War variables cloud economic outlook Uncertainty already a drag on business climate

www.bayarea.com Posted on Sun, Feb. 23, 2003 By George Avalos CONTRA COSTA TIMES

War fears ease -- markets rally. War jitters grow -- markets slump.

This back-and-forth, up-and-down gyration has become a familiar dance on the periphery of the Persian Gulf crisis. Some economists say consumers and business executives, along with Wall Street's hotshots, have hedged their bets about buying and investing until they can figure out the end game in the standoff over Iraq.

Nobody knows whether there will be a war. No one can say for sure how a war would play out. Would it be over in a week or two? Even if it's over quickly, might oil fields in Iraq be destroyed, which is what Iraqi leader Saddam Hussein did in Kuwait? Will there be a diplomatic solution or a coup that ousts Saddam, any banned weapons, or both? Will the U.S. military encounter unwelcome surprises that bog down the war's progress?

When one gets down to it, the only thing that's clear is that the outlook is murky.

"The current uncertainty and the worry about the war is already taking a toll on the economy," said economist Tapan Munroe, principal owner of Moraga-based Munroe Consulting Group. "Whether it turns out to be a short war or a long war, that has already happened."

Riding a roller coaster

The volatile nature of consumer, business and investor sentiment is underscored by this year's roller coaster for stocks, which have fluctuated wildly depending on news driven by the Iraqi crisis.

"You see the relief with which investors grasp at the straw of some diplomatic solution," said Dan Van Dyke, an economist with Berkeley-based Rosen Consulting Group. "Any glimmer, just the merest little shift, you see the stock market rally or fall."

The buildup to the last gulf war, which came in the middle of an eight-month recession, produced wild swings in the stock market.

On one memorable day, Jan. 9, 1991, stocks soared while U.S. and Iraqi diplomats held a six-hour meeting in Geneva to attempt to find a last-minute diplomatic solution that could stave off a war. But as soon as the U.S. negotiator emerged to disclose that talks had collapsed, stocks immediately plunged and crude oil prices rocketed higher. Once the war began and it became clear U.S.-led forces had the upper hand over Iraq, oil prices plummeted and stocks rallied to finish the year up 26 percent.

The current economic uncertainty is reflected not only in the swings of the stock market but other economic data. Gross domestic product registered a gain of only 0.7 percent in the fourth quarter, down sharply from the third quarter's 4 percent increase. While industrial production rose in January by the largest percentage since July, consumer confidence fell. Overall retail sales fell 0.9 percent last month, but excluding the volatile automobile category, they posted their biggest gain since September 2000.

A shaky Bay Area

The lack of clarity could be especially harmful to the Bay Area. After all, the region is already the consensus pick as the major urban center with the weakest economy in the nation.

"In the Bay Area, except for security-related technology companies, I'm afraid we're not off our lows yet," Van Dyke said. "We are still reaching for a bottom as far as jobs go in the Bay Area. And the uncertainty surrounding geopolitical events definitely doesn't help."

Still, some consumers say they haven't curbed their spending, despite the lack of a visible end game in Iraq.

"Life goes on," said Debbie DeSantis, who resides in Livermore with her husband and two children. "We're still doing stuff. We ordered a new couch. We go on vacation. We're talking about another vacation. We won't hold back. The only thing we won't rush out to buy is duct tape and plastic."

Bob and Kathy Alpert, Concord residents who own Bentelino's delicatessen in the same city, also say they haven't cut back -- yet.

"We bought some recliners," Kathy Alpert said. "We will probably put in some carpeting or new floors for the living room."

But things could change if a war begins. Uncertainty over the outcome could prompt the Alperts to defer some purchases. The big problem is that the economy isn't all that great right now, especially in the Bay Area.

"Gas prices are going up, and the stock market is going down," Bob Alpert said. "There is a lot of negativism in the air. That doesn't help the attitude of consumers. It hurts our deli. We're down a little bit in our business."

Robert Marshall, who owns Postal Annex in Concord, also sees a slump in business.

"As a business person, I'm worried about everyone cutting back," Marshall said. "I'm seeing a lot of people cutting back on their spending."

The quick fix

While the outcome of the crisis remains uncertain, what does seem clear is that there will be some sort of resolution relatively soon to the current limbo of U.N. weapons inspections. That could cause the pace of economic and financial market activity to accelerate.

"A quick resolution would be a tonic," said Sung Won Sohn, chief economist at San Francisco-based Wells Fargo Bank. "We can get back to business. Oil prices would come down. Consumer and business confidence would be restored. Uncertainty is killing us."

Sohn believes a quick resolution of the crisis means the economy could grow at a 5 percent annual pace, which would be at least twice as fast as what's happening now.

"The stock market would zoom up, and the Dow would gain several hundred points or more in a hurry," Sohn said. "Business capital spending would surge, based on all the pent-up demand. Consumer spending would be even stronger."

Donald Luskin, an economist and chief investment officer with TrendMacrolytics, a consulting firm in Menlo Park, also says he is convinced that some definitive resolution would be beneficial.

"It would certainly help the stock market, and the stock market would help everything," Luskin said. "If you just look at the economy, things are doing fine. The recession is over. But with this pervasive mood of uncertainty, it just depresses things. People do less of everything."

Risks and rewards

Luskin believes some of the problems -- which could continue if the crisis isn't resolved in the near future -- may make entrepreneurs less willing to take risks.

This trend might be appearing in the weak activity in venture capital financing for private companies, as well as the dismal market for initial public stock offerings. Venture funding in the Bay Area during 2002 was down a whopping 45 percent, according to the MoneyTree survey. The market for IPOs remains virtually invisible.

"The constant debate over how to resolve the Iraq situation hurt because it doesn't necessarily affect spending decisions, but it does affect risk-taking," Luskin said.

Why? Partly because of the nature of taking risks, such as starting a business or expanding one.

"Risk-taking is partly economic and partly emotional," Luskin said. "If you're a genius working for Intel, and you have a fantastic new product, you might start your own business if you're in a good mood about the economy. But if you're not in such a good mood, and you're down on things in general, you're generally risk-averse, and you tend not to take any action. The wellspring of economic growth is risk-taking."

Worst-case scenarios

But economists also must ponder the possibility of a grim outcome in a new Persian Gulf war. Analysts can't rule out the possibility that Iraq might attempt to destroy its own oil fields. Even worse, Iraq might attempt to destroy oil terminals in Saudi Arabia.

"As much as I would like to think the war will be short, decisive and quick, there is still concern that there will be complications," Sohn said. "It might not be as easy as 1991. Clearly there are two extreme scenarios, the quick resolution and the messy resolution, and there can be many shades and variations in between."

Iraq under Hussein's rule has become a lesser player in the world oil arena. But any disruption of Saudi supplies might make today's gasoline prices, now typically ranging from $1.80 to $2 a gallon, seem like the good old days.

"We would be talking about a double-dip recession, if the U.S. becomes bogged down in a long war, or the oil fields become an inferno, if there's a massive release of chemical and biological weapons," Munroe said. "You would have economic activity slowing, oil prices going up, and inflation could become a problem."

And it doesn't help that Venezuela is producing about one-third of the oil it normally does because of a strike.

Still, some consumers such as DeSantis won't be held hostage to the outcome of any war, or the geopolitical maneuvering that precedes any battles.

"Who knows what's going to happen?" DeSantis said. "We just have to go day by day, and live our lives."

George Avalos covers the economy. Reach him at 925-977-8477 or gavalos@cctimes.com.