An economic shock is anything that fundamentally alters the trajectory of the economy in the short and long run, since the shock effects linger into the long run," said Basu.

"This definitely fits the definition of an economic shock, because there is going to be a short- and long-run impact."

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