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The Paris Attacks and the Confidence Crisis

By Peter Atwater

The terrorist attacks in France last week were a tragedy, with 120 people killed and hundreds of others injured. As a concerned citizen of the world watching the horrifying news over television, my thoughts and prayers were focused on the victims and their families. Simultaneously as a socionomist and a researcher in confidence-driven decision making, my mind went immediately in two different directions after I heard the news.

The first question I wanted to answer was “Why now?” From my research and the work of other socionomists, I know that terrorism and other acts of sacrifice are tied to extreme lows in confidence. Was there something that could or would connect the so-called Islamic State and low confidence together in a meaningful way that would offer important clues on the timing of last week’s attacks as well as the risk of future attacks?

The second question I wanted to answer was “How will current social mood frame the reaction to the attacks?” European and American confidence is declining. That decline should, and likely will, impact how policymakers and voters respond to the attacks, particularly as it relates to the Syrian refugee crisis.

While not much time has passed since the attacks, here are my initial thoughts. Sadly, they are not encouraging.

Why Now?

Terrorism and other acts of deliberate and violent sacrifice are not random events. As I discussed in my book Moods and Markets, these actions are typically in response to a perceived sense of extreme uncertainty. They are a manifestation of our most basic “fight or flight” instinct and are an expression of bottoming sentiment/confidence.

In Moods and Markets, I offered the chart below, which shows a clear correlation between major Middle East terrorist attacks and major lows in the Egyptian stock market. As markets measure mood, the chart suggests that in the same way that investors flee uncertainty by aggressively selling their shares at the lows, terrorists react to intense fear with violence.

While the Egyptian stock market recorded a major low on Friday, I believe that the Islamic State’s mood and confidence level ties more closely to oil prices. As Defense Secretary Ashton Carter offered recently, oil is “a critical pillar of the financial infrastructure” of the group. According to U.S. Department of Treasury estimates, oil production and export generates about $40 million a month, or nearly $500 million a year, for the Islamic State.

Looking at the recent actions of the Islamic State through the lens of oil prices is incredibly revealing.

Last June, at the peak of a sharp two-year rally in oil prices, the Islamic State declared the creation of a caliphate with its leader, Abu Bakr al-Baghdadi, as the spiritual leader of all of Islam. Talk about a coincident expression of extreme confidence.

As crude oil prices bottomed in late 2014/early 2015, however, there was a flurry of Islamic State-related terrorist activity. The Sydney café attack, the attack at a Paris Kosher supermarket, and the Charlie Hebdo attack all occurred very near the low – with the most extreme attack within days of the low. As oil prices and the Islamic State confidence declined, the organization’s violence (and the actions of its supporters) intensified.

Today, things look even more challenging for the Islamic State. As The Wall Street Journal noted earlier this week, the group is facing increasing pressure from airstrikes by Russia and the U.S.-led coalition. Kurdish forces are also gaining control of Islamic State-held territory in both Iraq and Syria.

The United States and its allies have sharply increased their airstrikes against the sprawling oil fields that the Islamic State controls in eastern Syria in an effort to disrupt one of the terrorist group’s main sources of revenue.

On Friday, just hours before the Paris bombings, an American airstrike targeted and killed a top Islamic State leader in Libya. This was the first airstrike against the group’s Libyan leadership and came on the heels of a British operation late last week that officials believe likely killed “Jihadi John.”

Taken together, the news reports suggest that the Islamic State is an organization clearly on the defensive. That we have seen a brutal retaliatory terrorist attack fits with the organization’s extremely weak confidence environment. Unfortunately, the current weak confidence-driven environment within the Islamic State also raises the potential for further and equally brutal terrorist attacks. As we saw in late December 2014/early January 2015, there could easily be a cluster of events, and not just in France, but across the globe.

Given the clear connection between the Islamic State’s mood and oil prices, those involved in national and corporate security should pay very close attention to the price of crude. Based on the chart above, so long as crude prices stay low (and especially if they fall further) the risk of additional Islamic State-driven attacks remains high.

The Public Response to the Paris Attacks

As confidence falls, we naturally fear and become less tolerant of those who are different. The coincidence of xenophobia with periods of weak social mood is exceptionally high.

That French President François Hollande’s first act in response to the attacks was to close the borders fits with Europe’s falling social mood perfectly. So, too, did the announcement by Poland’s incoming Euroskeptic government that the country will no longer stand by its agreement to accept relocated refugees. The new government now wants “security guarantees” from Germany and the EU.

Not to be overly dramatic, but the Schengen Area ceased to exist on Friday. While its survival was already tenuous — what with eastern European nations erecting razor wire fences by the kilometer and countries like Sweden reestablishing border controls — the end is here. Based on current weak social mood, national divisions will explode. While nations will start by limiting the free mobility of individuals, as mood falls further, controls will expand to goods and services. Ironically, xenophobia knows no boundaries.

Caught in the crossfire of soaring nationalism will be the millions of Syrian refugees. Earlier this fall, I wrote this in an op-ed for the World Policy Institute:

Should European mood continue to sour, it will be extremely difficult for policymakers to reach a meaningful pan-European political solution to the refugee crisis in the face of rising protectionalism and xenophobia. The potential for violence will rise sharply, manifesting in clashes between refugees and local residents and government officials. This heightened violence will only make resolving the crisis more difficult. There is the very high probability of a contagious and impulsive backlash arising from both sides. We are seeing signs of this already in the escalation in tensions in Calais and Budapest. Unless mood improves quickly, the risk of a vicious deteriorating cycle is high.

As European policymakers and humanitarian organizations try to address the refugee crisis, they must appreciate that at its core, this is a crisis of confidence. To create a sustainable and successful solution, steps must be taken to boost the confidence of refugees and European residents alike. Both need to see their concerns adequately addressed. But finding solutions that meet the conflicting needs of both groups will be challenging given the volatility of the current social mood.

Far more than the plight of the refugees is at stake here, however. The current crisis is exposing just how fragile European leadership cohesion is today. Where the Greek crisis challenges policymakers to reconsider financial constructs of the region, the refugee crisis is revealing fundamental disagreements across a much broader swath of existential issues.

The longer the refugee crisis goes on and the further mood falls, the more national and even local divisions will become obvious. European policymakers continue to act as if the refugee crisis is a Greek-like financial crisis within their control. Nothing could be further from the truth. What is unfolding is a much broader crisis of social confidence. Across Europe, trust in institutions is evaporating, as the region’s mounting refugee crisis exemplifies.”

Those were my thoughts before the Paris attacks.

With European social mood sharply lower today than it was in September and vivid images running endlessly on television and the Internet, the potential for widespread anti-European backlash is high. Not only will the Syrian refugees get caught up in it, but so too will Angela Merkel. While I don’t wish her ill, it is hard to see how she can now survive in office. The fears of Germany’s anti-refugee extremists have now been proven correct. Merkel, I am afraid, is about to be caught up in a swirl of anti-immigration and Euroskeptic sentiment.

At the same time, unfolding events will also complicate things for Greece. Where prior bailout terms were predicated on austerity measures, current negotiations are likely to be driven by the country’s willingness to absorb an oversized allotment of refugees. Given current Greek mood, Prime Minister Alexis Tsipras will be hard-pressed to comply with EU demands. Default could quickly come back on the table.

Finally, with Gallup Economic Confidence here in the U.S. on the decline and now at approximately the same level as was reported just months following the bottom of the banking crisis, xenophobic, anti-immigration, and anti-refugee rhetoric will play especially well with voters. Donald Trump and Ted Cruz have already shown this, and I expect that other Republican candidates will now follow suit.

I would pay particularly close attention to comments from Hillary Clinton and Bernie Sanders. Based on current social mood, they too may be forced to offer a few isolationist crumbs. Needless to say, without a sharp rise in confidence, the potential for a vicious negative cycle of xenophobic anti-establishment sentiment is high.

The Big Picture

Friday’s attacks and the responses to the events offer a vivid demonstration of confidence-driven decision-making in real time. With crude prices offering a meaningful proxy by which to measure the Islamic State’s mood/confidence, the linkage between exceptionally weak confidence and terrorism is clear. The Islamic State is acting as one would expect. Extreme uncertainty has unleashed the organization’s anger. At the same time, falling confidence across Europe and the United States has framed the response. Xenophobia, nationalism, and isolationism are soaring. Millions of Syrian refugees, the European Union, and the careers of political leaders like Angela Merkel and Alexis Tsipras are now at risk.

I would pay very close attention to crude prices and to the major European market indices (the DAX, CAC40, FTSE 100, etc.), not to mention the Dow. As proxies for mood they matter. As the data above and elsewhere is showing, there is a lot resting on whether they move higher or lower from where they currently sit.

*****

*****

Peter Atwater is the President of Financial Insyghts, a research firm focused on the role of confidence in economic, financial, political, and social decision making.

[Photo courtesy of Freedom House; graphics courtesy of Peter Atwater]

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