U.S. Economy Staggers but Won't Fall

The terrorists who destroyed the World Trade Center and a part of the Pentagon have cruelly taken thousands of lives and destroyed many others. They have restricted our liberties. But will they also succeed in taking America's prosperity?

For a time, they may, as the economy reels from the effects of Tuesday's attack. But recovery will come.

Despite the heavy cash injections being made Wednesday by the Fed and other central banks and the high likelihood of interest rate cuts by these monetary authorities, the U.S. economy will be hit hard by these attacks. Harder than some experts are predicting: Well-known companies could disappear in the hardest-hit sectors, like air travel and finance. Business and consumer confidence will take a knock. But a recovery will come, like a Phoenix out of the ash that currently cakes New York's Financial District.

Airlines, Financials Look Weakest

First off, what's most vulnerable after Tuesday's appalling events? Let's start with the airlines. Already suffering large losses as a result of the economic slowdown, the big airlines have to be in a very precarious position now. They've lost large chunks of business through the flight ban.

Even when things get back to normal, it's likely that fewer flights will be made. People will be less willing to fly. And one has to assume that the introduction of more extensive security checks will reduce the amount of flights that can be made in a day. The airlines will have to foot the bill for a substantial part of the extra security costs.

And there's legal risk. Expect UAL (UAL - Cramer's Take - Stockpickr), which owns United Airlines, and AMR (AMR - Cramer's Take - Stockpickr), which owns American Airlines, to become the targets of lawsuits on behalf of the victims' families, citing lax security. (The intention here is not to criticize any suits that may be filed, but rather flag this as a potential financial risk to the two companies.)

Brokerage earnings will also show severe weakness. The trading halt and the mass destruction of the Financial District will lead to a big drop in revenue at some of the brokers, another sector that was already doing badly because of the economic downturn.

In the short term, the Fed will, of course, ensure that the brokers have all the short-term funds they need. And being quick-witted by nature, brokerage management will improvise in the face of great obstacles. There's talk that one large investment bank with offices in the World Trade Center secured large amounts of office space in New Jersey within hours of the two jets slamming into the Twin Towers.

The big question for the brokers is whether this is a one- or two-quarter event. For example, how long will it be before Merrill Lynch (MER - Cramer's Take - Stockpickr), American Express (AXP - Cramer's Take - Stockpickr) and Lehman Brothers (LEH - Cramer's Take - Stockpickr) can fully operate in their headquarters in the World Financial Center, the office development across the street from where the World Trade Center stood? Trading volumes will be down, and fewer investment banking deals will get done. Who's in a position to weather a dearth of commissions and fees? Hard to tell at this point, since the third quarter was already shaping up to be ugly.

Money Talking

From a macro perspective, all eyes must be on the dollar. If the greenback begins to fall, the Fed may have less leeway to cut rates by as much as it thinks necessary to offset potential financial-sector problems and any dip in consumer confidence. Alternatively, perception in the currency markets that the Fed is failing to cut enough could also weaken the dollar.

As always, the deciding factor in the currency markets will be inflation. All other things being equal, that wouldn't be a problem in a situation like this. But with the pols talking about spending huge sums to beef up defense and security, as well as provide billions of dollars in aid to victims and affected areas, there will be considerable stimulus from the government sector.

Over the longer term, military spending could soar, especially if America's leaders decide to wage long-term war on terrorist cells and the states they believe to have harbored and supported them. No politician is going to stick his or her neck out now and demand budget cuts after this. The fiscal surplus could be replaced by Reagan-era deficits if the generals and the intelligence agencies get what they want. This may well be the people's will, but it would also mean capital being diverted from productivity-enhancing investments in the private sector.

The shock of the attack will likely lead consumers across the nation to spend and borrow less. According to conventional wisdom, that's very bad news, as the consumer was supposed to be the one remaining source of strength in the economy. But debt levels suggested that it was high time for the consumer to retrench. The terrorists may have speeded up a tough but necessary adjustment in the consumer balance sheet. This will provide more capital to companies, whose investments, when measured properly, actually provide a far larger chunk of gross domestic product than pure consumption.

However, one thing is clear. An economic crisis is not afoot. These terrible terrorist acts will complicate and deepen some of the problems that the economy was already experiencing. But it will help in other, smaller ways. Wall Street, under Washington's proud gaze, will thrive again. As will America.