Fear Itself

Baldwin Louie — Mon, 24 Sep 2001 15:00:00 -0700

OPINION The markets were gripped by fear even before the terrorist attacks of September 11, as the economy slipped into a recession that nobody wanted to admit was happening (but everyone secretly knew was happening).

Now the markets are gripped by terror, as suddenly it becomes easy to admit that a recession was inevitable all along (we knew it all the time!). Now our private fears - and public denials - are all about the risk of slipping into a global depression as the world economy processes "the terrorist tax."

The terrorist tax is a tax we impose on ourselves because of our fear. The financial costs of turning the sands of Iraq to glass and creating Lake Afghanistan are trivial - we paid for the nukes long ago (using them now is just, well . . . efficient capacity utilization). The real tax is the countless frictions imposed by all the efforts to allay our fears here in what we now fondly call "the homeland."

We could afford things like breeding special mutant dogs to sniff out potentially deadly toothpicks that could be used as weapons, and might be concealed in the carry-on luggage we've waited in line two hours to be sniffed. And Oracle CEO Larry Ellison can afford to pick up the tab for mandatory identity cards for every man, woman, child and unborn in America, to show to the security guard before the dog starts sniffing.

But what's going to sink us is the cumulative tax we'll pay every time we fearfully decide to order one less piece of sushi . . . do without that new suit . . . save that trip to Hawaii until the spring . . . as we tell ourselves that it never hurts to have a little more in reserve, just in case. If we continue along that road, we're going to have 10% lopped off the GDP before you can say "I'll skip the giant clam, thank you."

And while I surely don't mean to trivialize the loss of more than 6,000 lives in the attacks themselves, it is our fears that will make that loss into the attack that keeps on attacking. An economy in depression kills by the millions, but it does it one at a time, and quietly: Those old tires aren't really bald yet . . . doing without vitamins isn't going to matter . . . in times like this, we can't really afford more AIDS research . . . As Stephen Sondheim put it, Every Day a Little Death.

And that's how the terrorists can win, if we let them. As Sun Tzu wrote in 500 BC in The Art of War,

"Supreme excellence consists in breaking the enemy's resistance without fighting . . . Therefore the skillful leader subdues the enemy's troops without any fighting; he captures their cities without laying siege to them; he overthrows their kingdom without lengthy operations in the field."

Overcoming our fear is the key, and Franklin D. Roosevelt knew it in times much worse than these. Most people think he uttered his famous advice, "We have nothing to fear but fear itself" after the Japanese bombing of Pearl Harbor in December 1941. Not so. It's from his first inaugural address, in March 1933. Here's the context:

"So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself - nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance."

"Retreat". . . "Advance". . . he's speaking in military terms, to be sure. But the war he was talking about wasn't World War II, which then was still almost a decade in the future. He was talking about winning the economic war against the Great Depression.

President George W. Bush understands intuitively that fear is the key. An hour after the attacks, in his first public statement, with a whole dictionary to choose from, Bush chose to characterize the attacks as "cowardly." As Susan Sontag points out in The New Yorker, stealing a jetliner and killing yourself by slamming it into a skyscraper may be vicious, crazy, bestial and horrific - but it's not cowardly.

But shutting down the economy to prevent the slightest risk of another attack is. And the wholesale dumping of equities last week is. Look, I'm not blaming anyone for doing what they have to do. I'm not flying unless I have to, and if I see a cropduster I'm jumping into the nearest fallout shelter. And I dumped all my stocks on Wednesday - though I'd love nothing more than to be proved wrong if this mess can turn itself around. But honestly I don't think it's going to.

That's because we're in the grips of a vicious cycle of self-perpetuating fear. And fear is a powerful corrosive that destroys economies - and equity values get dissolved first.

As David Gitlitz, president and chief economist of DG Capital Advisors, has pointed out in a client bulletin issued last Friday and published here today, the attacks have dealt a double blow to equity markets. First, the attacks have worsened an already declining earnings outlook, and second, at the same time, that worsened outlook has also become more uncertain.

And it's even worse than that, for it's truly a triple blow because of the psychological dimension I've been talking about. The worsened and uncertain outlook has been set before an investing public whose confidence - its willingness to bear uncertainty at any level - is shattered.

It's simple: Equity values are the product of three factors: expected returns, expected risks and investor risk tolerance. The attacks lowered expected returns, raised expected risk, and crippled investor risk tolerance.

The market will turn when the psychology of fear bottoms out - and that will happen long before earnings rebound, and even before the uncertainty of earnings abates. But the psychology of fear won't bottom out until our national leadership evolves both economic and military/diplomatic policies that are coherent and confidence-inspiring - policies that will both make us less afraid and create incentives for us to take more risks. But so far it's pretty obvious they don't have the first clue about what to do here.

And until they do, the markets will have fear itself to fear. And they'll be headed lower. We'll get it right - but in the meantime, sell rallies.

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Fear Itself