I remember working on a bank trading floor when the Gulf War began in early 1991 and when the Russian coup d'etat took place in the summer of 1991. At the time, I dispassionately noted that defense company stocks along with U.S. Treasury securities would rally at the former event and that gold prices and the dollar would jump at the latter. This week's terrorist attacks on the World Trade Center and the Pentagon had me glued to the television, sorrowed by the horror and struck with disbelief at the events. It seems a more difficult time to be dispassionate.

Remembering my economist's roots
The financial market perspective: U.S. Treasury securities were trading in Europe and the market was initially open in the U.S. when the first plane plunged into the World Trade Center. Prices of Treasury securities rallied immediately since, in times of uncertainty, investors turn to risk-free assets. We are likely to see more investors turn to Treasury securities in the short term.

Uncertainty, financial market turmoil and war also make investors turn to gold. In the London market gold prices shot up significantly. As the U.S. markets open, we are likely to see gold prices rise as well.

One would expect a sharp plunge in the stock market in reaction to such a tragedy. Foreign stock markets dropped sharply in their last hours of trading after learning of the terrorist attack on Tuesday. But they did recover modestly on Wednesday. One would certainly expect the U.S. stock market to open lower when the exchanges finally open, which may be Friday at the earliest. But the extent to which stock prices do drop - or if they even drop at all - is likely to be mitigated by the fact that the stock market was closed for several days, which has given investors some time to think before reacting. To some extent, a good deal of the stock market movement will be related to economic events; in this case, how the disaster is expected to impact the economy will determine how the market behaves.

The economic perspective: Tuesday's disaster will have short and long term implications for the economy. The most obvious short term effects are the losses from the attack itself. The death of many Wall Street and military professionals is a productive loss as well as a human loss to the United States. The loss of the World Trade Center and many surrounding buildings, as well as a portion of the Pentagon, is another loss of wealth to the country. Apart from the physical buildings, there will be significant property losses. For instance, the National Association for Business Economics was in the midst of its annual meeting at a hotel located in the World Trade Center. The attendees rushed out of their meeting without bothering to get their personal belongings from their rooms. Also consider all the personal belongings in the offices themselves as well as all the automobiles parked in and around the Trade Center.

All air traffic was halted for two days. Aside from individuals being far from their places of destination, this also prevented shipping of mail and goods. Bank checks that need to be cleared from one bank to another are routed through the mail and delays could possibly reduce financial liquidity, though the Federal Reserve quickly provided additional funds to the banking system and has been lending actively from its discount window to banks that need it.

Disneyland in California, Disney World in Florida and the Space Needle in Seattle closed down, while many major cities announced the closure of large retail malls. The closure of these shopping centers and amusement attractions will no doubt have an impact on the bottom line of businesses during September.

The longer term impact on the U.S. economy remains a question mark. If consumer confidence is shaken dramatically, retail stores may see a more permanent deterioration in sales. Some economists are going so far as to declare that this will likely lead to a global recession. They then point out that the Gulf War was associated with a drop in consumer confidence and the 1990-91 recession. There are major differences, however. The consumer confidence decline associated with the Gulf War began when oil prices started to rise sharply - in advance of the war. Consumer spending was hurt because disposable income was impeded by sharply rising gasoline prices. In addition, the Fed dramatically raised rates in 1988 and 1989 before the recession. This is not the case today.

To some extent, the rebuilding process will help spur economic activity in New York City and Washington D.C. But this will have a minor impact on total economic growth in the United States as a whole. To a greater extent, it is likely that defense spending will increase in the coming years. A defense build-up will have ripple effects through the economy that is likely to spur economy activity overall.

Based on the economic data we've already seen, most market players were already looking for the Fed to reduce the federal funds rate target at the next meeting in early October. Given current events, the Fed could very well make sure to reduce rates more frequently or by a larger amount in order to ensure that consumer and business spending resumes. Keep in mind that the positive impact of the rate reductions over the past eight months should start kicking in as well in the next few months. In addition, the tax rebate checks that were started to be mailed in July is continuing through September. This should also help spur some spending.

The bottom line? The stock market could very well fluctuate wildly when the market opens initially. But if investors consider the consequences of the disaster, you will see targeted companies that may benefit (defense-related industries) and those that may be hurt (insurance and re-insurance companies). Retail companies may initially feel the brunt of the negative sentiment, but these have the potential for quick rebound if retail sales data in the next couple of months reveal that American consumers won't play victim to terrorist attacks.

Evelina M. Tainer, Chief Economist, Econoday