http://www.feer.com/2001/0109_20/p016region.html

The Far Eastern Economic Review
Issue cover-dated 20th September 2001

ATTACK ON AMERICA

Terror's Aftermath

Beyond the staggering human toll of this week's attacks on the United States, the events will have a lasting impact on Asia's economies and on security in the region

By Bruce Gilley and REVIEW correspondents

IT WAS A SHOT HEARD--and felt--around the world. For Asia, which has pinned its future on a strong and confident United States, the September 11 terrorist attacks on the World Trade Centre and the Pentagon threaten not only U.S. economic leadership in Asia but also its willingness to undergird the region's often shaky security. The U.S. was the main victim of the outrage. But unless the governments and people of Asia respond quickly, they too will fall victim to the terrible impact.

The immediate toll in lives lost was not known as the REVIEW went to press. The numbers will be staggering, a bewildering testament to the horror of this day. Through television, our global village witnessed the world's worst act of terrorism.

"It was such a gorgeous day too. A perfect autumn morning. It was disbelief after disbelief," recalls Matt Pottinger, a Hong Kong-based reporter with The Asian Wall Street Journal who was heading into New York for a meeting at The Wall Street Journal offices as the first airliner slammed into the World Trade Centre next door. "After the report of the second plane, we turned for home. My heart just sank."

The U.S. nightmare spread quickly around the world, especially to Asia where stockmarkets tumbled, airports were thrown into chaos and financial sectors braced for crisis. Malaysia's twin Petronas Towers--Asia's answer to the World Trade Centre--were evacuated on September 12 after a terrorist threat.

Immediate security threats loom in Asia. China, despite words of condolence, has been a vocal critic of the U.S. military and political presence in the region. North Korea was the slowest Asian nation to respond. As the U.S. Seventh Fleet in Japan went into self-defence mode, the security of shipping through the Malacca Strait, Japan's key source of imported energy and the conduit for Asia's exports to Europe, was thrown into question. The Spratly Islands suddenly seemed more vulnerable to regional conflicts.

Critical to the impact on Asia is how the attacks affect U.S. foreign policy. Washington had taken a hawkish turn under President George W. Bush even before the attacks, forthrightly supporting Taiwan and acting tougher with North Korea. After September 11, that stance could harden further.

The question is whether the tragedy bolsters unilateralists who are already having their way in the Bush administration. Many voices will argue for an end to U.S. unilateralism in order to effectively cooperate with other nations against terrorism. But Washington will be under pressure at home to protect itself with or without regional help. That could mean sudden attacks on countries that harbour or support terrorists--possibly North Korea and Afghanistan (see story on page 22)--and immediate acceleration of plans to build a national missile-defence system that would render obsolete nuclear arsenals in China and Pakistan. A host of issues in which Asia needs U.S. cooperation--from the environment to global trade--could be affected.

More broadly, a renewed U.S. focus on fighting terrorism could halt the much-vaunted reorientation of U.S. foreign policy towards Asia. Unable to tackle security threats in both East and West, the U.S. could recommit to threats in the Middle East, opening up a power vacuum in Asia. China is the most obvious candidate to fill the void. Its China Times newspaper crowed the day after the attacks that the destruction would help bring an end to U.S. "power politics" and its "sense of God-given historic mission."

China, however, will be chagrined that the events in the U.S. stand to diminish one of the multilateral groupings to which it has warmed: the Asia-Pacific Economic Cooperation forum, or Apec. China is due to host Apec leaders in Shanghai in October, but if U.S. President George W. Bush is forced to cancel his attendance in order to deal with rebuilding confidence back home, this year's meeting will lose much of its weight.

U.S. allies like Australia, South Korea and Japan might have to step in to take up the slack. India, which has been working closely with the U.S. to fight terrorism, could see its relationship with the U.S. grow stronger. Indeed, the U.S. might make it clear it expects as much. Southeast Asian nations might also be under pressure to end their long-standing ambivalence towards the U.S. role in Asian security (see story on page 19).

It is too early to tell who was behind the attacks. If, as suspected, Muslim extremists were at work, it could provoke U.S. attacks on Muslim targets that would bring a backlash from Muslim groups around Asia. Not just Indonesia and Malaysia, but the Philippines, Thailand and Singapore could be pulled into the fight. That would take the region closer to the nightmare scenario sketched out by Harvard University political scientist Samuel Huntington, who argues in his 1998 book, The Clash of Civilizations and the Remaking of World Order, that conflicts between religious groups would be impossible to manage because they were based on faith and dogma.

"If it's not [just one] big shock and we have another shock coming, if there's some retaliation from the U.S., or some other things, it will be very bad for the world," says Thai Commerce Minister Adisai Bodharamik.

The economic impact could well overwhelm the security threat. The World Trade Centre included a Who's Who of Asian business, including 43 Japanese companies. Writ large, the building symbolized Asia's economic dependence on a strong U.S. Thailand's Charoen Pokphand, Japan's Fuji Bank, Taiwan's Chung Hwa Commercial Bank, Sinopec of China, Overseas Union Bank of Singapore, South Korea's LG Group--all were there. The attacks closed stockmarkets in Thailand, Taiwan and Malaysia.

Until last Tuesday there was still hope, albeit slim, that the U.S. economy could achieve a soft landing and that the world could avoid recession. By Wednesday, following the horrific assaults, that hope had all but vanished. Now there is a real danger that the attacks could precipitate a full-blown global recession.

One lost business day in U.S. and the ensuing disruption could easily knock 0.5% from the country's GDP. With 2001 growth currently forecast at 1.5% or lower, and the economy widely expected to stagnate in the third quarter, a recession appears inevitable.

The real impact could be on confidence. Taken by itself, the direct economic impact of the attacks could be seen as just a severe storm on the U.S. East Coast. But sentiment could worsen rapidly, causing a chain reaction.

The world economy was already vulnerable. Taken together, initial vulnerability and heightened perceptions of global risk add up to a potentially crushing combination.

"There is a risk, probably high, that this crisis, as it unfolds, could come to precipitate the capitulation of the U.S. consumer and mark a new inflection point in the U.S. recession," said John Woods, Hong Kong-based head of credit research at HSBC.

Deflating U.S. consumer demand will further hammer Asia's exporters, particularly in the electronics sector. Further layoffs are likely to follow in Malaysia, Taiwan and Singapore. Falling stock prices and wider corporate bond-yield spreads as investors flee to quality mean higher capital costs for U.S. corporations. That means lower investment both at home and abroad. Expect foreign and portfolio investment into Asia to fall as a result.

Brent crude spiked following the attack. U.S. retaliation against Islamic targets could easily push the price up further. That would severely hurt Asia's oil importers, especially Korea, where oil makes up around a quarter of all imports. Japan, Taiwan, Singapore, Thailand and the Philippines are also vulnerable, though a weaker dollar may alleviate some of the pain.

Stockmarkets around Asia will mirror declines in U.S. markets, further damaging corporate investment plans. Asian central banks have plenty of leeway to keep interest rates low, especially given the probability of lower U.S. rates and a moderately weaker dollar. However, in an environment of heightened global risk and weaker regional economies, Asian companies cannot expect easier credit. Unemployment will reach record levels and policy responses will have little impact.

In Japan, a further stockmarket decline would devastate the financial system. Japanese banks, already saddled with nonperforming loans and slimmer profits, would see the value of their large equity portfolios drop. Consumers concerned about the stability of financial institutions may begin to consider withdrawing their deposits, while it will become harder for the country to expect an economic recovery led by external demand.

"At the moment, people in Japan don't know how to interpret or digest the impact of what is happening in the U.S," says Masaaki Kanno, chief economist at JP Morgan.

The Asian century was nurtured by an American pre-eminence in Asia. Now it is up to Asia to show that it can respond to a vicious attack on the U.S. in a responsible and forthright manner.