Economics Finance MBA Level Term Paper

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disrupting America's economic system is a fundamental objective of terrorists

Even as the world continues to struggle with the terrible shock from the September 11 attacks in New York and Washington, one principle lesson has already become clear: disrupting our economic system is a fundamental objective of terrorists.

Prior to September 11, our economic environment was certainly not immune to terror, in comparison to many other nations; we lived relatively terror-free. Now, however, the aftermath of the terrorist attacks serves as a grim reminder that international relations and security developments can dramatically affect economic performance.

US History is replete with countless examples when macro fundamentals are overtaken by what economists refer to as, exogenous shocks -- surprise events that can profoundly and often unpredictably shift political and economic resources, and send even the most accurate forecasts astray. Commodity shocks, such as the two OPEC jolts in the 1970s, are classic examples of this kind of economic shock. In fact, throughout much of the past century, wars, labor strikes, currency market turmoil, and major natural disasters have all proven to be quite destabilizing to real U.S. economic activity.

Nevertheless, what are the real potential economic perils associated with an event like the September 11, 2001, terrorist attacks upon the U.S. In other words, aside from the immediate economic consequences of that event, what are the likely, longer-term, systemic implications for the economy, now that President Bush has formally declared a "War on Terrorism? The balance of this essay will look for some answers to that question. Specifically, this treatise will concentrate its focus on some of the direct, significant relationships between these types of events, and their resultant impact upon leading economic indicators.

The Impact of Exogenous Events upon U.S. Leading Economic Indicators

Overview:

As a member of President Clinton's Council of Economic Advisers, Harvard economist Jeffrey Frankel examined in 1998 the risks to the economy from the computer glitch dubbed the "Y2K bug." Frankel's study reviewed 20 major disasters in the U.S. between 1971 and 1995. The events included riots in Miami in 1980, the Mount St. Helens eruption in the same year, and a 1993 winter storm affecting 24 Eastern states. The report concluded that diversion of resources to replace buildings, for example, had only "a limited impact on current sales and production," he found.

The American economy is large, diverse, and resilient, and people will find ways around those disruptions...." Frankel noted in an annual report of Mr. Clinton's economic advisers. "Then there is a rebound," added business-cycle expert Victor Zarnowitz, an economist who authored a similar study for the New York-based Conference Board. For a major natural disaster - such as Hurricane Andrew in 1992 or the Northridge, Calif. earthquake of 1994 -- the impact barely show up in the national statistics on output or unemployment for the year.

The closest match to the September 11 disaster may be the 1990 Gulf War after Iraq invaded Kuwait. In that event, a recession had started a month before the U.S. And its allies entered the conflict. The war simply exacerbated the slump, which lasted until March 1991.

The September 11, terrorist event, however, is far more severe - in both loss of life and economic impacts. Nevertheless, on balance, most economists remain confident. "Recovery will be a bit stronger than it was going to be," says Paul Kasriel of the Northern Trust Co. In Chicago. "But it will start from a lower base."

Yet, even while the terrible shocks of the World Trade Center and Pentagon attacks are slowly absorbed by the U.S., one immediate lesson becomes clear - disrupting our economic system is a fundamental objective of terrorists. Moreover, although, prior to September 11, our economic environment was certainly not immune to terror, in comparison to many other nations, we lived relatively terror-free. Now, however, the aftermath of the terrorist attacks serves as a grim reminder that international relations and security developments can dramatically affect economic performance.

Indeed, U.S. History is replete with countless examples when macro fundamentals are overtaken by what economists refer to as, exogenous shocks -- surprise events that can profoundly and often unpredictably shift political and economic resources, and send even the most accurate forecasts astray. For example, commodity shocks, such as the two OPEC jolts in the 1970s, are classic examples of this kind of economic shock. Moreover, throughout the past century or so, wars, labor strikes, currency market turmoil, and major natural disasters have all proven to be quite destabilizing to real U.S. economic activity.

Nevertheless, what are the real potential economic perils associated with an event like the September 11, 2001, terrorist attacks upon the U.S. In other words, aside from the immediate economic consequences of that event, what are the likely, longer-term, systemic implications for the economy, now that President Bush has formally declared a "War on Terrorism? The balance of this essay will look for some answers to that question. Specifically, this treatise will concentrate its focus on some of the direct, significant relationships between these types of events, and their resultant impact upon leading economic indicators.

The San Francisco Earthquake:

While natural disasters such as, Hurricanes Andrew and Iniki, as well as man-made ones, such as the September 11, 2001, terrorist bombings in the U.S. all result in significant loss of money and property, the costs of the 1906 San Francisco Earthquake actually substantially higher (Wall Street Journal, October 9, 2001).

Damage from the San Francisco earthquake and fire of April 1906 was estimated to be between $350- $500 million, or 1.3 to 1.8% of U.S. GNP in 1906; Large amounts of relief flowed into the city in the weeks immediately following the disaster. Because British companies underwrote the majority of the city's fire insurance policies -- an estimated £23 million (or $108 million) at the time -- millions of pounds worth of insurance claims were soon presented in London, (Romer, 1989).

The magnitude of the resulting capital outflows in late summer and early autumn 1906 forced the Bank of England to undertake defensive measures to maintain a fixed sterling/dollar exchange rate. The central bank responded by raising its discount rate two hundred-fifty basis points between September and November 1906 and by pressuring British joint-stock companies to stop discounting American finance bills for the next year. (Economist: 10/20/1906, p1694).

Actions by the Bank of England attracted gold imports and sharply reduced the flow of gold to the United States. By May 1907, the United States had fallen into one of the shortest, but most severe recessions in American history (Friedman and Schwartz, [1963]). Thus primed for a financial crisis, already-weakened world markets crashed in October 1907 with the collapse of the Knickerbocker Trust Company in New York. Ultimately, the Panic of 1907 led to one of the most important institutional changes in American history: the creation of the Federal Reserve System designed to provide for an elastic currency and to act as a lender-of-last resort.

The Panic of 1907 was a watershed event for the United States. This was the last in a series of financial crises during the National Banking Era that prompted reform of the American financial system. Troubled by recurring financial panics and the economic distress that resulted, Congress established the National Monetary Commission to consider whether there was a role for government in managing the nation's money supply. The Commission recommended the formation of a central bank that would provide for an elastic currency and serve as a lender-of-last resort. Congress passed the Federal Reserve Act in 1913.

Given the importance of the 1907 Panic in the development of American financial institutions, it is not surprising that this event has been the subject of much investigation. Many scholars have attempted to identify the shocks that primed the United States for a financial panic. In particular, several studies have tried to uncover the origins of a liquidity crisis that plagued the London and New York money markets from 1906 until the onset of the Panic.

Previous literature has generally pointed to an American shock in 1906 that prompted nearly $70 million of gold imports from England (see Sprague, [1910]; Sayers, [1963]; Clapham, [1944]; Friedman and Schwartz, [1963]; Goodhart, [1969]; Kindleberger, [1978]). Policy responses of the U.S. Treasury and, more importantly, of the Bank of England exacerbated the liquidity crisis, making American and world financial markets vulnerable to shocks that otherwise would have been temporary in nature. Markets finally collapsed in October 1907 with a run on New York's Knickerbocker Trust Company.

O.W. Sprague, writing on behalf of the National Monetary Commission, traces tight credit conditions in 1906 to New York (Sprague, [1910]). He notes that the United States experienced surges of gold imports between April and May, and again between September and October. The United States imported over $50 million in the spring and approximately $80 million in the late summer and early fall.

Sprague attributes the first wave of gold imports to a cyclical boom in 1905 that placed extraordinary credit demands on…[continue]

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