Economy Stays Firm as World Rallies Round

It is difficult to concentrate on the economic consequences of the trauma through which America is going. The human suffering makes such things as the future of share prices, GDP and inflation seem trivial.

But the ability of the nation to survive the most serious threat it has faced since the Second World War will depend not only on its resolve but on its economic strength. After all, it was the productivity of the American economy that finally overwhelmed Germany and Japan. Not for nothing were we known as the arsenal of democracy.

So as Congress gives the president the first $40 billion of the much larger sum he will eventually need to shore up America's defenses against terrorism, and help rebuild New York's financial district, it is important to work out where the resources will come from to carry this war to its conclusion.

One thing is certain. All talk about preserving the current $160 billion annual budget surplus to "save social security" is no more. The hot issue of last Monday disappeared on Terror Tuesday - and good riddance.

Bill Clinton wanted to forestall a Republican move to cut taxes. So he created a fictitious "lockbox", into which he persuaded voters the surplus would be deposited, to be used to pay the pensions of the baby-boom generation.

There is, of course, no lockbox. Pensions are paid out of whatever income the government can raise from taxes when the pension bills come due - a pure pay-as-you-go system. But so potent is the image of this lockbox that during his election campaign George Bush promised not to raid it. That left him with a problem when the combined effect of his tax cut and a slowing economy reduced government revenues sufficiently to leave the Treasury with a mere $160 billion surplus - just enough to deposit in "the lockbox". Taking that sum out of circulation at a time when the economy needs a shot in the arm is irrational, but the politicians of both parties had locked themselves as well as the money into a box.

Last week's horrors extricated them. No politician is going to deny the president the sums he needs to shore up airport security, buy surveillance and other equipment that the intelligence services need, and re-equip the armed forces for the new kind of war they will have to fight if terrorism is to be obliterated.

And for now, but not for long, the battle over a missile- defense shield is in abeyance. The administration says the increased ruthlessness of the terrorists shows just how much America needs a shield. But Democrats and their friends in the predominantly liberal media are using the World Trade Center's destruction as proof that the danger of a missile attack is the least of our worries, and that resources should be devoted to defending America against attacks of the sort we witnessed last week.

It is not easy to sort through all this. We do know that fiscal policy will be considerably looser as America moves to a semi-war footing. That should boost growth.

But we also have reason to worry that consumers, growing weary and less confident even before last week's terror attack, will retrench, either because they have been frightened away from the malls or because they are less certain about the nation's future than they were a few days ago. Since consumer spending has enabled America to avoid a recession - just - any retreat on their part will have unpleasant economic consequences.

We can guess about the near-term fate of certain sectors. Several financial- services firms have lost important personnel and infrastructure, and some of the smaller ones may never reopen. But even hard-hit Morgan Stanley reports that it has located virtually all the 3,600 staff it employed on the high floors of the World Trade Center, and Philip Purcell, the bank's chairman, says "all our businesses are functioning and will continue to function".

Insurance companies will take a hit, but the balance sheets of most of them seem strong enough to survive the impact. High-tech firms and defense contractors will benefit from increases in defense spending. But airlines, already deep in the red, will be even harder hit as costs rise and travelers stay at home.

The overall effect of these conflicting forces will depend very much on how confident consumers are with the ability of their government to cope with the new world in which they live.

So far, so good. The Federal Reserve System and its central-bank counterparts in other countries have promised to provide sufficient liquidity to keep the world's financial systems out of trouble. The bond markets opened on Thursday, and were ho-hum orderly. The dollar did not collapse. Perhaps most important, oil prices rose but did not soar as they did during the Gulf war.

Politicians of both parties have behaved in an exemplary, bipartisan fashion. America's allies have stood "shoulder to shoulder" with us, to use the words of Tony Blair, who might at last have been impressed by his electorate's outpouring of support for America that the "special relationship" has more meaning to Britons than europhilia.

There will undoubtedly be what Paul O'Neill, treasury secretary, calls the "transitory effects" of the "short-term dislocations" owing to the fact that transport stopped last week. But the long-term fundamentals of the American economy have not changed.

If the Fed and other banks ease soon and significantly when the equity markets reopen, if Saudi Arabia keeps

to its quiet word to pump enough oil to prevent a price spike, and if Bush learns from Jimmy Carter's handling of the Iran hostage crisis that vacillation by government produces malaise among consumers, the outlook is not bad at all - at least, not from the narrow view of economists.