What will the effects of terrorism be on currencies and foreign exchange rates?
Last week Canada was subjected to an act of terrorism that surprised the world and reminded nations that attacks can occur anywhere. Unfortunately, since US and UK troops were pulled out of Iraq, geopolitical tensions have heightened, and the resultant fear and has impacted the currency market.
Last week a Canadian Islam convert drove his car into two soldiers, killing one. Several days later an armed man charged into Canada’s Parliamentary building after killing a uniformed soldier at a war memorial. The two acts have raised concerns regarding the current battle against Islam extremists, which brings us to the question: if terrorism attacks continue to occur or increase in magnitude, what will the effects be on our economy’s currencies and exchange rates?
How does ISIL Threaten Foreign Exchange Rates?
The extreme views of the Islamic State of Iraq and the Levant (ISIL or ISIS) has seen the group wage war against many nations. On the prospect of conflict in Iraq (after Western troops had been pulled out) the market felt tremors as investors reassessed their currency positions. The US Dollar to Pound Sterling (USD/GBP) exchange rate took a hit when uncertainty clouded the market as to how much involvement the US and UK were to have in the renewed conflict.
Furthermore, ISIL was once under the umbrella of Al-Qaeda in Iraq and was therefore heavily involved in the insurgency against the US military after the invasion of Iraq in 2003. The CIA predicts that the group has up to 31,500 members in Iraq and Syria alone. Al-Qaeda severed connections with ISIL after a turbulent eight month struggle between the groups. Al-Qaeda was reported to have split from the faction who had an appetite for brutality and ‘notorious intractability.’
So, what do ISIL actually hope to gain? The terrorist group are attempting to gather Muslim-inhabited areas and place them under its political control—starting with the Levant area. ISIL considers itself as a caliphate—an Islamic state that’s controlled both religiously and politically by someone deemed to be a ‘caliph’, which roughly translates into English as successor.
How Do ISIL’s Actions Inspire Currency Movement?
So now we’ve covered the basics, how do acts of terrorism translate into exchange rate fluctuations? Let’s use a previous event to understand how movement occurs. When the US was attacked by terrorists on September 11th 2001, the economy took a severe hit. Not only was it a devastating tragedy that struck the heart of millions, but the resultant economic consequences were multifaceted.
Investors Seek Safe-Haven Assets Such as Gold, the Swiss Franc (CHF) and Japanese Yen (JPY)
Initially, the price of gold jumped from $215.50 an ounce to $287 which reflected waning sentiment in the usually safe-haven US Dollar. As we mentioned in our previous article on the connection between Ebola and exchange rate volatility, uncertainty and fear shake markets. Investors are likely to seek safe-haven assets such as the Swiss Franc (CHF) and Japanese Yen (JPY). These currencies remain relatively stable in times of turmoil or crisis and therefore defend investments from the adverse impact of currency risk.
In the face of the catastrophic and overwhelming events of September 11th, oil and gas prices climbed as fear spread that the Middle East would be subject to oil restrictions. However, some of these effects were short lived and markets rebounded relatively quickly. Within the space of a week, oil prices were resuming normal levels as there were no other attacks and the US economy continued to import oil at its regular pace.
However, airlines felt the effects for quite some time. US travel took a nose dive and the pre-attack passenger level didn’t recover for four years. Many airlines were forced to declare themselves bankrupt or just disappeared off the map. Moreover, the heightened security required, along with the loss of so many flight routes, caused problems for the industry and had an additional impact on the economy. In addition, airlines were expected to refund the ticket costs for family members of those involved in the 9/11 attack, which caused massive losses to the industry.
As the US was already struggling through a recession when 9/11 took place, the airline industry struggles were an additional factor to hinder economic growth. Moreover, the payout from insurance companies topped out at $40.2 billion from 9/11 claims which saw most insurance firms re-evaluate their cover and remove terrorism as a coverable event.
Conversely, some areas of the economy were boosted in the aftermath of the attacks. Sectors such as defence, weaponry contractors and technology companies had a significant increase in share values as investors pre-empted an uptake from the government, especially as the war on terror became a long commitment.
Unemployment Rate Increases on Massive Job Loss Following Terrorism
When looking at the impact of terrorism on financial markets we need to consider other things that can affect the economy, such as confidence. A loss of confidence in business or governments can cause a reduction in spending, depress economic growth and inspire exchange rate depreciation. Another factor to consider is tourism. New York saw a massive decline in visitors and if tourism dips, the likelihood of sector-related job cuts heightens, which doesn’t bode well for the native currency. Hotels lost out with reservations falling below 40% and the hospitality industry alone saw shrinkage in employment of 3,000. In the three months that followed the initial attack, New York City saw 430,000 workers lose their jobs.
Chicago based industry expert John A. Challenger commented: ‘There is no way to gauge to what degree the effect 9/11 and the war on terror had on the economy. Global business is one of the keys to the turning around of this economy, and it has inevitably been affected.’
The US has a reputation for resilience (part of the reason why the US Dollar is considered a safe-haven asset) and within a month, major stock markets returned to normal. However, the current economic health of the US still suffers echoes of the 9/11 attacks. National debt for the war on terror has surged by trillions of US Dollars. The purpose of the attack imposed by Osama Bin-Laden was an attempt to devastate the US economy. The fact that the attack didn’t produce the desired effect is a credit to the strength of the US economy.
But 9/11 also affected other countries. The International Monetary Fund (IMF) downgraded the UK economic growth forecast from 2.4% to only 1.8% in 2002. In fact, despite the IMF’s revision, growth in the UK was only able to reach 1.6%–the weakest expansion in over ten years. The impact of the terror attack on the UK was a downturn in travel and tourism, causing stagnation in the hospitality industry.
How will the Current Economic Climate Fare in the Face of Terror?
At present, the world’s economies are still recovering from the global financial crisis which struck in 2008. The IMF has recently warned that a global slowdown could be descending, and this is a factor that’s already seen large market movements. With some of the biggest and most developed nations still balancing on a precarious recovery, the impact of a large scale terrorist attack could be catastrophic. However, with nations worldwide uniting against ISIL and the war on terror and security measures tightening, it is hoped that large scale attacks such as 9/11 won’t occur in the future.
