< meta name="DC.Date.Valid.End" content="20050825"> Amendment Nine: Terrorism, Liquidity, and Fighting War

Wednesday, February 02, 2005

Terrorism, Liquidity, and Fighting War

After 9/11 the equity markets tanked. See this 5 yr chart for a good view. You'll see that by Q1-2002, the Dow had recovered almost completely from the shock of 9/11. Bond markets, while much more volatile, show a similar pattern. Almost all US markets were "shocked" by 9/11, but within a quarter, they rebounded. This is why its now common to refer to terrorist events as short-term liquidity crunches.

One of my favorite people in the world is an arbitrage portfolio manager at a major investment bank. He calls terrorist events: "a pinch in the wallet, but a punch in the face." In other words, they knock you silly, but they don't rob you blind.

Now, look at that chart again, notice the Q2-2002 downward trend start to develop, and notice it not fully recover until Q4-2003. What caused that? Iraq. While terrorist events and the resulting fight with them results in a short-term liquidity crunch, invading and occupying a nation creates long-term, sustained liquidity problems. For example, oil goes up, but not just because of supply, demand too rises. Gasoline reserves are drained to power the Army that invades and now controls Iraq. Thats just one example, there are numerous others, just think about all the things that go into fighting war and all the demands that war places on the economy.

This is why, from an economic perspective, war is a serious pain in the ass. It kills returns. It skews markets. And it often rewards some of the least efficient businesses and industries. The only thing more of a pain than war, is an indefinite war.

My answer to this is for Bush to give an ultimatum tonight. "We will end this war by the time I leave office." If he says that, a lot of risk premium out there will be removed and inflows of venture capital will see a broader uptick than what they are already currently seeing. My only hope is, if he says it, that he really means it. Finishing the job with Al-Qaeda and completing the work in Iraq are necessary to encourage sustained economic growth. This may mean sacrifice, but right now, if we leave things in their current state, we'll sacrifice much more in the long run.