TERRORISM & THE FINANCIAL MARKETS
by Ghassan Abdallah, Ph.D.
July 30, 2007

Terrorism has always been cited as one of the exogenous variables impacting the financial markets and economy. Since the 9-11 attacks, the attention given by the press to this phenomenon has reached unprecedented levels. Presently, one cannot read a newspaper or watch a newscast without seeing or hearing some reference to terrorism. Terrorism has spawned the growth of a new multi-million dollar industry involving the media, think tanks, security firms, consultants, and academic experts. I argued in my last article, “Oil and the Iranian Conundrum,” that a likely military confrontation with Iran, an undisputed state sponsor of terror, would have major repercussions on the oil markets. That being said, it is very important to separate the impact of real threats and actual rising geopolitical tensions from the irrational fear that has gripped the country and the world over the last few years. We must be careful not to jump on the bandwagon of those who have an interest in terror threat inflation. In the paragraphs below I will attempt to assess the true nature of the terror threat and its effects on the country in general and on investors in particular, not by relying on “my gut feeling” a la our good Secretary of Homeland Defense Michael Chertoff, but rather by simply separating fact from fiction.

ASSESSING THE THREAT

One of the main problems facing those who research terrorism is the lack of consensus on a definition. Without delving into the relativity issue of “one man’s terrorist is another man’s freedom fighter,” which would require an entirely separate article to address, I will rely on the American Heritage Dictionary’s description of terrorism: “The unlawful use or threatened use of force or violence by a person or an organized group against people or property with the intention of intimidating or coercing societies or governments, often for ideological or political reasons.” Terrorism thus defined has a two thousand year history and dates back to the ancient world. The earliest terrorist activities were committed by the Sicari Jewish zealots movement against the Roman occupation of Palestine. The group’s name comes from the word “sica,” a short sword that was the preferred weapon of its members. Terrorism was here long before we were and will be here long after we are gone. 

No nation enjoys perfect security including the United States. However, a future attack similar in magnitude to the one launched on the World Trade Center in 2001 is an extremely low probability. The most recent National Intelligence Estimate prepared by government analysts for President Bush states that al-Qaida and Hezbollah pose “a persistent and evolving threat to the U.S. over the next three years.” The report also states that al-Qaida is using its growing strength in Pakistan and Iraq to plot attacks on American soil, heightening the terror threat facing the U.S. in the next few years. What the report failed to stress is that since 2001 thousands of al-Qaida militants, including the mastermind behind the 9-11 attacks, Khalid Sheikh Mohammad, have either been killed or arrested. As for the al-Qaida leadership, it is on the run hiding somewhere in the mountainous region between Pakistan and Afghanistan. It is very doubtful that 

al-Qaida has the logistical capability to launch an attack on U.S. soil. The September 11, 2001 attacks took years of preparations and involved the recruitment of hijackers in Germany who were then able to travel freely from Europe to Afghanistan, where they got terrorist training, and later obtain visas and travel freely to the U.S. where they received pilot training. The terrorists were not only able to travel freely but to communicate and wire funds freely. That is no longer possible today, and one looks with amazement how it was even possible then. The failure of the U.S government and its intelligence agencies to detect and counter the threat before September 2001 is inexcusable. Prior to the World Trade Center bombings, Al-Qaida had launched attacks on the USS Coles off the coast of Yemen and on U.S. embassies in East Africa. Anyone who followed the news in the mid to late 1990’s would have known that Bin Laden was dangerous and needed to be stopped. 

To reiterate, presently al-Qaida does not have the logistical capability to launch a spectacular attack on American soil. And I use the word spectacular because that is what terrorists aim to do. It is not just the immediate victims of the attacks that terrorists are after but the larger audience who terrorists hope would be consumed with fear and despair. 

The second Islamist group cited by the National Intelligence Estimate as potentially posing a terrorist threat is Hezbollah. This Lebanon-based and Iranian-backed group of militants, who have the arrogance to call themselves the Party of God, are potentially more dangerous. Unlike al-Qaida, which is stateless, Hezbollah is state sponsored. Iran created the organization in the early 1980’s and provides millions of dollars annually to finance the group’s activities inside and outside Lebanon. Hezbollah has gone largely untouched by the Bush Administration’s war on terror and has the ability to move people and money worldwide. Hezbollah has sympathizers in Europe and the United States, individuals with dual citizenships who can travel freely between East and West. It is truly a terrorist organization with a global reach and one that has to be monitored very closely by U.S. intelligence agencies. Hezbollah is one of the few cards that Iran’s Supreme Spiritual Leader, Ali Khameini, holds when it comes to his confrontation with the United States over Iran’s nuclear program. What are the odds of a Hezbollah terror strike in the West? Currently very low, however those odds will increase significantly if there is a military confrontation between the U.S. and Iran. 

MARKET EFFECTS

The 2001 WTC bombings were followed by a significant sell off in stocks, which the media conveniently linked to the attacks. However, a careful examination of the direction of the markets before the 2001 attacks reveals that the markets were already heading down. The Bear market that ultimately led to an 80% decline in the Nasdaq began in the Spring of 2000 and was caused by wild speculation facilitated by years of easy monetary policy by then Fed chief Alan Greenspan. Since the September 2001 attacks there have been three major terrorist attacks linked to al-Qaida sympathizers. First came the October 2002 bombings on the Indonesian island of Bali, resulting in the death of 202 people. Those were followed in 2004 by the Madrid commuter train bombings, resulting in the deaths of 191 people. The third major terrorist attack targeted London’s public transport system in 2005, causing 52 deaths. All three terrorist incidents were shrugged off by the global financial markets, which kept on climbing higher. Now as we enter the late stages of the economic cycle and as profits decelerate the markets are adjusting by going lower. That is what markets do-- they go up and they go down irrespective of the terrorist threat. Businesses and the economy in general can only be adversely affected by terrorism if the terrorist campaign is sustained over a long period of time. For example, a terrorist campaign such as the one occurring in Iraq can lead to severe disruptions to business as a result of loss of revenue, relocation, inflation, and property damage. However, such a consistent and prolonged terror campaign is not likely to occur in the West. 

Price movements in precious metals are also often linked to rising concerns of terrorism. It is not uncommon for the mass media to link a $10 up move in the ounce of gold to heightened security concerns. Such a move is commonly referred to as a “flight to safety.” In actuality the run up in gold prices over the last few years had very little to do with the threat of terrorism and a lot to do with the Bush administration’s so called “strong Dollar policy,” which has led to the debasement of the U.S. currency. An American corporation that sells overseas increases it profits when it exchanges for more dollars. However, the average American worker loses because it takes more of his dollars to purchase most goods especially those imported.

In the end an investor is better off watching Bernanke not Bin laden for clues concerning the next market move. The pressure on the Fed to come to the rescue will increase as the markets decline. When Bernanke eventually presses the panic button, gold and gold stocks will be the biggest beneficiaries. 

© 2007 Ghassan Abdallah, PhD
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